Difference Between Pension Plans vs. IRA

by Naomi Smith

    Pension plans and IRAs differ in all aspects of contributions and payouts.

    Glass jar with change and Retirement label image by torben from Fotolia.com

    Among the many ways to fund a retirement, pension plans and individual retirement accounts are two of the most popular. However, with a decline in the number of companies offering pensions and more workers changing jobs during their lifetimes, individual retirement options have become an even more important part of retirement planning. According to CNN Money, only about 10 percent of employers now offer pension plans, compared with 60 percent during the early 1980s.

    Pensions are often called "defined benefit" plans because employees know just how much the plans will pay annually after retirement. Your employer sets aside some money each year you work for the company, and a fund management company invests the retirement funds. Individual employees have no control over how the money is invested and often little information on what securities the pension is invested in. You generally can't take the money with you when you leave the employer, though some companies offer partial payouts.

    Employees generally receive a percentage of the ending salary once they retire. You may receive a higher percentage the more years you work, and your payout is not a function of how well the investments performed. Your employer may offer you an option to take a lump-sum rather than an annual pension payment. Pension payments are taxed as regular income once you retire.

    Known as "defined contribution" plans because employees make the contributions, these plans are owned and controlled entirely by the individual worker. Traditional IRA contributions may be tax deductible, but Roth IRA contributions are not. As of publication, your contributions are limited to $5,000 per year ($6,000 if you are age 50 or over). You are responsible for choosing which investments to make, though the Internal Revenue Service restricts your options and does not allow you to purchase life insurance, and there are additional restrictions on investing in collectibles and real estate.

    Because you choose how to invest the money and the return on those investments is uncertain, it is difficult to estimate the value of your IRA when you retire. You can take as much out as you like each year after age 55 if you are retired. If you are still working you may not take distributions until the year you reach age 59 1/2, and the IRS will require you to take minimum distributions beginning at age 70½ for traditional IRAs, even if you haven't retired. You pay tax on traditional IRA distributions as regular income, but Roth IRA distributions are tax free.

    Photo Credits

    • Glass jar with change and Retirement label image by torben from Fotolia.com

    About the Author

    Naomi Smith has been writing full-time since 2009, following a career in finance. Her fiction has been published by Loose Id and Dreamspinner Press, among others. She holds a Master of Science in financial economics from the London School of Economics and a Bachelor of Arts in political economy from the University of California, Berkeley.

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