Money in an IRA, or an individual retirement account, is not a pension. IRAs and pensions are both designed to provide retirement income, but they have significant differences. An IRA account is funded and managed by each individual as part of a personal retirement savings plan. In contrast, a pension is a retirement plan funded, established and managed by a public or private employer for the benefit of its employees.
Individual Retirement Accounts
As part of a retirement savings plan, you can establish an IRA account at a bank, credit union, mutual fund company or other financial institution. Then, each year, you can contribute money, up to a legally allowed limit, to the account, investing it as you choose based on your retirement goals. Typical IRA investment options include CDs, savings accounts, money market accounts, stock and bond mutual funds, and annuities. When you're ready to retire, the IRA’s value will be a combination of the contributions you have made over the years and any losses or gains that resulted from your investment choices. Common individual retirement accounts are traditional IRAs and Roth IRAs.
A pension differs from an IRA in three important ways. First, the employer makes all contributions to the fund, which means that if you participate in a pension, you can't make contributions to the fund as an individual. Second, the employer, or a third-party specialist acting on the employer’s behalf, is responsible for managing the fund without individual employee involvement. Third, a pension is a defined benefit plan, which means it provides a specified benefit at retirement. The benefit can be in the form of an annuity, which provides specific payments on a defined schedule, or a lump sum cash payout.
IRA Advantages and Disadvantages
All IRAs offer tax advantages. Contributions to a traditional IRA are tax-deferred, which means you can deduct contributions from your taxable income for the year the contribution is made. In addition, all the money you contribute can grow tax-deferred until you retire. If your tax rate goes down when you retire, you'll be taxed at the lower rate when you make withdrawals. Roth IRA contributions are not tax deducible, but withdrawals from Roth IRA accounts are, in most cases, tax-free. Early withdrawal penalties are the most important disadvantage of individual retirement accounts.
Pension Advantages and Disadvantages
The biggest advantage of participating in a pension plan is that your employer makes all contributions on your behalf. Unlike individual retirement accounts, you don't have to contribute a portion of your earned income to benefit at retirement. In addition, in many cases, pension-plan participants can also have other tax-advantaged retirement accounts to which they can contribute earned income. Pension plans have disadvantages, though. If you leave a job before meeting the plan’s full vesting requirements, you'll lose the unvested portion of your benefit. Additionally, you can't take your pension with you to another job, and it will be your responsibility later in life to contact your former employer to claim the benefits you earned.