A pension plan is designed to provide an employee with retirement income. Benefits are generally based on a variety of factors, including salary, length of service, and a benefit formula that averages the employee’s earnings over a prescribed period of years. In some instances, an employee may make additional contributions. To receive benefits, you generally must wait to reach the normal retirement age (NRA), typically age 65, and attain a certain number of years of employment. Upon retiring, you may have options as to how and when you collect your benefits, such as in monthly payments or in one lump sum.
A 401(k) plan, offered by many private employers, provides the opportunity to contribute part of your salary, with restrictions, into a retirement fund. Your employer may match your contributions up to a pre-determined percentage, subject to a maximum. For example, if your employer matches your contributions by 50%, for every dollar you put into the fund, your employer will add $.50. Your contributions are pre-tax, so you defer any payment of taxes until you begin taking withdrawals. If you withdraw money from your 401(k) before the age of 59½, you may incur a 10% Federal income tax penalty, except under certain circumstances, such as financial hardship, purchase of your first home, or higher education expenses.