Both pension plans and 403(b) plans are tax-advantaged retirement plans designed to benefit workers. The structure of these two financial products are very different. Pension plans are more traditional than 403(b) plans, and essentially rely on the generosity of employers to provide employee benefits. For better or worse, employees have more control over the contributions and performance of their 403(b) plans than with pension plans.
Contributions
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Contributions to a pension plan are made solely by employers. Also known as a defined benefit plan, a pension plan is meant to pay out a specific monthly amount to employees at retirement. The amount of the payout usually is based on an employee's salary, age and the number of years worked for the employer. Employers receive tax deductions for contributions to the plan, and earnings grow tax-deferred.
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A 403(b) plan is a type of defined contribution plan designed specifically for tax-exempt organizations, public school employees and ministers. Employees can elect to have a portion of their paycheck withheld and deposited directly into the plan before they are taxed. Employers have the option, but not the obligation, to contribute to the plan on behalf of employees.
Investment Options
With a traditional pension plan, employees have no say over how the money is invested. The company makes all the contributions to the plan, so it has complete authority over investment decisions with those funds. Since a pension plan promises to make certain payments to employees upon retirement, they are typically invested in conservative, low-cost investments that tend to outperform the average investor. However, some pension plans are underfunded, typically as a result of poor management. In some cases, a plan will trim benefits or even fail, resulting in the Pension Benefit Guaranty Corporation, a government agency, taking over responsibility for making payments.
If you participate in a 403(b) plan, you bear the responsibility for how you want to invest your money, rather than your employer. Typical 403(b) plans offer an assortment of mutual funds and annuities that you can choose from to invest your funds. The amount you receive at retirement is based on how your funds perform rather than on what your employer will pay you. While this can work to your benefit if you are a shrewd investor, there is no guarantee, either from your company or from any government agency, of receiving any money from your 403(b) plan at retirement.
Distributions
Most traditional pension plans start to pay out when you reach age 65. Some plans allow distributions once you've reached age 55 with certain provisos, such as having worked at the company for at least 10 years. If you take your pension distribution early, you'll likely receive a smaller monthly payout than if you had waited for full retirement age. Pension payout are nearly always taxable.
With a 403(b) plan, you usually can take money out after you reach age 59 1/2 or in the event of your death or disability. If you leave your job, you also usually can take a distribution or roll over your money into another tax-advantaged plan, such as an IRA. Some plans allow for hardship distributions as well, defined by the IRS as a "heavy and immediate financial need." As with pension plans, distributions from 403(b) plans are fully taxable.