Most employers that provide retirement benefits offer a 401(k) or other defined contribution plan. In these plans, you contribute money to the plan, invest it yourself, and receive the money in it when you retire. But if you’re lucky enough to have a pension plan instead, most retirement plan advice won’t be useful to you.
Pensions are defined-benefit plans, meaning the amount you will receive at retirement is guaranteed. Instead of depending on market performance, your retirement income is based on your years with the company and your salary while there.
Pensions vs. Defined Contribution Plans
The main difference between pensions and other types of plans is the risk involved. In a 401(k), you and your employer both contribute to the plan, but after that it’s mainly your responsibility. You choose the allocations, and the results depend on your choices and how well the market does.
In a pension, all investments are purely your employer’s responsibility. You don’t have any control of the money in the pension fund. Instead, it’s professionally invested in bulk. But as a result, you take on no risk. The benefit you will receive during your retirement is already defined in the your plan’s terms. Even if the market does badly, pensions are generally insured so that you will still receive your benefit.
Like many other retirement plans, pensions come with tax benefits. But since most or all of the contributions come from your employer, rather than you, you likely won’t notice those tax benefits yourself.
Pension Terms
Pensions come in a variety of types. Your benefit amount is usually calculated by some kind of formula, based on your years with the company and your position there. For instance, you might receive a percentage of your salary for every year you work there. Your salary, for this purpose, might be the average of your annual salary for the last three or five years at the company.
In some cases, the pension doesn’t vest at all until you’ve been with the company for several years. For instance, you might not be eligible for any pension if you quit within the first seven years. If a job offers you a pension, find out when it vests. That could be important to your career decisions.
Another thing to look for in your pension plan is whether the benefit will be dispersed as an annuity or as a lump sum upon your retirement. Annuities are more common, meaning you’ll receive money periodically to support your retirement.
Lastly, you’ll need to consider spousal benefits. Some pensions only pay you the benefit during your lifetime, while others pay your surviving spouse 50% to 100% of your benefit if you die first. You may have the option of adding survivors’ benefits in exchange for a lower benefit overall.
Saving for Retirement
Depending on the amount of your pension, it may or may not be enough to live on during your retirement. Your retirement planning should take into account any pensions you have as well as your savings and Social Security.
Pensions are not portable, meaning you can’t roll over one into another like you can with 401(k)s. But if you leave your job after your pension is fully vested, you don’t lose it. You simply have that pension in addition to any other retirement plans you might collect over your career.
If your pension won’t be enough to live on, you should plan to make up the difference with your own savings. You can save in a traditional or Roth IRA for tax-advantaged savings and investment.
Action Steps
When you first receive documents about your pension, take care to read them carefully and understand the terms. You may have several options, so be sure to consider all the factors before deciding. And check in regularly thereafter, to keep track of any changes and make sure your information with them is current. Deciding on the best options for you isn’t a simple task. You may benefit from double-checking your selections with an experienced professional. For any pension or retirement help, contact us to reach a financial advisor.
