What are Pension Plans, Do I Need One? (vs 401k)
January 18, 2022
A pension plan is a form of retirement plan offered to employees by an employer. This type of plan pays the employee a previously set income at the time the employee retires. This income is usually based upon how long the employee worked for the company. Pension plans are less and less common as more employers have switched to offering 401(k) plans.
Pension plans are not funded through taking small amounts of money from an employee’s regular paycheck like a 401(k). A pension plan requires the employer to invest money into a pension plan fund that is paid to employees at retirement.
If your company offers a pension plan it is a good idea to know the specifics about them to help you determine if investing in the plan is right for you.
How Pension Plans Work
Traditional pension plans are called defined benefit pension plans. These plans guarantee that the employee will receive a certain amount of money when they retire regardless of the investment’s performance. The secures that an employee will receive the predicted amount of income each month during retirement. The amount is calculated depending upon the individual plan and is usually highly dependent upon the years of work history.
Some pensions pay a fixed dollar amount multiplied by the number of years worked at the company offering the pension while in the pension program. Some monthly payout are determined by the average of the employee’s final year of salary, accrual rate, and length of employment.
Private-sector jobs (those not paid with tax dollars i.e. police and teachers) are usually insured by the Pension Benefit Guaranty Corporation. It is good to know if your pension plan is insured.
Pension Plans vs. 401(k) Plans
Sometimes the two can get confused as 401(k)s are sometimes referred to as defined contribution pension plans, but they are very different.
- Guarantees employee benefits in retirement
- Funded by the employer: the company an employee works for is responsible for funding a pension, the employer takes on most of the responsibility
- Employee may be required to contribute or may be able to choose to contribute as well
- Rarely gives employee control over investment options
- Does not guarantee a retirement benefit: this does not guarantee employees any form of payment in retirement. Employee contributions are invested and the account balance form which the retiree makes withdrawals with reflect investment gains or losses.
- Employee contributes a portion of each paycheck: the choice is up to the employee to contribute to their own retirement
- Can include employer matching contribution
- Employees can choose investment options
Do You Need a Pension Plan?
Very few companies offer a choice in retirement plans, most employers now offer 401(k) plans as an only option. Most public employees however still receive a pension plan. 91% of public-sector employees, such as police, public school teachers, and military have access to pensions as compared to just 68% of private-sector jobs.
If your company gives the opportunity to choose between a pension or a 401(k) you should consider the pension plan if:
- You need a secure income for retirement.
- You intend to only work for the same company your entire career or until you retire
- You do not plan to move out of state
For more information on the best retirement plan decision for you and other retirement planning advice in Bellingham
and Washington State please contact us any time.