What Is a Pension Plan and Should I Have One?

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Definition of Pension Plan

A pension plan is a type of retirement plan similar to a 401(k) plan or a 403(b) plan. A pension may have you make monthly contributions of a set percentage, but the largest portion of the contributions will come through your employer. The pension plan does not give you the same investing options as a 401(k), but it does guarantee you a certain amount of money each month once you reach retirement age.

The formula for this amount will vary by company. It does take into account the length of time that you have been working for the company, your salary, and other factors.

Is a Pension Plan or 401(k) Better?

Pensions were very popular back around World War II and into the eighties, because at that time most employees stayed with the company from the time they started working there until they retired. With the mobility that most people experience in the job market now, many people favor the 401(k) plan which you can rollover into an IRA when you switch jobs. The 401(k) also gives you a bit more control over the investments than a pension plan would. You may also increase your contributions with a 401(k) plan, and you are not allowed to do that with most pension plans.

Should I Choose a 401(k) or a Pension Plan?

Companies began phasing out pension plans in the 1980s and began offering 401(k) plans instead.

You may have the option for a pension plan if you work for a government agency or for a company with a large union. These are companies where you may spend your entire career working. If you know that you are going to be with the company for most of your career, it makes sense to invest in the pension plan.

However, if you are going to be moving between companies, you may not benefit as much from the pension plan. Some companies will offer both options. Your choice should be based on how long you plan to stick with the company. If you are working as a teacher, and the state runs the retirement plan, you may qualify for a pension plan and it may make sense to choose that option since you will likely keep working in the same state. However, if your plan is to leave in five or ten years, it makes more sense to go with the 401(k). 

How Should I Plan for Retirement with a Pension Plan?

There are different types of pension plans, and your contribution rules may be different depending on the rules surrounding the plan. The company may require you to contribute a set monthly amount to your plan. This can go towards your fifteen percent contribution goal for retirement savings. You should understand how long it takes for you to become vested in the plan. This means that you will receive the full retirement benefits you have currently earned, even if you leave the company to work for someone else.

When your job offers a pension plan, you will handle your retirement planning a bit differently. In addition to your pension, you will need to invest for your retirement with other retirement accounts. You should open a Roth IRA and contribute the maximum allowable amount each year. This will give you more flexibility then your pension plan offers and it helps you to take control of your retirement. The Roth IRA gives you the best tax benefits for the long term. If you do not have enough money to invest the allowable amount all at once, most investing firms will set up a monthly contribution transfer to allow you to open the account.

Is a Pension Plan a Good Option?

A pension has both negative and positive aspects. When you work for the government, you may not have much choice in the type of retirement plan you are offered. It is important to understand the specific details related to your plan. Most employers will offer an annual workshop on the plan or go over the specifics of the plan during orientation. If you are unsure of the type of plan that you are getting, and whether or not the plan is funded (money being set aside to pay you benefits later) or unfunded (no money being set aside for future benefits), talk to a human resource representative. Once you understand all aspects of the plan, you will be able to make retirement planning decisions so that you can retire comfortably. Some agencies and companies have converted from a pension to a 401(k) plan, and if you are offered a pension this may happen to you as well. You need to carefully read the terms and conditions and review the benefit amounts you will receive when the conversion happens to make sure that your retirement still protected.

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