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Defined Benefit Pensions

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A defined benefit pension is a type of retirement plan that your employer may offer as the only plan offered, or in conjunction with a 401(k) plan. If you have access to a defined benefit pension or are currently participating in one, you are in rare company as these types of plans are becoming few and far between.

Defined benefit pensions are different from 401(k)-type plans (called defined contribution plans) in several ways. One of the biggest differences is the fact that the employer is responsible for the funding of the plan in addition to accepting all the investment risk of the plan’s assets. With a 401(k)-type plan, the employee is responsible for funding and the risk in the investment portfolio. Many defined benefit pensions are also backed by the Pension Benefit Guarantee Corporation (PBGC), which protects your pension up to a certain amount in event of plan termination.

Another difference is that at retirement, the defined benefit pension pays the retiree a guaranteed income stream for life (an annuity), and that guaranteed income may or may not have an inflation increase. If you’re married, by law the pension must be paid as a joint and survivor annuity – meaning that if the spouse who has the pension dies, a benefit is still paid to the surviving spouse.

With a 401(k)-type plan, the account balance at retirement is based on the employee’s contributions (and any employer match) and how it was invested. At retirement, the retiree is responsible for taking income from the account. They may choose to take periodic withdrawals, fund an annuity, or leave it invested should they not need the money just yet.

The key point is the employee is responsible for these decisions. With a defined benefit plan, the decisions are already made, and if not, are very simplified.

The amount of the retirement benefit from a defined benefit pension is generally based on length of service, age, and final average salary. Thus, the longer you work and are participating in the pension, the higher the monthly benefit. Usually, companies will cap the years of service credit at some number such as 30 years – which means there’s no increase in the pension based on working longer. Most companies allow employees to become “vested” (the pension is fully the employee’s) after 5 years, sometimes less.

If you work for a company offering a defined benefit pension and are considering changing jobs, see if the new company has a defined benefit pension (among other benefits). Also check to see if you’re vested in the current pension. If not, consider staying until you are. Even a small pension can make a difference in retirement. Naturally, this won’t be your only criteria for staying or leaving but it’s important. Imagine receiving a guaranteed retirement income where no matter what happens, you’ll get the same payment every month. Regardless of how the economy is doing, and regardless of your 401(k) or IRA performance, you’ll get the same monthly amount. This is the beauty of a defined

3 Comments

  1. walt says:

    Ive seen several articles discussing offers from employers to take a lump sum buy out of their defined benefit pension. I can understand a concern that an employer might go bankrupt, but most of us would be paid in full from the pension fund. The primary reason employers offer buy outs is to make money! My wife’s hospital employer offered an amount that looked to be 20-30% below the market price of a similar annuity. In fact, they posed it as a survey question, and then in small print, said it was an “irrevocable decision.” The good old days of HR looking out for employees have long gone. I expect HR folks go to seminars that advise them of how they can say they made money or saved money for the corporation.

    1. sraskie says:

      Thanks for commenting, Walt. It’s been my experience that employers offer buyouts to save on costs and expenses related to the pension.

  2. David says:

    These were popular when employers actually carded about their employees.

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