Key Points About Pension Plans

A pension plan is a retirement plan sponsored by an employer that provides a fixed income to employees during retirement, based on their years of service. These plans are becoming less common as more employers offer 401(k) plans.

Employers fund traditional pension plans, but employees may also contribute. Pension plans can benefit private-sector employees who plan to stay long-term with a company and public-sector employees who want to be eligible for a state-sponsored pension.

Definition and Example of Pension Plans

A pension plan is a defined-benefit retirement plan sponsored by an employer that pays out income during retirement. Unlike a 401(k), employees do not fund pension plans directly; instead, employers contribute to a fund that provides employees with a set income upon retirement.

Functionality of Pension Plans

Traditional pension plans, or defined-benefit plans, guarantee employees a specific benefit in retirement, regardless of investment performance. The amount employees receive is based on factors like years of service and the final salary. These plans are generally insured by the Pension Benefit Guaranty Corporation.

Pension Plans vs. 401(k)s

Pension plans are funded by employers and guarantee retirement benefits, while 401(k)s require employee contributions and do not guarantee benefits. 401(k)s provide more control over investment options compared to pension plans.

Making a Choice

Your choice between a pension plan and a 401(k) may depend on factors like income security, long-term company commitment, and tax advantages. Public sector workers are more likely to have access to defined-benefit pension plans.