A pension, what is it? How it differs from 401(k) Plan?

Have you always wondered what a pension really means? We’re going to explain it in a way that you can actually understand.

Pension

What is a Pension?

A pension is a retirement plan that gives you money every month of your retirement. Your employer funds the plan 100%, and they also manage the plan’s investments.

Pensions are guaranteed retirement income, but good luck finding many private employers that offer them. Government organizations typically offer pensions.

Pensions have to follow certain rules created by the Department of Labor. These rules outline how much your employer has to put away every year into an investment fund to guarantee your pension amount in the future.

How Do Pensions Work?

A basic formula is used to determine how much a pension will pay each month. Usually, the formula is based on a combination of factors, like:

  • Your age
  • How long you’ve been working for the company
  • How much you earn

For example, your pension may pay you 50% of what you’re currently earning if you work for the company for at least 10 years and retire at age 55. Someone who works for the company for 30 years and retires at 65, on the other hand, may get 85% of their salary at retirement.
The longer you work and stay with the company, the more money you’ll get.

Can Pensions be Terminated?

Now, here’s the thing with pensions: Your employer can terminate it any time. If they decide to do that, they will freeze your account, and whatever you had accrued up until then will be paid to you during retirement. You won’t get any additional income.

If your employer does a bad job of managing your pension plan, you do have some recourse. The Pension Benefit Guaranty Corporation, or PBGC, will intervene and pay your benefits up to the maximum amount permitted by the law. This amount depends on your age when you retire and whether your plan has survivor benefits.

What About Taxes?

Pension benefits are usually taxable. If you’re receiving a military or government pension because of a disability, that income may be exempt from taxes.

You can choose to have taxes withheld from your pension payments.

Is a Pension Like a 401(k) Plan?

Sort of. Both pensions and 401(k)s are retirement plans. But with a pension, you don’t have to contribute any money to your plan. Your employer handles everything, from the funding to the management.

With a 401(k), which is more common with private employers, you are responsible for contributing and choosing your investments. Your employer may contribute some money to your account, but they aren’t obligated to do so.

Pensions are guaranteed, and they’re based on how much you earned while working.

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