Pension (Defined Benefit Plan)
Definition
A retirement plan where the employer guarantees a specific monthly payment in retirement, calculated based on years of service and salary history, with the employer bearing investment risk.
Pensions provide a guaranteed monthly income in retirement, calculated using a formula typically based on: years of service x a multiplier (like 1.5-2.5%) x average salary. A 30-year employee with a 2% multiplier and $80,000 average salary would receive $48,000/year (30 x 2% x $80,000) for life.
The key advantage of pensions is certainty — you know exactly how much retirement income you'll receive, regardless of market performance. The employer bears all investment risk and is responsible for funding the pension. This contrasts sharply with 401(k) plans where the employee bears investment risk.
Pensions have become increasingly rare in the private sector. In 1980, 38% of private sector workers had pensions; today it's under 15%. Public sector pensions (teachers, firefighters, police, government workers) remain common but face funding challenges — many state and municipal pension systems are significantly underfunded.
If you have a pension, key decisions include: when to retire (additional years of service significantly increase the benefit), whether to take a lump sum or annuity payout (annuity provides guaranteed income; lump sum provides control and inheritance potential), and survivor benefit elections (reduced benefit that continues paying your spouse after death).
The Pension Benefit Guaranty Corporation (PBGC) insures private sector pensions if the sponsoring company goes bankrupt, though the guaranteed amounts have limits. Public sector pensions are backed by the taxing authority of the government entity, making them generally secure despite funding concerns.
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Related Terms
Frequently Asked Questions
Should I take a pension lump sum or monthly payments?
Monthly annuity provides guaranteed lifetime income (no investment risk) and is often the better choice, especially with survivor benefits. A lump sum gives investment flexibility and the ability to leave remaining funds to heirs. Consider your health, other income sources, investment skill, and whether you have a spouse who needs survivor benefits.
Is my pension safe?
Private sector pensions are insured by the PBGC (with limits). Government pensions are backed by taxing authority and are generally secure, though benefits could potentially be reduced for future retirees if funding shortfalls persist. Current retirees' benefits are typically protected by law and contract.