Pension plans are a type of retirement account. They are primarily funded by an employer who puts a set amount of money aside for their employee upon retirement. According to the Pension Rights Center, about 31% of retirees are currently receiving pension plan benefits. The number of people who have access to a pension in retirement is dwindling; however, if you have a pension, it’s important to understand how it works.
Types of pension plans
There are two types of pension plans: defined contribution and defined benefit. A defined contribution pension plan is similar to a 401(k) in that your employer makes specific contributions to your account. This is typically accomplished through some sort of matching program.
In a defined benefit pension plan, an employer commits to providing a certain amount in retirement for their employee. While there are typically rules around how many years you must stay with your company in order to collect your pension, once you have done so and are considered “fully vested,” the company is liable for the amount agreed upon. In more recent decades, it has become much less common for private companies to provide defined benefit pension plans, but it’s still fairly popular practice among government employers.
Things to consider
If you have a defined benefit pension, you should make sure that you understand your company’s vesting schedule. The schedule will tell you how much money you’ll receive based on the number of years you’re with that company, and it could impact your decision to stay or go.
With many pension plans, you’ll be able to access your funds around retirement age. Typically, this is when you turn 65.
Lump sum vs. monthly payments
Sometimes you can choose whether to have your defined benefit pension paid out in a lump sum amount or monthly installments. If you decide to get all of the pension money at once, you should consider whether you want to do all the work to invest and manage the money on your own.
While the money sits in the pension, there is no tax on the contributions. However, once you start collecting money from your pension, it will be taxed. You can read more about how taxes differ during retirement by reading this article.