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.

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