Pensions are an often-confusing component of your retirement plan. For years, pensions were the gold standard for retirement benefits across industries. However, in recent years, pension plans have largely fallen to the wayside as bigger companies are moving toward exclusively offering 401(k) plans to their employees.
So, if you have a pension available to you, it’s important to make sure you’re taking full advantage of it.
What Is a Pension?
A pension, or defined-benefit plan, is a post-employment benefit offered to employees by employers. They’re one of the many ways that an employer can offer incentive for their employees to stick around for the long-haul. By showing you (the employee) that they (your employer) are invested in you and your successful retirement, you’re more likely to stay with the company long-term.
Pensions are funded or unfunded obligations of a company. They’re funded by your employer over the course of your career. They aren’t individualized like a 401(k), because they aren’t technically individual investment accounts. Instead, the pension plan is funded as a whole by your employer, and then they pay out benefits to each qualifying employee from the plan. Furthermore, your employer has full control of your pension – from the investments in them, to the way they structure benefit payouts.
Every employer has a different equation they use to calculate your pension benefit. However, typically they leverage these three components in varying ways:
How long you’ve worked at the company
Your age (when you retire)
Your salary – either your final salary or an average over your tenure
Because every company arranges their pension benefit in a unique way, it’s tough to use a “catch all” equation to calculate yours – you should dig in to figure out what your pension plan outlines for their benefit payout structure.
Then, the plan pays out a guaranteed amount to you during retirement depending on what pension election option you select.
When Does Your Pension Vest?
After a certain period of time (varying by company), your pension will “vest.” This means that the funds in the pension become fully available to you when you retire.
Pensions can sometimes vest in stages, meaning it will partially vest after a certain number of years with your employer, then it will fully vest after another number of years. Other times, your pension fully vests after you pass one employment milestone. These two different vesting schedules are called graded vesting and cliff vesting.
Graded Vesting: This vesting schedule happens in different intervals. For example, let’s say that Suzanne works for Company X. If she stays with Company X for 3 years, and retires at 55, she will receive 20% of her benefit. If she stays for five years, she’ll receive 50%. By the end of her seventh year she’s fully vested, and will receive 100% of her benefit. (Keep in mind that these numbers are just an example – every pension plan with graded vesting has a different vesting schedule).
Cliff Vesting: Cliff vesting means that your pension vests all at once after you cross a single work milestone. So, if Suzanne works for Company Y and they have a pension plan with a cliff vesting schedule, she could potentially be fully vested in her plan (receive 100% of her benefit after retirement) after working there for 5 years. However, if she left after 4 years, she is not vested and will receive nothing.
Your Pension and Retirement Planning
Your pension can be a big part of your retirement income, but it’s important to plan for every scenario. For example, if you choose to leave your job, you’ll have to decide whether to leave your pension and take the payout during retirement as a monthly benefit or to cash out your pension when you move to a new company, and invest the funds yourself in a different retirement savings vehicle.
There are pros and cons to each of these decisions. However, it can be boiled down to one deciding factor: time. If you have a notable amount of time between now and retirement, taking the lump sum “pay out” when you change jobs may be in your best interest. You’ll have more time in the market, and you’ll be able to invest the funds in a way that lines up with your personal goals and retirement timeline.
If retirement is right around the corner, leaving your pension untouched when you change jobs in order to guarantee the consistent monthly payout during retirement may be in your best interest. It can be beneficial to count on a portion of retirement income, even if it won’t cover 100% of your expenses during your years as a retiree.
Pensions Aren’t Fail-Safe
It’s also important to keep in mind that, even if you plan to stay at your current until you retire, you don’t have control of the funds in your pension. In fact, your employer can freeze your pension at any time if they choose to stop funding it, or stop offering pensions at all as a retirement benefit for employees. Given this scenario, you’d be entitled to the amount in your pension, but wouldn’t be able to continue having your employer contribute to the fund. In other words, don’t put all of your eggs in one basket.
Relying solely on your pension to be your retirement plan, or refusing to seek out a better-paying or more fulfilling job because you’re worried about leaving behind your pension benefit, isn’t always the right line of thinking. You need to leverage your pension to make sure you get the most out of it, but you also need to plan ahead in your career and for your retirement – and that means finding other methods of retirement funding outside of your pension.
Are you confused, or frustrated, trying to figure out your pension? Schedule a call with me today. I’d be happy to help walk you through your options as part of your comprehensive financial plan.