What Exactly Is a Pension?

Pensions and retirement aren’t just for old people to worry about. Whether you are starting your first job or counting down the last few days in your office, understanding retirement account options can be the difference between the future you want and years of regret. The first step is getting a grasp on your needs and expectations — use a retirement calculator to see how much money you will need to save. Then you can make a plan and get to work, knowing both how much you need and what it will take for you to get there.

How Contributions Work

The main difference between pensions and retirement plans is who puts up the money. A pension is employer-funded and used to be the standard benefit for a lifetime of work, but now has been largely replaced by plans primarily funded by employees. Pensions are “defined benefit” programs, meaning an employer sets money aside into an investment vehicle that then pays benefits to retired employees based on a combination of how long you worked for the company, your income while working and your age. A retirement account like a 401(k) is a “defined contribution” program and you put your own money into these, sometimes with employer contributions and matches. You put in a certain amount but how much you get out will depend on how the market and your investments perform.

Pension Basics

Pension plans provide a set level of income in retirement from money that your employer has set aside and invested on your behalf. You may receive this income in a lump sum or regular payment through an annuity. Some plans allow benefits to transfer to surviving dependents in case of your death. With a pension program, you don’t participate in the management of your funds — which can be good because you don’t have to worry about it but bad because you are vulnerable to investing mistakes your employer might make. You also may not receive any benefits from your pension if you don’t stay with your employer until your benefits “vest,” so pay attention to your vesting form and schedule. You should also be aware that pension income is taxable because it grows tax-deferred during working years, and it could affect your Social Security eligibility.

401(k)s & IRAs

Pensions were very popular in the past, but defined contribution plans now dominate the landscape. In fact, the private sector has largely replaced pension plans with the 401(k). The money you and/or your employer put into your plan regularly accumulates and earns interest from investment, providing a nest egg. Like a pension, a 401(k) grows tax-deferred, but unlike a pension, a 401(k) does not guarantee a certain income in retirement. There are also individual retirement account options that you can open apart from your employer. Some employers now also offer Roth 401(k)s, which are funded with after-tax money.

When it comes down to it, the most important part of retirement planning is starting early and saving often. The last thing you want to do is to go into debt in retirement because you didn’t plan well. The more you know about your company’s plans as well as the best way to set aside and grow money on your own, the better you can get prepared and the happier you will be when the time for retirement finally comes.

More Money-Saving Reads:

• What’s a Good Credit Score?
• What’s a Bad Credit Score?
• How Credit Impacts Your Day-to-Day Life

Image: iStock