What is a Pension Plan?

Pensions are sadly a dying breed of a type of benefits that reward employees for their loyalty for working for the same firm for a long time. With the newest batch of employees that are just graduating expected to have 5 to 7 jobs in their career, there hasn’t been much need to develop a plan that will reward you for staying with the same company for so long.

That having been said, some of you are still lucky enough to work for companies that offer a pension benefit to their employees. Yet even individuals with pensions don’t always know what that exactly means, or how to maximize their benefit. Not to mention those of us without pensions. There’s no way we have a solid understanding of the ins and outs of a pension plan.

So what exactly is a pension plan and if you have one, should you hold onto it?

What is a Pension Plan?

A pension plan is a benefit that companies give to their employees. It is a type of retirement account like a 401(k) except that with a pension you don’t have to do anything. That means you don’t have to contribute anything; the company awards you benefit based on tenure with the company. You also don’t have to make any investment or account management decisions; the firm hires an investment firm to manage the assets of the pension plan.

It is kind of like getting company-paid life insurance for an employee. You don’t have to manage the policy or send the check in each year to renew the policy. The company takes care of everything.

A pension plan is also similar to an annuity in that when you retire, you get a consistent payment from the pension plan based on both your tenure with the company and your salary during the years you worked there.

Do I Have a Pension?

If you have a pension you should know it. Signing paperwork with human resources can be confusing though, so it never hurts to review everything or simply ask. Most companies that have a pension plan still intact make sure their employees know it and are proud of it.

If you don’t have a pension, there isn’t anything you can do to make your company have one. Maintaining a healthy pension plan is a monumental task, so they are becoming more rare.

What is Vesting?

A key aspect of understanding your pension is that of vesting. Vesting isn’t a pension-only term. Some companies have vesting of their contributions into your 401(k) account, with stock options, or with big bonuses.

Vesting is the process of you earning the right to keep whatever perk has been given to you, usually through staying employed with the company a certain number of years.

For pensions, this means that you may not be locked in to getting pension benefits from the first day you are employed with the company. To avoid having to pay out pension payments for employees that don’t stay around, many plans require you to stay 5 years or longer to earn your way to pension rights. This can be done one of two ways. One option is to give employees a percentage toward earning the benefit each year. For example, if they require you to be employed for 5 years before you can get benefits, you would get 20% credit toward the full benefit each year you stay. The other option is to wait to get 100% vesting at the end of the 5 year period. So you wouldn’t get credit for the first four years, but after the 5th year you would be fully vested into the plan.

About the Author

By , on Oct 21, 2012
Kevin Mulligan
Kevin Mulligan is a debt reduction champion with a passion for teaching people how to budget and stay out of debt. He's building a personal finance freelance writing career and has written for RothIRA.com, Discover Bank, and many others.

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