Pension

A pension is a retirement plan where an employer promises to pay a worker a regular monthly income for life after they retire. The employer funds most or all of the plan, and the benefit amount is usually based on factors like how long the employee worked there and their final salary. This type of plan is often called a defined benefit plan because the payout amount is set in advance.

Pensions were once common across many industries, but they have become less widespread in the private sector over recent decades. Today, they are most often found in government jobs, military service, and some union positions. Teachers, police officers, and federal employees are among the most common pension recipients in the United States.

How the benefit is calculated:

• Years of service at the employer
• Final average salary, often based on the last three to five years of earnings
• A multiplier set by the plan, such as 1.5% or 2% per year of service

Practical example: A public school teacher works for 30 years and has a final average salary of $60,000. If the pension plan uses a 2% multiplier, the calculation would be 30 years times 2% times $60,000, which equals $36,000 per year, or $3,000 per month for life.

Some pensions also include cost-of-living adjustments, called COLAs, which increase monthly payments over time to help keep up with inflation. Others offer survivor benefits, meaning a spouse or dependent can continue receiving payments after the retiree passes away.

Workers who leave a job before retirement age may still be entitled to a reduced pension if they are vested, meaning they have worked long enough to qualify for future benefits. Vesting schedules vary by plan but often require five to ten years of service.

Unlike a 401(k) or IRA, workers generally do not control how pension funds are invested. That responsibility falls on the plan administrator. The financial health of the pension fund matters greatly, as underfunded plans can sometimes reduce promised benefits.

RetireGrader is not a financial advisor or fiduciary. This content is for educational purposes only.