What Is A Pension?


What you’ll learn:

  • A pension, unlike an IRA, is a retirement plan that your employer fully funds to provide a monthly income in retirement. 
  • Pensions are based on the employee’s compensation, years of service, and age at retirement, but they aren’t offered by all employers.

At Jacobs Financial Services, many of our clients in West Michigan and surrounding areas have asked us, what is a pension? It is a fair and frequent question, as pensions aren’t as common in recent times as they used to be. However, some companies do still provide pension funds. This blog will explore what a pension is, how you accumulate pension benefits and how it provides pension income. 

What Is a Pension?

A pension is designed to guarantee you a retirement income. It differs from some other retirement accounts like IRAs and 401ks in that it is fully funded and managed by the employer. Though it has fallen out of favor with many private businesses, it is still common in government organizations. 

How Does a Pension Work?

A formula determines pension income. The formula considers your years of service with the organization, your compensation, and your age at retirement. Pension funds must comply with rules set forth by the Department of Labor that detail the amount the company must invest each year to fully fund the specified pension income in the future. 

Pension benefits may require the fund participant to be vested. Vesting means that you earn a portion of the pension fund based on years of service, and it can vary by the organization. For example, you may have to work until the age of 55 with at least ten years of service to qualify for 50% of your compensation over the last three years of employment. The same plan could incentivize participants to work longer to receive more significant pension benefits, such as working to age 65 with at least 30 years of service for 85% of the last three years’ compensation. 

What Are Some Alternatives to Pensions?

Pension plans are very attractive as a form of guaranteed retirement income. For many in West Michigan and the surrounding areas, it isn’t something that their companies offer. When employees don’t have access to a pension fund, it is up to them to plan for their retirement income. Fortunately, there are some alternatives.

Individual retirement accounts or IRAs are an alternative to pensions that are accessible by almost anyone. These retirement saving accounts have some tax advantages associated with them. Some rules restrict how much can be contributed in any year for tax advantages. 

401(k) plans have been a popular replacement for pension plans in many companies. While they offer various investment choices, most don’t provide opportunities to invest in anything that provides guaranteed income. However, the IRS does allow employers the freedom to provide an investment instrument called a qualified longevity annuity contract or QLAC within a 401(k) plan. If this option is available to you, it means that you can choose to invest your retirement saving in it for a guaranteed income. 

Professional Retirement Guidance in West Michigan

Planning the next important chapter in your life is exciting, but it is also full of choices. Many of our longtime clients trust us to help guide them through their investment options so that they can realize the retirement of their dreams. Schedule a meeting with us today to discuss your dream retirement goals. 

Featured Image: ITTIGallery/Shutterstock

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