A pension plan is a retirement savings plan offered by employers to their employees. There are many different types, but all of them share some common features — as well as some risks. In this article, we'll explain what pension plans are, define the two main types of pension plans and describe retirement plan alternatives.
What Is a Pension Plan?
A pension is a retirement savings plan option. Typically, pension plans are either defined benefit plans or defined contribution plans.
Defined benefit plans promise a specific amount of benefits upon retirement — either a monthly plan or a lump sum payment when the employee retires. With a defined contribution plan, employers and employees make contributions to an investment account. The employees receive the benefit, but the amount depends on how well the underlying investments perform. It's not a guaranteed amount.
Both types of pensions have their pros and cons. Defined benefit pensions are more costly for employers, but they offer employees more certainty about their future income stream. Defined contribution pensions are less expensive for employers, but they carry more risk for employees since the amount of benefit they receive isn't guaranteed. For this risk, employees may realize greater returns.
When choosing a type of pension, it is important to consider your own needs and preferences. If you're looking for a secure retirement income stream, a defined benefit pension may be the right option for you. If you're comfortable with taking on some risk to potentially maximize your return, a defined contribution pension may be a better choice.
Talk to your employer about enrolling in their pension plan if they offer one. You can consult with a financial advisor if you have specific questions about your retirement plans and whether or not a pension plan is right for you.
What Are Some Pension Plans Risks?
There are a few risks that come with participating in a pension, including:
- Employer bankruptcy. If your employer goes bankrupt, you may not receive the benefits you were expecting.
- Investment risk. The value of your retirement savings can go up or down depending on how the market performs.
- Lack of control. You may not be able to access your money until you reach retirement age, which can limit your ability to make withdrawals in case of an emergency.
Are There Pension Plans Alternatives?
There are also a few retirement plan alternatives you can open instead of a pension.
Individual Retirement Accounts
Individual Retirement Accounts (IRAs) are retirement accounts, and the most common types are the Traditional IRA and the Roth IRA. Typically, individuals open IRAs in addition to other retirement accounts as they have a relatively low annual contribution limit.
Annuities are not investments. Rather, they are contracts between an individual and an insurance company through which the individual agrees to make regular payments to the insurance company in exchange for a guaranteed income stream upon retirement.
401(k)s are employer-sponsored savings plans that allow employees to contribute money and invest it during their working years and then withdraw it at retirement.
Is a Pension Plan Right for Your Retirement?
When it comes to retirement plans, you have options. So, is a pension plan the right choice for you?
Here are some things to consider:
Do you need a secure income stream upon retirement?
Do you trust that your company's pension plan will remain intact when you retire?
How much can you contribute each month/year toward your retirement?
How long do you have until retirement?
Do you plan to stay at your job until retirement?
With the answers to these questions, you can decide whether or not a pension is right for you. Keep in mind that not all companies offer pension plans. Similarly, some companies that do offer them require their employees to enroll. So, whether or not a pension plan works for you ultimately depends on the company you work for, what they offer, how long you plan to be there and your personal risk tolerance when it comes to investing for retirement.