Pension Plans

Defined benefit plans — commonly referred to as traditional pension plans — have been offered in the workplace since the late nineteenth century.

Unlike today’s more common defined contribution plans, such as 401(k), 403(b), and profit-sharing plans, traditional pensions pay employees a specific monthly benefit at retirement — without any required yearly contribution or investment decisions on the employee’s part. 

Traditional pensions covered 40 percent of workers in the mid-1980s, but that's down to 20 percent today.   About 34 million people expect to receive payments from their employers defined benefit plans. 

Very few companies are starting new pension plans today and others have frozen their plans or failed.  These traditional defined benefit pension plans are disappearing and workers must focus on saving in IRA's, and employer plans like 401k's.

Taking the Money from a Pension

When an employee retires, there are a number of ways pension benefits are disbursed to them.  Most defined-benefit pension plans provide two types of payouts to the employees:

  •  Lump sum payout   The lump sum payout has been popular the last several years.  About half of workers with pensions now have the lump sum option and the majority use this.  If the company allows a lump-sum distribution, consider taking it and rolling into a IRA.  This money can continue to grow tax deferred. Call your pension provider-they will make a check payable to your IRA custodian and send to you.
  •  Annuity payout which provides a income stream.  The annuity payout can be either a single life payout (which yields more per month during retirement) or a joint and survivor payout (which reduces the monthly payout 20-0% while theoretically extending the payout period). 

Cash Balance Pension Plans

There have been numberous lawsuits regarding cash balance pension plans but employers are switching to these new -style pensions.  Cash-balance plans are pensions in which your account grows by an annual credit, typically 3% of your pay each year, plus interest.  When you leave your job, you usually roll the pension into an IRA or cash it out.   Older employee's have concerns about these new pensions as the pension calculation will produce lower benefits.

PBGC and Pension Plan Update

There has been a lot of attention focused on plans that are bankrupt or underfunded.  Several industries including auto, airline, and steel have had problems with their defined benefit pension plans. 

The PBGC was created by Congress in 1974 after auto industry bankruptcies left retirees without pensions.  The PBGC guarantees defined pension plans and is currently the trustee of 3,500 plans with about one million participants. If a pension plan shuts down without enough money to meet its obligations the PBGC guarantees up to $45,164 annually for employee who retire at age 65.

January 2006 Pension Update

Starting in January, companies must provide a comparison of the estimated values of the plans various payout options.  Employers will have to disclose these comparisons of single-life, joint and survivor, and lump sum options.  Employers will have to specify the difference in values only if one payment option is worth less than 95% of the retirees standard annuity option.  Under the rules, companies must give retiring employees the information 30 to 90 days before the first pension payout.

Visit the Department of Labor website on our LInks section to learn more.