Pension plans were starting to seem like a thing of the past. But a recent resurgence suggests this retirement benefit may be staging a comeback.
As companies work to “settle negotiations with labor unions or win over employees in fields where recruiting and retaining workers is especially competitive,” a “small but growing number” of them have begun to either reopen their pension plans or start them, said The Wall Street Journal. However, these pensions may look a little different than those of the past, as “many newer plans instead give workers market-linked returns, similar to a 401(k),” which in turn “shifts most of the investment risk to employees.” Here is what to know.
What is a pension plan?
It’s an employer-sponsored retirement savings account wherein “employers make regular contributions to a pool of money set aside to fund payments to eligible employees after they retire,” said Investopedia. Employees may also be required to make additional contributions to the plan.
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Payouts in retirement depend on the type of pension plan. With a defined-benefit plan, the type of pension that used to be more common, the employer “guarantees that the employee receives a specific monthly payment after retiring and for life, regardless of the performance of the underlying investment pool,” said Investopedia. Meanwhile, with the increasingly offered defined-contribution plan, the “final benefit to the employee depends on the investment performance of the plan” and the company’s “liability ends when the total contributions are expended.”
How is a pension different from a 401(k)?
A 401(k) is another type of defined-contribution plan, but it has some meaningful differences from a pension. For one, the “employer provides the bulk of funding for a pension plan, while 401(k) plans are primarily funded by the employee,” said SoFi. This also grants the employer greater control, particularly as a “defined benefit plan generally pools money in the company’s pension fund,” as opposed to an investment account in your name, said SmartAsset.
There is also no option to bring a pension with you if you change jobs, as you can with a 401(k) rollover. Rather, “when an employee leaves a company in which they have a vested pension benefit, the employee must keep track of their pension benefit after their departure,” said Investopedia.
What are the benefits and risks of pensions?
The benefits and risks of pensions can vary widely depending on the specific plan. For instance, if the pension is a defined-benefit plan, the employee can largely count on receiving a certain amount at retirement — though “in the case of public pensions, there’s also the risk that the state or municipality will encounter economic issues and declare bankruptcy, which could result in a reduction of benefits for pension plan participants,” said SmartAsset.
With a defined-contribution plan, payout in retirement will largely depend on investment performance, similar to a 401(k). But “unlike with a 401(k) plan or IRA, you have no say in how your company invests the money in your pension fund,” which means that “if the manager of the fund makes bad investment decisions, that could result in insufficient funds for the overall pension,” said SmartAsset.
As another benefit, “both pension plans allow the worker to defer tax on the retirement plan’s earnings until withdrawals begin,” which “allows the employee to reinvest dividend income, interest income and capital gains — all of which compound and can generate a much higher rate of return,” said Investopedia.
