Retirement and pensions. It’s something that most of us don’t think we need to worry about until we get older. Retirement is also something that most of us don’t think we can worry about right now. After all, we have student loans, expensive healthcare costs, rising housing prices, kid’s college, aging parents, and a host of other financial worries that usually push the idea of retirement to the back of our mind. Additionally, retirement can be overwhelming. Most people have no idea what to invest in, how the investing process works, what tax implications our decisions may have, and most of all; how much money do you need to retire. 

While all of these questions will be answered in future articles, this article will start on the ground floor with the question: What are the different types of retirement plans? There are several different types of retirement plans and in this article, we will be addressing #10: Defined Benefit Plans (AKA pensions). These articles will give you an idea of what to look for when deciding on how to save for retirement and what type(s) of retirement accounts to save in.

Types of Retirement Plans

1. Traditional IRA
2. Roth IRA
3. 401(k)
4. 403(b)
5. SIMPLE IRA
6. Simplified Employee Pension (SEP)
7. Salary Reduction Simplified Employee Pension Plan (SARSEP)
8. Payroll Deduction IRA
9. Profit-Sharing Plan
10. Defined Benefit Plan (this article)
11. Money Purchase Plan
12. Employee Stock Ownership Plan (ESOP)
13. Thrift Savings Plan (TSP)
14. 457 Plan

IMPORTANT: READ THIS BEFORE CONTINUING

Before we get into the types of retirement accounts, it is important to make one key distinction. A retirement account, itself, is not an investment. If you say something to the extent of, “My 401(k) hasn’t done very well this past year and I’m thinking of picking a different one” you would be making an incorrect statement.

Think of it like this: There are 14 different types of retirement accounts (we will discuss the other 13 in different articles). Each one of those retirement accounts should be thought of as a cooking pot. If you cook something in that pot and you don’t like what it tastes like, you don’t dump the contents into another pot and hope that it tastes better. You change the ingredients of that pot to something else. Now think of the ingredients as different investment products (stocks, bonds, cash, mutual funds, and/or a host of other products/ingredients).To get the taste you want, you change the ingredients, not the pot. You may be wondering, what ingredients do I put into my pot? That is a fair question, but you cannot answer that question until you figure out what pot is best for you. Now buckle up and find out what the 14 different types of retirement accounts (pots) you have at your disposal.

Credit: Nicholas Gras: https://unsplash.com/@armgd

(10) Defined Benefit Plans/Pensions

A Defined benefit plan is the official IRS verbage for a pension plan. So for the rest of this article, if I refer to a pension, just know that I am also referring to a defined benefit plan. 

When you think of a pension plan, think of your grandparents. Pension plans are far less common than they were a few decades ago. Largely, pensions have been replaced with defined contribution plans (401k’s, 403b’s, IRAs, etc.). Pension plans are usually available to state and local government employees, hospitals, and some large corporations. Chances are, if you don’t work for one of these organizations, you do not have a pension offered to you.

A pension is an employer sponsored retirement plan that gives workers a guaranteed income (usually monthly income)starting when they retire until their death. Juxtaposed to a defined contribution plan that requires the employee to contribute to their own retirement savings, a pension plan generally does not require the employee to contribute to their own retirement savings. 

To keep the difference between a defined benefit and a defined contribution plan just think of the name.

Defined Contribution Plan: You contribute your own money to the plan. (401k, 403b, IRA, etc.)

Defined Benefit Plan: You are given the benefit of not paying for the plan.

The largest benefit of pensions is that with a pension, you will not outlive your money. But with a defined contribution plan, you have the potential to outlive your money. For example, you may want to withdraw a certain amount of money out of your 401k plan when you retire each month to live on. But if you withdraw too much money out of that plan, you will eventually have spent all of the money in your 401k. 

That doesn’t happen with a pension. With a pension, you will be allotted a certain amount of money each month for as long as you live. The downside is that you will probably not have enough money to live comfortably (or at all) with JUST a pension when you retire. In some circumstances you will, but not many. This is because pensions are almost always invested very conservatively. There are a lot of laws regulating how a pension can be invested, leading to the conservative nature of them.

Eligibility requirements to qualify to receive a pension depend on a number of different inputs. 

1. Time working for the organization
2. Level you have achieved within the hierarchy of the organization
3. Pay
4. Other organizational-specific requirements

Another big bonus of a pension plan is that generally the employer will make all of the contributions to it. That means that you don’t have to contribute ANYTHING to it. Woo hoo!

The downside to not contributing anything to it? You have no control over it. Because it is not your money that you contributed to the plan, the pension plan can be invested in any way that the pension custodian sees fit (usually really really conservatively). 

And even more importantly, sometimes pension plans can be misused and poorly managed. For example, the state of Illinois and the City of Chicago have a HUGE pension shortage. This means that over time, people expecting pensions could potentially not receive them. That is scary.

Most pension funds are managed well. But it is important to understand that because the money was never contributed by you, you have no say in how it is managed. 

Remember, as stated before, a pension plan is much like a cooking pot. Inside the cooking pot are different ingredients (investments). Pension plans are invested according to the rules and regulations of their governing bodies. 

Within a pension plan you can have many different investments such as:

1. Stocks
2. Bonds
3. Mutual funds
4. Unit investment trusts
5. Government securities (Treasury bills, treasury notes, and treasury bonds)
6. US government-issued gold and silver coins. 

If you don’t know what all of these different terms mean, that is perfectly fine. Just know that you can have nearly all investments within a pension plan.

But, there are a few items that cannot be in a pension plan. Pension plans cannot have:

1. Antiques
2. Gems
3. Rare coins
4. Works of art
5. Life insurance contracts: This is because life insurance contracts are not securities (investments).
6. Municipal bonds: This is because putting a municipal bond in a pension plan would negate the tax free status of the municipal bond.

Antiques, gems, rare coins, and works of art cannot be included in pensions because these items do not have a solid market value. Meaning: I might be willing to pay $50,000 for a painting, but you may be willing to only pay $3,000 for the same painting. It is too difficult to find an agreeable market value.

There are some stipulations to having a Pension that are important to know.

1. Contribution Limits (as of 2021): There are generally no contribution limits to pensions because you (the worker) are not the one contributing to the pension, the employer is. There are situations where workers can buy back years and other things like that, but that is way outside the scope of this article.

2. Contribution Deductions (as of 2021): Unlike a defined contribution plan, a pension generally does not have any tax deductions. Again, because you (the employee) are not contributing to the plan itself.

3. Early Withdrawal (as of 2021): Generally, pensions do not allow withdrawals before age 59 ½ without penalty. There are some circumstances that this is not the case (most notably so with retired military). There are a few other exceptions that are generally organization specific. To find out if you can withdraw money from your pension before age 59 ½, check with your HR department and/or talk to a good CPA.

4. Required Minimum Distributions (as of 2021): RMDs are not really a thing with pensions (as they are with defined contribution plans) because once you retire, you will receive a set amount of money each month. So you won’t have to worry about withdrawing too much money that you run out or too little that you’ll be taxed out the wazoo for it.

Final Thoughts

Pension plans can be a very useful retirement tool. However, not many people have one available to them. In my personal opinion, if you have a pension plan at your workplace already, great! It will be there for you if you stick around at the company long enough. But please don’t stay in a toxic work environment or hold yourself back professionally because of a pension. If a better opportunity arises elsewhere, take it.

Also, I may just be salty and distrusting but I don’t want to rely on someone else for my retirement income. And since a pension plan is managed and run by someone else, I wouldn’t want to rely on it alone (my own personal views).

If you have a pension plan, that is great. Just make sure that you are saving for retirement by yourself as well. Do it in a 401k or 403b if you have one available within your organization. But if you don’t, then use one of the other retirement vehicles outlined here.

Until next time!