What Is a Pension Plan?

What Is a Pension Plan?
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Pension Plans Provide Money After Retirement

Whether you always make plans in advance to reach your goals or you get by on a wing and a prayer, planning for retirement is essential for everybody. Saving money for the future should be foremost in your mind, just as providing for your child is now. You can have financial freedom after retirement if you start investing in your future through a pension plan.

What Is a Pension Plan, and How Does It Work?

A pension plan is a retirement plan where you set aside a portion of your salary in an account. The portion of salary you contribute to the fund can be before or after taxes, depending on the type of account. When you retire, you can receive the pension in monthly payments or in one large lump sum. Your employer might combine your account with the other employees and invest it in stocks or bonds to earn more interest. Alternately, the pension funds can simply be in a bank account earning interest.

When you retire, usually at the age of 65, you will have quite a tidy sum of money to live off if you consistently contribute to the account throughout your working career. You can collect a monthly payment and leave some of the money in your account to draw more interest for future payments. If you suddenly have the need for a monthly stipend before you hit retirement age, you'll pay a penalty to start collecting it. The fee can be in the form of extra taxes or a reduced monthly amount. If you are withdrawing the money early due to a disability, there are no penalties to pay. Usually, you have to remain working for the same company for 10 years to get your pension.

What Is the Difference Between a Private and a Public Pension?

Public pension plans are for anyone who works in federal, state or local governments. This includes law enforcement and firefighters. Private pension plans are through any other type of employer that offers them, but not all companies offer a pension plan.

What Is the Difference Between a Pension Plan and a 401(k)?

Even though a pension plan and a 401(k) can both hold your money and have investments in stocks or bonds, they do differ. When you leave a job that has a pension plan in place, you can’t take the money with you and transfer it to another company. With a 401(k), you have more control as you can move your funds to your new employer or into an IRA rollover. With a pension plan, when you reach retirement age, you’ll have to contact the employer where the plan is and apply for your benefits.

How Long Do You Get Your Pension For?

The length of payout depends on the plan itself. When you reach retirement age, you usually have a few options for how much you get monthly and for how long.

Single and joint life annuities. One option is a life annuity that pays you monthly until you pass away. This type of payout ends when you die. A joint and survivor annuity can let someone continue to receive monthly payments even after you die. A joint annuity designates that the money go to a spouse. While these annuities pay longer than the single life annuity, they pay at a lesser amount per month.

Period-certain annuities. Period-certain annuities are plans where you choose a specific amount of years, such as 10 or 20 years. If you die before the payout date is reached, you can designate a beneficiary, such as a child, to get the payments until the plan reaches the specified amount of years.

Lump-sum payments. If you dare, and you are really good at personal investments, you can choose a lump-sum payment for your money. Some people can handle this quite well and invest a portion to increase its value, while others might go hog wild, overspend and be broke within a year or so.

What Is a Pension Plan Buyout?

When a company no longer wants the responsibility of handling a pension plan, it can offer you a buyout with a cash amount in a lump sum, monthly payments starting immediately or monthly payments when you turn 65. The company might be looking at the pension plan as a liability that it wants to remove and just pay you off. To make a good decision at this point, figure the actual present value of what you would get in each of the offers you receive.

What Is a Pension Plan in Canada?

The Canada Pension Plan pays out partial replacement of earnings when you retire, if you become disabled or when you pass away. Most everyone who works in Canada outside Quebec contributes to the CPP. The Quebec Pension Plan provides the same types of payments for anyone who lives in the city. You can contribute to one or both if you live in Canada. Both of these plans are similar to Social Security in the United States. Benefits of the Canadian programs include the following:

  • Retirement pension
  • Post-retirement benefit
  • Disability benefits
  • Survivor’s pension
  • Death benefit
  • Children’s benefits

If you live in Canada, you must contribute to one of the two programs based on where you live.

The earlier age that you start contributions to a pension plan, the more you will get upon retirement. Consider all of your options and weigh their benefits to decide which type of plan works best for you and your family.