A pension plan is a type of retirement plan. It is a defined benefit plan, meaning you are guaranteed a minimum amount in retirement. Your employer must determine how much of your salary you will receive when you retire. This percentage largely depends on the type of pension plan your employer uses and how your employer wants to make payments to you when you retire.
Private pensions are often defined benefit plans. This means a benefit amount is determined in advance. This benefit payment is then paid out to you when you retire. The benefit payment is normally a percentage of your salary or a fixed dollar amount. Your employer may give you $50 a month per year of service as a flat benefit amount, or it may provide you with 1 or 2 percent of your three consecutive highest-earning years.
Government pensions are generally based on a combination of a basic annuity payment, a savings plan you contribute to (called a Thrift Savings Plan) and Social Security. The basic annuity is calculated by taking the average of your highest three consecutive earning years and paying 1 percent per year of service based on this amount.
Your pension benefit is guaranteed in both cases. Your pension payment also remains level for your entire life. You also have the option to leave a portion of your pension for your spouse after you die. You select a pension payment, which provides 50 percent, 75 percent or 100 percent of your pension payment after your death. By doing this, you effectively reduce your full pension benefit payment.
You should consider saving an additional amount of money in addition to your pension plan benefits. For government employees, this is built right into the retirement plan. You receive access to a Thrift Savings Plan, and you contribute money to this as you would any other employer-sponsored retirement plan. Your private sector employer may offer you a 401k plan or other retirement plan so that you can contribute your own money to your retirement. If this isn't an option, consider investing in an individual retirement account, or IRA. IRAs are private savings plans that aren't attached to your employer and allow you to save money on your own. You control the contribution amount, which is tax-deferred and choose the investments in the account.
- "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, Anandi P. Sahu, Robert A Crane; 2007
- Internal Revenue Service: Publication 575
- U.S. Office of Personal Management: FERS Retirement