Pensions remain an important source of retirement income for millions of Americans. Understanding the different types of pension plans, how they work, and what protections exist can help you plan more effectively for retirement.
Defined Benefit Plans
A defined benefit (DB) plan promises a specific monthly payment at retirement, typically based on a formula that considers your salary history and years of service. The employer bears the investment risk and is responsible for funding the plan. These are the traditional pension plans most people think of when they hear the word “pension.”
Common formula example: 1.5% × years of service × final average salary. So an employee with 30 years of service and a final average salary of $60,000 would receive $27,000 per year ($60,000 × 30 × 0.015).
Defined Contribution Plans
Defined contribution (DC) plans, such as 401(k), 403(b), and 457 plans, do not guarantee a specific benefit at retirement. Instead, you and possibly your employer contribute to an individual account. The final benefit depends on contributions made and investment performance over time. The investment risk falls on the employee.
Cash Balance Plans
Cash balance plans are a hybrid between defined benefit and defined contribution plans. They are technically defined benefit plans, but each participant has a hypothetical account balance that grows with annual pay credits and interest credits. At retirement, you can typically choose between a lump sum payout or an annuity.
Government Pensions
Federal, state, and local government employees may participate in government-sponsored pension systems. The Federal Employees Retirement System (FERS) includes a defined benefit component, Social Security, and the Thrift Savings Plan (TSP). State and municipal plans vary widely in their structure, funding levels, and benefit formulas.
Military Pensions
Service members who complete at least 20 years of service are eligible for military retirement pay. The Blended Retirement System (BRS), introduced in 2018, combines a reduced defined benefit with TSP contributions and matching. Legacy system participants under the High-3 formula receive 2.5% of their highest 36 months of basic pay per year of service.
Pension Protection
The Pension Benefit Guaranty Corporation (PBGC) insures defined benefit plans in the private sector. If a plan fails or an employer goes bankrupt, the PBGC steps in to pay benefits up to certain limits. In 2024, the maximum guaranteed annual benefit for a 65-year-old retiree is approximately $81,000. Government pensions are not covered by the PBGC but are typically backed by the sponsoring government entity.
Key Considerations
- Vesting — You may need to work a minimum number of years before you’re entitled to employer-funded pension benefits
- Portability — Defined contribution plans are generally more portable than defined benefit plans when changing jobs
- Survivor benefits — Many pension plans offer reduced benefits that continue to a surviving spouse
- Cost-of-living adjustments — Some pensions include annual COLA increases; others pay a fixed amount
- Lump sum vs. annuity — When given the choice, consider your life expectancy, other income sources, and investment confidence