When you hear the word “pension,” you might immediately think of the company jobs that gave employees a living after retirement. Not so long ago, it was pretty common for someone to work their entire adult life at one company, then retire to a comfortable pension. Pension plans still exist, but they’re not nearly as common as they used to be. So here we’ll talk about what pensions are, the alternatives, and the pros and cons of pension plans today.
A pension plan is a benefit that some employers provide to their employees. Rather than placing the burden of retirement saving on the employee, the company invests funds over the years. They then distribute a certain amount to employees after they retire, providing them necessary income to live on.
Defined-benefit plans
Usually when we talk about pensions, what we are referring to are “defined-benefit” plans. Quite simply, former employees receive a specific, defined sum of money per month in retirement. This number depends on the number of years of service with that company or industry.
Some pensions are single-life pensions, which means only the employee or member receives benefits. Once they pass away, surviving family members do not receive any pension funds. Or you might select a joint-life or survivor pension. The positive of this is that your designated beneficiary would continue receiving benefits after your (the member’s) death.
Social Security is also essentially a pension program. However, most of us mean a company pension plan, and that’s what we’ll focus on here. So, do you really need a pension? Let’s examine the pros and cons of pensions here.
Pros of Pension Plans
Even though pensions may sound a little outdated, there’s plenty to love about them. If you’re looking into a new job or career path, it might be worth considering whether a pension is important to you. Let’s talk about the primary pros, or benefits, to those who have pensions today.
- Burden of investing falls on the employer, not the employee.
- Employers also take on the burden of risk involving how the fund is invested.
- Benefits to the member or employee are fixed.
- Members receive payouts from the day they retire until their death (and longer, if they select an option that continues payments to a surviving spouse or beneficiary).
Pro of pensions: burden of investing is on the employer
When you work for a pension company, there’s a promise that the company will take care of you when you retire. If you only have the option of a 401(k), it’s up to you, the employee, to put away money for retirement.
Your employer has the burden of investing in your pension fund. While some pensions allow employees to contribute additional money to the pension fund, the employer must contribute. They have to be able to provide the promised retirement income to their employees.
The pension differs from the 401(k) because the employee doesn’t have to contribute to the fund. In a 401(k), the employees have to research and implement investments on their own. It can be a relief for an employee to leave the responsibility of investing with the employer. (That’s especially helpful if you have a propensity for spending and not for saving.)
Investment risks are with the employer
Going hand-in-hand with the burden of investing, the burden of risk falls on the employer as well. As a single investor trying to prepare for your retirement, it can be daunting to consider all the risks involved. How do you choose good investments, and how can you determine your risk tolerance?
With a pension plan, employees can somewhat relax because the stress of both investing and the potential risks are on the employer. And since the company needs to fund many employees’ retirements, it will likely do plenty of research to protect that money.
A positive with pensions is that the employer is responsible for making sound investments. The burden of making sure the company money is invested to bring good returns is on the employer, not the employee. For someone who might be worried about how to select good investments, a pension could be very appealing.
Pension benefits are fixed
While the exact dollar amount is not the same for every employee, a pension is a defined-benefit plan. The employer must provide monthly income during retirement until the member passes away. Benefit amounts are usually based on calculations using your years of service and a percentage of your income.
With a 401(k), on the other hand, employees have to guess how much to save for retirement. There’s no guarantee of a certain amount of distributions for the rest of your life. Instead, you have to estimate carefully to try not to run out of money in retirement. Once the money’s gone, it’s gone.
With so many uncertainties involved in retirement, it’s no wonder a pension sounds like a good option. You can’t be sure how long you’ll live, so there’s a bit of chance involved in the estimation. Health issues, the strength or weakness of the market, and inflation are all retirement concerns. Pensions take away some of the “unknown” factor of stress in retirement planning.
*This could be a pro or a con for a pension: is there a benefit to your surviving spouse? There are options for both single-life and joint-life pensions. Single-life means it only covers the employee for life. Joint-life, or survivor, pensions, continue to pay out money each month after your death to your designated beneficiary.
For those who are married, a joint-life pension could be ideal. However, that will reduce the amount of your monthly payments. The employer has to hedge against the risk of more years of payouts.
If your company only has a single-life pension option, that doesn’t help your spouse in the event that you die first. (A defined-contribution plan would be better in this case. If one spouse dies a few years into retirement, the surviving spouse still receives income.)
Cons of Pension Plans
No retirement plan is perfect. Every option offers slightly different types of usefulness to the employee or retiree. With that said, here are some downsides associated with pensions.
- Employees have no control over how their pension money is invested.
- Company failure could lead to bankruptcy and reduction in employee pension benefits.
- Not all pensions transfer if you change employers.
- They’re difficult to access.
No employee control over investments
First of all, if you want some say in how your money is invested, a pension doesn’t provide that. You are subject to whatever type of fund your company decides to invest its pension contributions in. There will likely be many options that would see superior returns, but you get what you get.
It’s a good trade-off, though, to realize that the company is on the hook. They’re the ones who have an obligation to make sure the money promised to you is there when you retire. So there’s a strong probability the employer will strive to wisely invest the funds.
Risk of company bankruptcy
If your employer goes bankrupt or faces extreme financial hardship, that can trickle down to impact your pension. This kind of severe lack of funding might not even be the result of company failure. Dramatic drops in the overall stock market can cause these issues as well.
When your employer goes bankrupt or is simply very low on funds, it won’t be able to pay full pension benefits. Usually you’d still get something, but it might be significantly lower than the expected amount. Considering that retirees often make plans based on a fixed income, even a slight reduction in benefits could be devastating.
*One thing to note: many pension plans are insured, but not all. In the private sector, pensions have added protections through the Pension Benefit Guaranty Corporation (PBGC). This also insures many cash-balance plans, where members are due to receive a lump-sum upon retirement.
The PBGC, although a lifeline for some, does not cover government or military pensions. It has some other limitations as well, including a maximum monthly payout.
Not all pensions are transferable
A pension with a specific company is often less flexible than a 401(k) or other defined-contribution plan. This could be a major con of pension plans: you may not be able to bring the funds with you should you change jobs.
There’s quite a bit of variance with this issue. In some industries or companies, you must be employed for a certain number of years before being “vested” there. When someone is vested, it means they own a set percentage of their account in a retirement plan.
Once vested, an employee can take any pension benefits with them if they change employers. For example, you might become partially vested after 4 years of employment and fully vested after 7 years. You could have enough years of service with a company to take a certain percentage of your pension along to your new employer.
It’s a big con of pensions to not always allow members to retain ownership of their benefits. The likelihood of someone staying with a single employer their entire working career is much lower than a few decades ago. So in this way, a 401(k) or defined-contribution plan is a better option, since it’s portable no matter where you work.
Difficult to access
Another con of pension plans is their inaccessibility. Your pension is locked up with your employer until retirement day. That means if you end up in an emergency situation and need a big chunk of money to take care of it, your pension won’t help.
Of course, you’d ideally keep a separate emergency fund with enough cash to pay for a major home repair or other unexpected expense. Relying on your retirement account isn’t a wise course of action. But sometimes things just go badly and we need money—fast.
While it’s not great to withdraw money early from a 401(k), you can do it if absolutely necessary. The penalties for early withdrawals are fairly steep. Actually, in a sense, the difficulty of access is a positive part of pensions. It prevents people from rashly robbing their future retired selves. The harder it is to access a savings or retirement account, the better if you want your money to grow.
Industries Where Pension Plans Are Still Common
While traditional pensions have become less common, there are some industries in which you’re still likely to have a pension plan offered. Many industries and companies place the burden of retirement saving on the employees. But in these career fields, there’s a decent chance your employer will provide a pension to keep you going after retirement.
- State and local government employees
- Teachers
- Utilities
- Protective services like firefighters and police officers
- Insurance industry
- Pharmaceutical
- Nurses
- Transportation
- Military
- Union jobs
Generally, the highest likelihood for getting a defined benefit retirement plan was for those working in state and local government positions. In the 2020 Employee Benefits Survey by the U.S. Bureau of Labor Statistics, 86% of government jobs offered pensions. Only 37% of those polled in state and local government jobs had access to a defined-contribution plan like a 401(k).
By comparison, only 25% of civilian workers polled had access to a pension for the same year. In those careers, employers prefer defined-contribution plans that depend on employee initiative. 60 percent of people in these jobs could access a 401(k) or similar retirement plan.
The odds of having the benefit of a pension drops even lower in private industry. Only 15 percent of workers in these fields said their employers offered them a pension plan. Again, these employers emphasize defined-contribution plans, rather than defined-benefit. 64% of private industry workers could save in a defined-contribution plan.
Should You Look For a Job With a Pension?
Often, you don’t have much of a choice in whether you have a pension or a defined-contribution plan. But if you’re changing jobs or companies, it’s important to figure out how important a pension or 401(k) is to you. Steer your search toward employers who value your contributions and want to help you plan for a successful retirement.
