Retirement Plans: Pensions vs. Social Security

Pension vs. Social Security: An Overview

There are many different types of income that retired folks draw on, depending on how they spent their working days. Two of the best-known are pensions and Social Security. The two programs are funded and structured in totally different ways.

Pensions are typically workplace retirement plans, in which an employer makes contributions to a pool of funds on behalf of employees. Social Security is handled by the federal government and funded through payroll taxes collected from employees and companies.

Key Takeaways

  • Retirement income can be guaranteed through a company's defined-benefit pension plan and federally funded Social Security.
  • These days, fewer companies offer guaranteed pensions. Instead, they offer their workers 401(k) plans, which are self-directed investments designed to generate retirement income.
  • Self-employed people have access to Individual Retirement Accounts (IRAs), which they fund on their own.
  • Social Security is a government-guaranteed basic income for older Americans, funded through a special tax paid by employees and employers.
  • For most retirees without a pension, Social Security will not be enough; other types of retirement savings, like a 401(k) or an IRA, are encouraged.

Pensions

Before the advent of IRAs and 401(k) plans, there were pensions. Your parents and grandparents, if they worked for the same company for many years, may have enjoyed generous pension benefits. Pensions nowadays are known officially as defined-benefit plans because the payment amount you'll receive in retirement is decided or defined in advance.

A private pension is a retirement account created by an employer for the employees’ future benefit. Employers, governed by certain laws and regulations, contribute on behalf of employees and invest the money as they see fit.

Upon retirement, the employee receives monthly payments.

Although they're becoming rare in the private sector, state government employees frequently have pension systems. For example, in Ohio, state workers pay into the Ohio Public Employees Retirement System in lieu of Social Security.

The private pension payout depends upon a number of factors, such as how long you worked for the employer as well as what your salary was. In some cases, you can choose a lump-sum payment or a monthly annuity check.

In the past, employers were required to maintain excess pension assets within the plan and were not to use the funds for other expenses. This law was put in place so that the money would be available to be paid out to eligible retired individuals. It also ensured that payments could continue during times when investment returns were lower than expected.

Many years ago, employers encouraged Congress to amend the pension rules and allow them to use money in over-funded pension plans for other employee benefits, such as retiree health plans and early-retirement payments. In her book "Retirement Heist: How Companies Plunder and Profit from the Nest Eggs of American Workers," Ellen Schultz relates how these changes led many companies to move pension assets into unrelated company coffers.

That resulted in a mass downsizing of pension monies and, ultimately, underfunded pension funds.

Private-sector pensions are gradually becoming obsolete, but over 33 million Americans are still covered by them.

Pensions, in general, are considered qualified employer-sponsored plans, which makes them subject to required minimum distribution (RMDs) rules. This means participants must begin taking distributions at the age of 73 or face a hefty penalty. (The age was raised to 73 from 72 as of Jan. 1, 2023.)

Provisions for distributions before 73 can vary. Many participants begin distributions at the age of 65. 

Social Security

Although many seniors receive Social Security benefits in retirement, the Social Security system isn't considered a pension. It may look like a pension because upon retirement (if you have paid into the system during your working years), you are eligible to receive monthly benefits. These benefits can begin at the age of 62.

The amount of the check varies based on the age at which you begin receiving benefits as well as how many years you worked and the amounts you earned while you were contributing to the program. Social Security isn't designed to fully replace your income or meet all of your financial needs in retirement.

Social Security is funded by a pay-as-you-go system. This means that while you are working, you pay into the system. On your pay stub, the entry for Social Security taxes is listed as FICA. Some of the payments you make while working go to fund current retirees’ benefits.

Key Differences

There are several other distinctions between pensions and Social Security. Social Security has a disability insurance program that extends benefits to workers who become disabled.

Pensions normally don’t provide disability benefits unless the employee is disabled in an on-the-job accident.

Although spouses may receive a partial pension payment, it’s unlikely that a child would also benefit from pension income—as is the case with Social Security.

Finally, pensions may offer a lump-sum payout upon retirement. This option is not available through the Social Security system.

Both pensions and Social Security may provide an income stream to retirees. Pensions can begin as early as 55, and are usually taken around age 65. Social Security can begin at age 62.

Does Anyone Get a Pension Anymore?

Most government employees at the federal, state, and local levels continue to get pensions. Police, firefighters, and teachers usually get them.

Their pensions may be getting less generous, though. They have become part of a larger retirement plan that encourages employees to contribute separately to a variation on the 401(k) plan. The 403(b) and the 457, for example, are designed for public and non-profit employees.

Can You Get Both a Pension and Social Security?

Absolutely. All Americans with a work history (and their spouses) are eligible for Social Security, no matter what their income or assets are.

Keep in mind that a portion of Social Security benefits is taxable if the taxpayer's total income is above a certain level. That level is very low, kicking in at about $25,000 a year. If you have a pension, you'll probably lose some of your benefits to taxes.

Are Pensions Paid for Life?

Generally, pension payments are for life. However, there are a number of options for how the benefits are paid. For instance, you can take a lower payout in order to guarantee a surviving spouse a continuing payment.

The various options are regulated by the government.

The Bottom Line

Pensions and Social Security operate for the same goal—to provide retirement funds. But they are not funded and structured in the same ways, which leads to different challenges for each.

The federal Social Security system will likely continue to provide aid to the disabled and elderly for many years—though by how much remains to be seen. But the private pension-plan system is dying out and being replaced by defined contribution plans such as IRAs and 401(k) plans.

Article Sources
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  1. U.S. Department of Labor. "What You Should Know About Your Retirement Plan," Page 4.

  2. Social Security Administration. "How Is Social Security Financed?"

  3. Ohio Public Employees Retirement System. "What is OPERS?"

  4. Pension Benefit Guaranty Corporation. "Annuity or Lump Sum."

  5. Ellen E. Schultz. "Retirement Heist: How Companies Plunder and Profit from the Nest Eggs of American Workers," Introduction. Penguin, 2011.

  6. Pension Benefit Guaranty Corporation. "PBGC Pension Insurance: We've Got You Covered."

  7. U.S. Department of Labor. "What You Should Know About Your Retirement Plan," Pages 17-18.

  8. U.S. Senate, Committee of Finance. "SECURE 2.0 Act of 2022," Page 2.

  9. Social Security Administration. "You Can Receive Benefits Before Your Full Retirement Age."

  10. Social Security Administration. "Your Retirement Benefit: How It's Figured," Page 1.

  11. Social Security Administration. "What is FICA?"

  12. Social Security Administration. "Benefits for People with Disabilities."

  13. U.S. Department of Labor. "What You Should Know About Your Retirement Plan," Pages 18-19.

  14. Social Security Administration. "If You Are the Survivor."

  15. Social Security Administration. "Social Security Benefit Amounts."

  16. Internal Revenue Service. "Retirement Topics - Significant Ages for Retirement Plan Participants."

  17. U.S. Bureau of Labor Statistics. "Retirement Plans for Workers in Private Industry and State and Local Government in 2022."

  18. Internal Revenue Service. "IRC 403(b) Tax-Sheltered Annuity Plans."

  19. Internal Revenue Service. "IRC 457(b) Deferred Compensation Plans."

  20. Social Security Administration. "Eligibility for Social Security in Retirement."

  21. Social Security Administration. "Income Taxes And Your Social Security Benefit."

  22. Social Security Administration. "Summary: Actuarial Status of the Social Security Trust Funds."

  23. Congressional Research Service. "Worker Participation in Employer-Sponsored Pensions: A Fact Sheet," Page 1.

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