The Basics of Pensions
How do pensions work?
The most common type of pension plan is a defined benefit plan. Under that type, after an employee with a pension retires, they receive monthly benefits from the plan that grew through contributions from the employer and sometimes the employee. The amount they receive is based on a formula that weighs how many years they worked for that company and provides a percentage of their average salary during the last few years of their employment.
Are pensions taxable?
All or some of the benefits a person receives from a pension or annuity payment from a qualified employer retirement plan may be taxable unless the funds are part of a qualified distribution from a Roth account. Benefits are fully taxable if you did not make any after-tax contributions, your employer didn't withhold after-tax contributions, or you received your after-tax contributions tax-free previously.
Do pensions last for life?
Regular pension payments continue for the rest of your life, no matter how long you live, and sometimes can continue being paid to your spouse after your death. If an employer goes bankrupt, pension payments could stop but the Pension Benefit Guaranty Corporation (PBGC) insurance covers defined-benefit plans. The PBGC does not safeguard defined-contribution plans such as 401(k)s.
Can my ex-spouse claim my pension after divorce?
It depends on state law and the details governing your specific pension plan. But a pension earned by one spouse is generally considered a joint asset, meaning it's subject to division in divorce. Review your state's laws to determine the best way to protect your pension in a divorce. To determine how much a former spouse may be entitled to, you can often divide the pension benefits earned during the course of the marriage in half.
Can a child claim a deceased parent's pension?
Pension death benefits for children vary depending on the type of pension a parent had. Typically, plans only allow for the employee or a surviving spouse to receive benefit payments. But there are limited instances for child beneficiaries. For instance, if a married employee chooses a joint-life payout, the default beneficiary is the member's spouse unless the spouse waives that option in writing. If so, the member can designate a different beneficiary such as a child.
Keogh plans are rarely-used tax-deferred pension plans used for retirement by self-employed individuals or unincorporated businesses. There are two main types: a defined benefit or a defined contribution plan. Usually, contributions are tax-deductible up to a percentage of annual income with absolute limits set by the Internal Revenue Service (IRS) each year.
A lump-sum payment is an amount paid all at once, as opposed to an amount that is paid in installments over time. They are often associated with pension plans when an employee chooses a smaller upfront payment rather than annuities over the rest of their lifetime. Lottery winners often take a lump-sum payout as well, rather than yearly payments.
A pension plan is pool of money created by employer contributions that are then used to fund payments made to eligible employees after retirement. There are two main types: defined benefit plans and lump-sum payments. Traditional plans have become increasingly rare in the U.S., and have largely been replaced by retirement options such as 401(k)s that cost employers less.
Defined Benefit Plan
A defined benefit plan is the most common type of employer-sponsored retirement pension plan. Employee benefits are calculated using a formula to that considers how long an employee has worked for the company and how much salary they earned. The employer is responsible for managing the plan's investments and risk, and usually hires an outside investment manager to do that.
Teacher Retirement System (TRS)
The Teacher Retirement System (TRS) is a network of local city and state organizations that administer pensions and retirement accounts for public education employees. They also offer educators retirement planning assistance and advice. Each organization offers different plans and benefits to beneficiaries.
Underfunded Pension Plan
When a company-sponsored retirement plan has more liabilities than assets, it is considered an underfunded pension plan. That means the money needed to cover current and future employees who retire is not readily available. This can be caused by interest rate changes, stock market losses, and economic slowdowns. An underfunded pension plan is risky for employers because the guarantees to employees are often binding.
Cash Balance Pension Plan
In a cash balance pension plan, employees who retire receive a set percentage of their annual compensation plus interest. This type of plan is maintained on an individual account basis like a defined-contribution plan such as a 401(k). The funding limits, funding requirements, and investment risk are based on the same requirements as a defined-benefit plan.
The person or company responsible for managing a retirement fund or a pension plan on behalf of participants and beneficiaries is known as a plan administrator. They have a fiduciary duty to act in the interests of plan participants and must properly collect and distribute funds to qualified participants.