What Is a Corporate Pension Plan?

A corporate pension plan is an employee benefit that provides income after retirement based on length of service to the company and the employee's salary history.

Pension plans for American workers have become relatively rare outside of government employment. Although 86% of state and local government workers were eligible for a pension plan, only 17% of employees of companies had them as of March 2018.

Key Takeaways

  • A defined-benefit pension plan commits a company to a specific payment amount for life to each eligible employee, depending on length of service and final salary.
  • The defined-contribution pension plan requires the company or employee, or both, to contribute regular sums towards a retirement income. The payments depend on investment returns.
  • Pension plans are becoming increasingly rare in the private sector, although most civil service employees get them.

The best access to pension plans in the private sector these days is provided by large companies. About 41% of employees of large firms, defined as those with 500 or more employees, offer a pension plan as a benefit.

Understanding the Corporate Pension Plan

Pension plans typically have a vesting period requiring the individual to work for the company for a minimum number of years before becoming eligible. The individual benefit is based on the employee's salary history with the company.

In the past, employers were wholly responsible for contributing to the plan based on an employee's length of employment and salary. That is becoming increasingly rare.

Two of the most common types of pension plans are the defined-benefit and defined-contribution plans.

The defined benefit plan is the traditional approach to pensions. The defined-contribution plan is the model that has been widely adopted in recent years.

The Defined-Benefit Pension Plan

In a defined-benefit plan, the company commits to a specific payment amount for the lifetime of the employee. The benefit is calculated in advance of the employee's retirement, using a formula based on the employee's age, length of service, and salary at retirement.

17%

The percentage of American private-sector employees who are eligible for pension plans.

In the U.S., the maximum retirement benefit permitted under a defined benefit plan was $225,000. The maximum is adjusted annually.

Defined-benefit plans may be funded exclusively by the employer or jointly by the employer and the employee. The pension fund is financed from a pool of funds from which periodic payments to retired employees are made.

The payouts are based on a formula that calculates the contributions needed to meet the defined benefit. The formula factors in the employee's life expectancy and normal retirement age, possible changes to interest rates, and annual retirement benefit amount.

The Defined-Contribution Pension Plan

Defined-contribution plans don't guarantee a set benefit amount. 

Contributions are paid into an individual account by the employer or the employee, or both. The contributions are invested and the returns on the investment are credited to the individual's account, or debited from it if there are losses.

The payout from this plan, therefore, depends upon the success of the investments made for the pension plan. On retirement, the member's account provides the retirement benefit, usually through an annuity. The payments fluctuate with the value of the account.

In the U.S. the best-known defined-contribution pension plan is the Thrift Savings Plan, which is open to federal employees and members of the Armed Services.

Defined contribution plans have become widespread in recent years and are now the dominant form of plan in the private sector in many countries. The number of defined contribution plans in the U.S. has been steadily increasing, as employers find them to be a more affordable alternative to a defined benefit plan.