Yahoo Finance Traditional Pension Plans in Retirement — How Do They Work, and Who Has Them?
Imagine you receive a fixed amount of money from your employer every month after you retire, enough to cover your living expenses. It’s almost like you’re still getting a paycheck. That’s how traditional pension plans, also known as defined benefit plans, work.
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These plans used to be a common benefit offered by employers to ensure their employees had financial security in retirement. While they are less common nowadays, there are still a few employers left that offer them. Here are details on how they work and who has them.
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How Pension Plans Work
The story of traditional pension plans in the U.S. began in the late 1800s. The first broad-based pension plan was introduced by American Express in 1875, giving benefits to employees who were at least 60 years old and had worked at least 20 years for the company.
Initially, these plans were set up to provide financial security to employees who were loyal to a company for many years, encouraging them to stay until retirement. Over time, more companies, especially large corporations, and public sector organizations started offering similar benefits.
Here’s how traditional pension plans usually work.
Employers contribute to a pension account, which is set up to collect and manage the employees’ retirement money. Unlike in a personal savings account, the employees typically don’t put in their own money in a pension account.
The longer an employee works for a company, the more money is in their pension.
Employees receive guaranteed payouts upon retirement. When employees retire, they start receiving benefits — usually monthly payments. The amount of these payments is determined by a formula that considers how long they worked for the company and their salary.
In large organizations, pension funds may be pooled into one large account and invested on behalf of employees. The money in the pension fund is managed and invested by professionals who try to grow the fund over the years so that there’s more money to pay for everyone’s retirement.
This can be especially important if pension payments to retired employees are adjusted to increases in cost of living. In this situation, the money in the fund should grow at least enough to keep up with inflation so that everyone can get paid without the fund running out.
Many pension funds are insured to make sure that employees will receive the money even if something happens to the company they worked for. Many pension funds are insured through the Pension Benefit Guaranty Corporation, which is a U.S. government agency.
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Defined Benefit vs. Defined Contribution Plans
Over the last few decades, there’s been a big change in how retirement plans are handled. Nowadays, only 15% of private sector employees have access to a traditional pension plan.
Private companies have moved away from traditional pension plans (defined benefit plans) and toward what are known as defined contribution plans, like the 401(k). Unlike traditional pensions, where the employer promises a set payout at retirement based on salary and years of service, 401(k) plans put the responsibility on employees to contribute and choose investments. The final amount available at retirement depends on how much was put in and how well those investments performed.
Employers will sometimes match employee contributions up to a certain amount. For example, an employer may match every dollar an employee puts in up to a total of 3% of the employee’s salary.
A 401(k) is more like a personal savings account for retirement that gets some help from the company. While 401(k) plans offer more control and potentially high returns, they also come with risks. The amount of money workers have at retirement depends heavily on their ability to save and invest wisely. Unlike with traditional pensions, the payouts from 401(k) plans aren’t guaranteed. If your investments tank, you can lose most of your money.
Who Still Gets Pensions?
Today, most of the jobs with pensions are in the public sector — 86% of state and government employees have access to pensions.
Public Sector Employees
Many government workers, such as teachers, firefighters and police officers, still receive traditional pensions. These plans are popular in the public sector because they help cities and states attract people to these important jobs.
For example, the California Public Employees’ Retirement System is the largest public pension fund in the U.S. It manages the pension benefits for over 2 million public employees in California. These workers can rely on a steady income after they retire, which makes planning their future a lot easier.
The benefits of these plans are pretty stable. Since they are backed by government agencies, the payments are seen as more secure. This means retirees can count on receiving their benefits, unlike some private sector pension plans that might be at risk if a company runs into financial trouble.
Private Sector Employees
In the private sector, traditional pensions are becoming less common, but some industries and big companies still offer them. For example, large corporations like UPS still provide pension plans to their employees. These companies use pensions as a way to keep good workers.
However, there have been changes. Some companies have “frozen” their pension plans. This means they won’t take away the pension benefits that workers have already earned, but these workers won’t accumulate any more pension benefits in the future. Instead, they might be shifted to a 401(k) plan for their remaining years with the company.
Unions often have a big role in negotiating pension benefits, especially in industries like automotive manufacturing and airlines. Major car companies like General Motors and Ford used to offer pension plans to their unionized workers but stopped after the 2007-2008 financial crisis. During the last automotive strike, United Auto Workers included the return of pensions as one of its conditions, but it was unable to force manufacturers to accept the terms. United Auto Workers maintains that it is committed to fighting for pension plans and will continue to push for them at the next contract negotiation in 2028.
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