When most people think of a pension, they think in terms of receiving a specified benefit, typically on a monthly basis for the rest of their life. This is the traditional pension—technically known as a defined benefit plan. In this type of retirement plan, the company first determines your projected retirement benefit and then makes contributions to make sure those benefits get paid. You don't have a separate account in your name. Based on the company's pension formula, the employer is able to estimate a projected future benefit you can use in your retirement planning.
If your company offers a defined benefit plan, there are a few important things you should know:
- Your actual benefit is generally based on a formula which takes into consideration (a) years of credited service, (b) the amount of your compensation, and (c) the age at which you leave the company.
- Your plan has a vesting schedule. Vesting means that you have a right to specified pension benefits, regardless of whether you remain an employee of the company. Your employer's plan most likely uses either one of two vesting schedules: (1) three-year cliff vesting, which means you are vested 100% after three years of service or (2) six-year graduated vesting, which means you are entitled to 20% of your benefits after two years and 20% for each year thereafter until 100% vesting is reached after six years. If you're thinking of leaving your present employer after the first couple of years, check your vesting schedule; it might be worthwhile to stay on a few extra years.
- If you are thinking about cutting back your hours for a period of time, check with your employer to determine the amount of hours needed to continue receiving pension credits.
- You should also know that your pension is entirely or partially guaranteed by the Pension Benefit Guaranty Corporation (PBGC), to which your employer pays an annual premium. The maximum monthly benefit amount is capped, so you may not receive your full benefit.