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For some people, a pension is a route to retirement, but often it's not the only way to get there. Here’s what pensions are, how they work and options if you don’t have access to a pension plan — or if the payouts will be too small to live off of in retirement.
What is a pension plan?
A pension plan is a retirement-savings plan typically funded by an employer. Money goes into the pension on behalf of the employee while the employee works for the organization. The employee receives regular payments in retirement. Pensions differ from 401(k)s, though both are employer-sponsored retirement plans.
Technically Social Security is a pension program, but when people talk about pensions, they tend to mean those with a company.
How pensions work: an overview
Pensions are usually defined benefit plans, where the amount you receive in retirement depends on years worked and earnings over time. In general, employers offer a pension plan as a perk to attract talent.
Here are some of their main features:
Employers usually fund them. The pool of money in a defined benefit pension plan typically comes from the employer, though sometimes employees can contribute their own money to the plan if they choose.
Tenure and compensation matter. How much an employee gets from an employer’s pension plan usually depends on how long the employee works for the employer and how much the employee earns.
Payouts start when you retire. Upon retirement, the employee receives regular periodic payments, usually for life. In general, your annual benefit from a defined benefit plan can’t exceed either 100% of your average compensation for your highest three consecutive calendar years, or $230,000 (that's the threshold for 2020 and 2021), whichever is less. The annual dollar amounts are subject to cost-of-living adjustments.
Pensions generally aren’t portable. If you leave the company and get a job elsewhere, you may not be able to move the money into another account such as a 401(k) or an IRA. (In some cases, though, particularly with government jobs, employees may be able to transfer some or all of a pension to the pension plan at a different government job.) The money typically stays in the pension plan until you retire. In some cases and under certain circumstances, companies may offer employees lump-sum distributions or buyouts.
Pensions are pretty rare these days. A generation or two ago, defined benefit plans were common. Today, employer-sponsored retirement plans are typically defined contribution plans such as a 401(k), which is fundamentally different (see the table below).
You’ll probably get paid even if the company goes bankrupt. Many defined benefit plans are guaranteed by an agency of the federal government called the Pension Benefit Guaranty Corporation. That means that if the employer goes out of business or doesn’t have enough cash to pay retirees, the PBGC will step in and pay. Companies buy this insurance, and the pension plan is insured even if the employer falls behind on the insurance premiums for the coverage.
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Is a 401(k) or a pension plan better?
There are upsides and downsides to each, so what’s “better” depends on your circumstances and what’s important to you.
A defined contribution plan such as a 401(k) lets employees (and sometimes employers) contribute to an investment account. A defined benefit plan, on the other hand, promises employees a set benefit at retirement and puts the responsibility of providing that benefit — including the investment risk — on the employer.
Another difference lies in who controls the investments available within the plan. Employees with a pension generally have little or no say in how their money is managed, and if they leave the company, they likely can't roll over the funds into a 401(k) or an IRA. Employees with a 401(k) can choose from a roster of available investments, and upon leaving are able to roll over their money into an IRA or a 401(k) at their new job.
401(k)s vs. pension plans
401(k) (defined contribution plan)
Pension (defined benefit plan)
How much payout you get
Payouts are based on how much employee contributes and how employee invests the money before retirement
Payouts are based on how long employee works for company and how much employee earns there
Who funds the account
Mostly the employee (an employer may match some contributions)
Mostly the employer
Who manages the investments and bears the investment risk
Mostly the employee
Mostly the employer
Who has control over money before retirement
Employee can move money into another 401(k) or IRA if leaving the company (called a rollover)
Employer retains until employee retires
How long a payout lasts
Until the money runs out
What if I don’t have access to a pension plan or a 401(k)?
An IRA is a tax-deferred or tax-free retirement savings account that many financial institutions offer. You can invest in stocks, bonds and other assets. How much your IRA earns and whether you lose money depends on how you invest. You can withdraw your money any time, but you may face a 10% penalty and a tax bill if you do it before age 59 1/2, unless you qualify for an exception.