The term 'Pension' is included in the Investments edition of the Financial Dictionary. Get your copy on Amazon in Kindle, Paperback or Audio edition. Choose your edition here...
A pension refers to a type of defined benefit plan. In such a plan, workers receive precisely what their employing company promised them. This would be a pre-determined and -defined monthly monetary benefit. With pensions, workers must first attain certain preset qualifications. This might include number of years working with the company. At such a time when the various conditions are met, the individual employee is said to be vested, or eligible to obtain the arranged pension benefits after he or she officially retires.
It is the employers who functionally manage the pensions on behalf of their current and past employees. Employees do not have the right to select any funds or investments within the pension funds. The amount payable to the employee in question comes from how many years the worker served the company and the final few years of average payroll amount. This means the more years that individuals work at a company, the greater amount they will obtain in retirement monthly benefits.
At retirement, the monthly benefit does not come from current revenues or turnover of the company. Instead, checks come from the pension fund into which the firm paid years ago. This is the reason that firms which offer pensions to their employees have to first set up and then routinely make contributions to the pension fund so that it will be capable of covering the retirees’ promised monthly benefits.
Bigger corporations will often handle a great amount of the oversight of such pensions entirely in house. They will trust investment firms or funds to handle the investments and management of the account funds however. Smaller companies wisely outsource the entire affair to one of a number of different third parties who will oversee the entire enterprise on their behalf.
Pensions have historically been popular with workforces that were heavily unionized. This meant especially public sector employment, manufacturing jobs, skilled trades, and teachers/educators. Labor contracts keep these types of benefits alive for the future of the union members. In the last decades, these pensions have slowly deteriorated to the point that they are no longer common outside of government space jobs. They are still a central component of public jobs for police, educators, firefighters, and administrative job workers throughout the local, country, state, and Federal employee sectors.
Pension benefits are not mobile. Employees cannot accrue time at one firm towards a pension then continue it at another. Once an employee becomes vested in the pension, the pension benefits will be paid out to the employee after retirement begins. The amounts will have frozen at the point where the employee left the company however. This means that the benefits are not lost by migrating to another company or industry. There are a few rare scenarios where employees who are fully vested in the pension fund may receive a one-time lump sum payout upon physical departure from the firm. This would substitute for the future monthly benefits over the remainder of the employees’ lifetimes.
Another type of defined benefit plan is referred to by the name of Cash Balance Plan. In such an arrangement, the employer will make deposits for a predetermined dollar amount every year into the employees’ individual names but held within the defined benefit fund. The return earned will often be guaranteed via an annuity or other type of insurance company contractual arrangement. Some employers who maintain such a plan will allow their departing employees to move the balance funds to a personally held IRA when they separate from the firm. This means that the cash value will be assigned rather than guaranteed as with pensions.