Understanding Your Pension Plan
With thirty (30) years in the Human Resources and Benefits field, I can report that very few employees pay any serious attention to their company pension plan until they reach age fifty or greater. In essence, they do not have a “plan” for their retirement.
This brief primer is intended to assist in at least understanding what plan your company/sponsor provides, and where the responsibility for a successful retirement plan lies.
Simplistically, there are two types of pension plans: a “defined benefit plan” and a “defined contribution plan.”
With a “defined benefit plan,” the company/sponsor will provide a document called a Summary Plan description. It will state a formula for how your pension will be calculated. An example may read something like the following:
You are eligible to receive 100% of your pension upon completion of thirty (30) years of full-time service. Your pension amount plus the full amount of your Social Security benefits will be equal to 60% of your five (5) highest years of your annual compensation.
Can you begin to see all of the variables in this calculation? The company/sponsor must have an auditor/financial analyst review all of the information required on an annual basis to determine how much the company must contribute to the pension plan to keep it fully funded.
NOTE: If you read the news frequently, you will be aware that many companies/sponsors delay fully funding their pension plans on an annual basis, and sometimes that manifests into a problem that affects the employee at a much later date. The later date occurs when it is discovered the plan is not fully funded.
Bottom line, the company/sponsor of the defined benefit plan bears all the responsibility for funding the plan, the administrative expenses, and the risks associated with the economic/market variability. This would at least partially explain why very few companies today sponsor a defined benefit pension plan.
The “defined contribution plan” is much simpler in every way. An example of a typical defined contribution plan is the standard 401(k) plan, as offered by most for-profit companies. A typical summary plan description may define the plan as follows: An employee may become a participant in the plan on the first day of the month, following thirty (30) days of employment. The employee’s pre-tax deductions will then be matched by the Company/Sponsor at the rate of 50 cents for each dollar he or she contributes for the first six percent (6%) he or she contributes.
Can you see the differences? With a defined contribution plan, the employee bears complete responsibility for having saved enough to be able to retire. The company can calculate its required expenses annually and must make the contributions to the employee account on a government-specified schedule.
You always own the monies you contributed, and you own the company contributions once they are vested. Vested means the ownership has transferred to you.
Defined Benefit Plans are becoming rare today. Companies that sponsor them began doing so several years ago. The company bears responsibility for the funding, the administrative expenses, and the variables of the financial markets.
With a Defined Contribution Plan, the company in many cases provides a company match to a specified amount of funds to reward and encourage employees to participate. The employee bears responsibility for the final retirement amount and the variables of the financial markets. Because these types of plans are given more attention, the possibility of underfunding is usually discovered quickly and is very unlikely.