Are you interested in learning more about how pensions work? Let’s start with a definition: pensions are compensation received after an employee has retired.
Pensions are designed to provide a stream of income for retired people. This income stream might be the sole source of income for some, but in the United States, pensions are typically just a portion of a retiree’s income. Other sources can include Social Security and investment income.
There are two major categories of pensions: defined benefit and defined contribution. In a defined benefit plan, workers receive a set amount of income after they retire, typically based on years of service, their pay grade, and their age at retirement. This amount may be fixed, or may be indexed to inflation or may have a standard annual percentage increase. In a defined contribution pension plan, there is no set amount of income. Instead, workers set aside a certain amount of money each month while they are working. That money is placed in various investment vehicles. After the retirement the resulting money is used to provide an income to the retiree, but the amount depends on the success of the investments during the worker’s career.
Whether defined benefit or defined contribution, pensions provide the following benefits to retirees:
- Regular monthly or bi-monthly payments
- Sometimes indexed for inflation
- Given for the life of the retiree
- Some pensions also provide payments to the widow or widower of a retiree
Therefore, having either type of pension, along with Social Security payments and other investment payments, can really help secure your retirement by providing a reliable source of income.