Pensions—also called defined benefit plans—guarantee you a monthly check for life after retirement. They're increasingly rare in the private sector but still common in government jobs. If you have access to one, here's what you need to know.
Pension vs. 401(k): The Key Difference
| Feature | Pension | 401(k) |
|---|---|---|
| Who funds it | Mostly employer | Mostly you |
| Investment risk | Employer bears it | You bear it |
| Payout | Guaranteed monthly income | Depends on balance and withdrawals |
| Predictability | Know what you'll get | Unknown until retirement |
Pensions remove the guesswork. You know exactly what you'll receive.
How Pension Benefits Are Calculated
Most pensions use a formula based on:
- Years of service
- Final average salary (often highest 3-5 years)
- Multiplier (typically 1-2%)
Formula: Years × Final Salary × Multiplier = Annual Pension
Real Example
30 years of service × $80,000 final salary × 2% multiplier = $48,000/year pension ($4,000/month for life)
Vesting: When You Earn the Benefit
Cliff Vesting
You must work a set number of years (often 5) to earn ANY pension.
- Leave at year 4: Get nothing
- Leave at year 5: Get full earned benefit
Graded Vesting
You earn increasing percentage over time.
- Year 3: 20% vested
- Year 4: 40% vested
- Year 5: 60% vested
- Year 6: 80% vested
- Year 7: 100% vested
Critical: Understand your vesting schedule. Leaving before vesting = losing benefits.
Payout Options at Retirement
Single Life Annuity
Highest monthly payment. Ends when you die. Spouse gets nothing.
Joint and Survivor Annuity
Lower monthly payment. Continues (often at 50-75%) to surviving spouse.
Lump Sum
Some plans offer a one-time payment instead of monthly checks. You're responsible for investing it.
Pro Tip
If married, joint and survivor is usually the right choice. The reduced payment is like buying life insurance for your spouse.
Where Pensions Still Exist
Government Jobs
- Federal employees (FERS)
- State and local government
- Teachers
- Military
- Police and firefighters
Some Private Sector
- Some utilities
- A few large corporations (shrinking)
- Union jobs in some industries
Hybrid Plans
Some employers offer a small pension PLUS a 401(k).
Making Career Decisions with Pensions
The "Golden Handcuffs"
Pensions encourage staying:
- Benefits grow with tenure
- Leaving early forfeits significant value
- Late-career years often count most in formula
Should You Stay for the Pension?
Calculate the value:
- Estimate your pension benefit
- Calculate the lump sum equivalent (multiply annual by 20-25)
- Compare to what you'd earn elsewhere
Real Example
$40,000/year pension = $800,000-$1,000,000 equivalent in retirement savings
That's significant. But if a job change offers $50,000 more annually, you might make more investing the difference.
Don't Ignore Vesting Cliffs
If you're at year 4 of a 5-year cliff vesting, seriously consider staying one more year.
Pension Risks
Employer Bankruptcy
Private pensions are insured by the PBGC (Pension Benefit Guaranty Corporation), but:
- There are maximum limits ($67,295/year max for 2024)
- High earners might not get full benefit
- Public pensions have less protection
Inflation
Most pensions don't adjust for inflation.
- $40,000 pension today
- Worth $24,000 in purchasing power in 20 years (at 2.5% inflation)
Some plans (especially government) have COLAs (Cost of Living Adjustments), but many don't.
Plan Changes
Companies can freeze or reduce pension formulas going forward (usually not retroactively).
Maximizing Your Pension
Stay Until Vesting
Don't leave money on the table. Know your vesting date.
Work Your High-Earning Years
Final average salary matters. If raises come late career, that helps your pension.
Consider Timing
Some plans have optimal retirement ages. Leaving too early or too late might not maximize benefits.
Get a Pension Estimate
Request periodic estimates from HR. Know where you stand.
The Bottom Line
Pensions are valuable but rare. If you have one, understand the formula, know your vesting, and factor it into career decisions. The guaranteed lifetime income can be worth staying at a job—but run the numbers to be sure.