When it comes to planning for retirement, you may be covered by a pension plan at your employer, or you could have a retirement account that you contribute to. Both of these types of retirement plans can provide you with benefits once you reach retirement age. One requires you to make contributions while the other is funded by an employer.
Pension plans are type of retirement plan that is always employment related. You cannot fund your own pension plan. The technical term for this type of plan is "Defined Benefit," because they promise the employee a certain amount at retirement, usually based on a formula that includes years of service and a percentage of income or fixed amount per year. The employer is responsible for contributing an amount that, including income projections, will provide the employee with the defined benefit at retirement. Pension plans are not as common as they once were, but there are still many companies that use this model. Many government and union employees are covered by pension plans.
Retirement plans are available through employers as well as on an individual basis. With these types of plans, it is up to the individual to fund the majority of the account, though employers my provide a match. With a retirement plan, participants do not know exactly how much money will be available for them when they retire. Instead, they simply make regular contributions to the account that are invested in different securities like stocks and bonds.
One of the differences between a pension plan and a retirement plan is in who is making the investment decisions. With a pension plan, a pension manager makes all of the investment decisions for the group. With a retirement plan, you make your own investing decisions. You decide whether you want to put a certain amount of money in a particular mutual fund or stock and then you allocate the proper amount of money.
Another key difference between these two types of retirement plans is the level of certainty in your retirement benefits. With a pension plan, you know exactly how much you will receive once you retire, after working a certain number of years. With a defined contribution plan, you do not know what to expect. If your investments do well, you could have a large amount of money available for retirement. If the investments perform poorly, you may not have enough to retire on.
Once you reach retirement age, both of these plans typically pay benefits in different ways. With a pension plan, you may have the choice of getting a lump sum distribution or taking monthly payments. With an individual retirement account, you have the option to take the money out as you choose. You can take out a large sum or you can take out small payments on a regular basis.