Even though the number of 401(k) plans has increased dramatically, close to 20 percent of the work force is still covered by a defined-benefit plan, which promises to pay a benefit related to salary and length of employment.

Since responsibility for investing the pension funds and paying the benefits rests with the employer, many employees pay no attention to the plan until they are ready to collect benefits. But this is likely to be a significant revenue source in retirement, so you should find out answers to the following questions:

  • Are you covered by the plan?  Certain groups of employees can be excluded from coverage, 
    so make sure you're not one of them. 

  • When do you vest?  Once you're vested, you're entitled to benefits even if you leave the company. Most plans provide full vesting after five years, although the period can stretch as long as seven years.

  • How are benefits calculated?  While the specific formula depends on your particular pension plan, the most common formula is based on average compensation for the final few years of employment multiplied by a benefit percentage and your years of service. Find out the formula for your plan and ask for an estimate of what benefits you can expect.

    Many plans also integrate pension benefits with Social Security benefits, meaning your pension will be reduced by some portion of your Social Security benefits. Based on the way benefits are typically calculated, you'll normally receive a larger benefit by staying at one company for many years than by switching companies, even if you vest at each company.

  • What are your payout options?  Some plans allow you to select between a lump-sum distribution and an annuity. There are usually several payout options for the annuity. A single life option pays a fixed sum monthly for your lifetime, with no benefits paid after your death.

    A joint-and-survivor option pays a fixed monthly sum for the retiree's lifetime and then a reduced benefit to the spouse for the rest of his/her life. The benefit amount is smaller than the life annuity option since payments are also made to the surviving spouse. Married participants must be paid this way unless the participant elects otherwise with the consent of his/her spouse.

  • When will you receive benefits?  Ask for details regarding when you can collect benefits for normal retirement, early retirement, and late retirement. Review how much your benefits would be reduced if you retire early or how much they would increase with a later retirement.

  • Will you receive cost-of-living adjustments?  Most pension plans don't provide cost-of-living adjustments, which you should keep in mind when planning for retirement. 

  • What happens if your company goes out of business?  The Pension Benefit Guaranty Corporation (PBGC) guarantees pension benefits. This program is funded by insurance premiums paid by companies with defined-benefit plans. While the PBGC guarantees some benefits, it has limits, so that highly paid employees might not receive their entire pension benefit. It also does not cover health insurance, life insurance, disability benefits, or severance pay. 

  • Is your benefit amount correct?  Companies can make mistakes when calculating benefits, so be sure to double check the calculations. If the calculation is complicated, you might want a professional to review it.


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