What is pension?

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DEFINITION:

A pension plan is an employer-sponsored retirement plan that promises employees a specific benefit in retirement.

Understanding pensions

A pension plan is a retirement plan in which an employer guarantees employees a specified benefit. The employer pays into a fund that is invested for the benefit of the employees; the earnings on those investments are then paid to the employees as a benefit upon retirement. A pension plan differs from a defined contribution plan, such as a 401(k) plan, in which employees set aside a portion of their earnings for retirement (and in which the employer may match a portion of the employee contributions). With retirement plans, the investment risk is on the employer, not the employee. This is because pension plans are a “defined benefit plan,” meaning employees are promised a certain amount of money for retirement – regardless of investment returns.

Takeaway

A pension plan is like your employer planting a vegetable garden for you (with a guarantee behind it)…

While you’re working, your employer plants seeds. Your employer hopes that these seeds will produce enough food to provide you with what he promised you for the winter (your pension). But even if some of the plants die or are eaten by animals, your employer is stuck with the cost. If the garden doesn’t produce enough, he’s to buy you food from the store. The risk is entirely his.

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