Pensions vs. Social Security
Pensions and Social Security both provide income to people during retirement, but they are very different programs. Employers may offer pensions to their employees, but they don't have to. The United States government runs Social Security, which is a mandatory program for most workers. It is not a true retirement plan, although retirement benefits are part of the program.
A pension is a retirement benefit that your employer may provide to you as part of your overall benefits package. In a traditional pension plan, your employer promises to pay you a monthly benefit check for life after you retire. Payments are typically based on your years of service and salary. In many plans, the payments are also intended to provide enough money for you to live on without any other income. These plans are also called defined benefit plans, because the amount of the benefit is determined (defined) in advance. The promise of monthly payments for life does not depend on the pension plan actually having enough money to cover the payouts, which has sometimes led to private pension plans having trouble paying benefits. The Pension Protection Act of 2006 attempted to solve that problem by requiring companies to fully fund their plans, meaning they need to they have enough money in the fund to cover all promises made to all participating workers. Many public pension plans are also underfunded and in trouble. At one time, the traditional pension was common, but most companies have replaced the defined benefit plan with defined contribution plans. These are the 401k and similar plans that employees contribute their own money into and make their own decisions about how to invest. Employers will often match the employee's contribution up to a certain percentage. Some will also contribute a small amount even if the employee does not make any contributions. These are not true pensions. They are employer sponsored retirement plans, and you do not get a guaranteed monthly payment. Your income during retirement depends on how much they grow. Traditional pensions can be funded entirely by the employer, paid into by employees or both. Unions may also fund pensions for their members.
Public Pensions and Private Pensions
When thinking about pensions, it's also important to realize that there are some significant differences between public and private pensions. Private pensions are offered by companies, while public pensions are offered by governments. Today most local and state workers are still covered by a traditional pension plan. Most private sector employees are not, although defined contribution plans are common. Companies that offer pensions typically fund them without contributions from employees. Public sector employees usually contribute a percentage of their salaries toward their pensions. However, many government employees do not contribute to Social Security and are considered non-covered workers. They will not be eligible for Social Security retirement benefits, and their pensions may be their only source of retirement income. Private sector employees do pay into Social Security. They are covered workers and will receive Social Security during retirement. Public pension payments tend to include an annual cost of living adjustment (COLA). Some also include additional adjustments based on investment returns. Few private pensions plans include either adjustment.
Social Security is Not a Pension
Social Security isn't a pension or a retirement plan, although some aspects of it are similar. One of the benefits Social Security provides is a monthly retirement benefit. This benefit is based on your salary during your working years, similar to a pension. The Social Security Administration (SSA) also applies an annual COLA to payments, similar to public pensions. However, Social Security payments are not designed to provide a living wage like many pensions. They are intended to supplement your other retirement income. Here are some other key differences between Social Security and pensions: - Social Security benefits are funded by taxpayers in a pay-as-you-go system. Most workers pay a portion of their salary to Social Security taxes (FICA), and the SSA uses those funds to pay current benefits. People in the workforce when you retire will pay your benefits. - Social Security includes a Disability Insurance program that covers any worker with enough credits if he or she becomes disabled. Pensions do not usually pay for a disability unless it is work-related. - People who have never worked may still be able to collect Social Security based on a spouse's or parent's work history. This is not true of pensions. Some pensions do offer a "joint and survivor" option with smaller monthly payouts so that a spouse can continue to receive payments if the worker dies, but this is not the same thing.
Some pensions can affect Social Security benefits
Having a pension from a private employer will not affect your Social Security benefits, since you will have paid FICA taxes during your working years. However, pensions from government jobs will generally reduce Social Security benefits. Many people spend time working in both covered and non-covered employment during their working years. Thus they may be eligible for both Social Security and a public pension. Depending on your circumstances, the SSA may use a modified formula for calculating your benefits. In this case, you will most likely receive a lower benefit. The various sources of retirement income can be confusing, but it's important to understand the ones that apply to your situation. That's the best way to ensure a secure retirement.