Pensions

A pension, in the way most people use the word, is a defined benefit plan: an employer's promise to pay you a fixed monthly amount for the rest of your life after you retire. You do not pick the investments, you cannot outlive the payments, and the plan, not you, absorbs bad markets. That structure is the mirror image of a 401(k), where the balance belongs to you but so does every decision and every risk.

Pensions have grown scarce in private industry while remaining standard in government. As of 2022, 15 percent of private industry workers had access to a defined benefit plan, compared with 86 percent of state and local government workers ¹. Many surviving private plans are "frozen," meaning employees keep the benefits they have already earned but stop building new ones. Even so, the Pension Benefit Guaranty Corporation (PBGC), the federal insurer of private pensions, protects plans covering about 30 million workers and retirees ².

If a pension is part of your retirement, most of the consequential decisions arrive near the end of your career: when to start payments, whether to trade the monthly check for a lump sum, and how much protection to leave a spouse. Each of those choices is permanent, so it helps to understand the machinery before the paperwork shows up.

How the benefit is calculated#

Most defined benefit plans use a three-part formula: a multiplier set by the plan, your years of credited service, and an average of your salary over your final or highest-paid years, often the highest three or five. A plan with a 1.5 percent multiplier pays a 30-year employee with an $80,000 final average salary an annual pension of 1.5 percent times 30 times $80,000, which works out to $36,000 a year, or $3,000 a month, for life.

The details vary a lot from plan to plan. Multipliers commonly run from 1 to 2.5 percent, with public safety plans at the high end. Most private plans set a normal retirement age of 65; starting payments earlier usually triggers a reduction for each year you are short of that age, though some plans subsidize early retirement for long-service workers. Cost-of-living increases after retirement are common in public plans and rare in private ones, so a private pension's buying power typically erodes over a long retirement. In a frozen plan, the service or salary clock has stopped, and the benefit you see on your statement is close to what you will get.

Unlike a 401(k) balance, none of this depends on how the plan's investments perform. The employer funds the promise and makes up shortfalls. Public employees usually chip in a percentage of salary as well.

Vesting: when the benefit is yours to keep#

Vesting is the point at which the employer-funded benefit belongs to you even if you quit the next day. For private defined benefit plans, federal law allows two basic schedules: cliff vesting, in which you are 0 percent vested until you complete five years of service and 100 percent vested after, or graded vesting, which must reach at least 20 percent after three years and rise 20 points a year to 100 percent after seven ³. Plans can be more generous, not less. Government and church plans are exempt from these federal minimums, and public plans often require five to ten years.

Leave before vesting and the employer-funded benefit is gone. Leave after vesting and you hold a deferred vested pension: a benefit, frozen at your departure salary and service, payable when you reach the plan's retirement age. People forget these. If you have an old pension, keep the plan informed of your address, save your benefit statements and summary plan description, and check PBGC's unclaimed pension search and the Department of Labor's lost and found database for retirement benefits, created under the SECURE 2.0 law, if you have lost track of a plan.

Sources for this section: [3]

Lump sum or monthly annuity#

Many private plans, and a growing number of public ones, let you take the benefit as a single payment instead of a lifetime check. The lump sum is the present value of your future payments, calculated with interest rates and mortality tables prescribed by the IRS. The arithmetic means the two move in opposite directions: when interest rates rise, lump sum offers shrink, and when rates fall, they grow. Employers also run occasional buyout windows for former employees and increasingly transfer whole plans to insurance companies, in which case a state guaranty association rather than PBGC stands behind the annuity.

Neither answer is right for everyone. The monthly check tends to suit people in good health, with longevity in the family, who want a floor of guaranteed income and no investment chores; a payment that arrives every month is also easy to budget around. The lump sum tends to attract people with serious health problems, substantial other guaranteed income, or a strong wish to leave money to heirs, and it turns the pension into a portfolio problem, covered in retirement withdrawal strategies. A lump sum can also be used to buy a commercial annuity, which converts it back into lifetime income at market prices.

Caution: If you take a lump sum, having it paid directly to you rather than rolled into an IRA or other retirement account triggers mandatory 20 percent tax withholding, and a 10 percent early withdrawal penalty can apply before age 59 1/2. A direct rollover avoids both and keeps the money growing tax-deferred.

Survivor options#

Federal law makes a qualified joint and survivor annuity the default for married participants in private plans: after you die, your spouse continues to receive between 50 and 100 percent of your benefit, depending on the option, for the rest of their life ⁴. Because the plan expects to pay over two lifetimes, the starting check is smaller than a single-life annuity. A typical menu includes single life, joint and 50 percent, joint and 75 percent, and joint and 100 percent, with each step of extra protection lowering the monthly amount.

Choosing the higher single-life payment requires your spouse's written consent, witnessed by a notary or plan representative ⁴. That rule exists because widows were once routinely left with nothing when a retiree's pension stopped at death. Plans also provide a preretirement survivor annuity to a vested worker's spouse if the worker dies before payments begin. Some advisers pitch "pension maximization," taking the single-life option and buying life insurance instead; it can work on paper but leaves the survivor exposed if the policy lapses or the insurance proves unaffordable later. In a divorce, a court order called a QDRO can divide pension rights between the spouses, which matters for estate planning and settlement talks.

Sources for this section: [4]

When a plan fails: PBGC insurance#

PBGC was created by the Employee Retirement Income Security Act of 1974 and is funded by premiums paid by plans and by the assets of failed plans, not by general tax revenue ². When a single-employer plan runs out of money, typically in an employer bankruptcy, PBGC takes it over and keeps paying benefits up to legal maximums that depend on your age when the plan fails.

The straight-life figure comes to $93,477 a year ⁵. The cap is lower if you start benefits before 65 and higher if you start later. Most people in failed plans receive everything they earned, because their benefit sits below the cap; the limits mainly bite high earners, early retirees, and people whose plans promised recent benefit increases, which are only partly guaranteed.

Multiemployer plans, the union-negotiated plans that pool many employers, carry a separate and far lower guarantee: 100 percent of the first $11 of the monthly benefit rate per year of service plus 75 percent of the next $33, a formula that tops out at $35.75 a month per year of service, or $12,870 a year for a 30-year worker ⁶. That formula is not indexed for inflation. A 2021 federal law provided special financial assistance that shored up the most troubled multiemployer plans for decades. PBGC does not insure government plans at any level, most church plans, or pensions already transferred to insurance companies.

Sources for this section: [2] [5] [6]

Public pensions and private pensions#

Public plans differ from private ones in more than generosity. Employees almost always contribute several percent of pay, benefits often include automatic cost-of-living adjustments, and the legal protection comes from state constitutions and statutes rather than PBGC insurance. Funding health varies widely by state and city, which is why public pension debates flare up in state budgets. Federal workers hired since 1984 are covered by FERS, which pairs a modest pension with Social Security and the Thrift Savings Plan; the older CSRS system stood in for Social Security entirely.

One quirk still shapes public retirees' planning: about a quarter of state and local government employees, roughly 6.5 million workers as of 2018, are outside Social Security altogether because their government employer never joined the system ⁷. Teachers in states such as California, Texas, Ohio, and Massachusetts are the best-known examples. Their pensions substitute for Social Security, which is why two federal offset rules mattered so much for so long.

Sources for this section: [7]

The WEP and GPO repeal#

For four decades, two provisions cut the Social Security checks of many government retirees. The Windfall Elimination Provision (WEP) used a less generous formula for people who earned a pension from non-covered government work but also qualified for Social Security through other jobs. The Government Pension Offset (GPO) reduced spousal and survivor benefits by two-thirds of a non-covered government pension, and often eliminated those benefits entirely. Between them, the two rules reached several million teachers, firefighters, police officers, postal workers, and other public employees.

The Social Security Fairness Act, signed on January 5, 2025, repealed both provisions retroactive to benefits payable for January 2024 ⁸. The Social Security Administration recalculated benefits and, by July 2025, had sent more than 3.1 million retroactive payments totaling $17 billion, with higher monthly checks flowing from the spring of 2025 onward ⁸. For public pensioners the practical effect is simple: Social Security benefits are now figured under the same rules as everyone else's, with no reduction for a government pension. If you delayed claiming or never applied because WEP or GPO would have wiped out the benefit, the calculation has changed, and the tradeoffs in when to claim Social Security now apply to you at full strength. Pension income itself remains taxable as ordinary income in most cases; how that interacts with other income is covered in taxes in retirement, and how a pension fits alongside savings and Social Security is part of broader retirement planning.

Sources for this section: [8]

RetiredWiki. (2026, July 6). Pensions. https://retiredwiki.com/article/pension