Pension
A pension is a retirement income arrangement, most commonly a defined benefit plan, under which an employer promises to pay former employees a regular income for life beginning at retirement, funded through contributions made during the employee's working years.
The word 'pension' is often used interchangeably with 'defined benefit plan,' though technically a pension can refer to any systematic retirement income stream. In common U.S. usage, it refers to the traditional employer-funded retirement benefit in which a formula — usually based on years of service and final or average salary — determines a guaranteed monthly payment for the rest of the retiree's life, and often for a surviving spouse as well.
Private-sector pensions are regulated primarily under ERISA, which sets minimum standards for plan participation, vesting schedules, funding requirements, and fiduciary duties. ERISA requires plan sponsors to fund promised benefits on an actuarially sound basis, using assumptions about investment returns, mortality rates, and salary growth. Actuaries certify plan valuations annually, and underfunded plans are required to make additional contributions to reach target funding levels.
The Pension Benefit Guaranty Corporation, established by ERISA in 1974, insures benefits in private-sector defined benefit plans up to legislatively determined maximums. If a plan terminates with insufficient assets — typically because the employer has gone bankrupt — the PBGC takes over the plan and continues paying benefits up to the guaranteed limit. For 2024, the maximum PBGC guarantee for a participant retiring at age 65 is $7,107.95 per month under the single-employer insurance program.
Public-sector pensions — covering federal, state, and local government workers — operate under different legal frameworks. Federal civilian employees hired after 1983 participate in the Federal Employees Retirement System (FERS), which combines a defined benefit component, Social Security, and the Thrift Savings Plan. State and local government plans are not covered by ERISA and vary widely in their benefit generosity, funding requirements, and governance structures.
Pension income is generally taxable as ordinary income in the year received. However, if an employee made after-tax contributions to a pension during their career, a portion of each payment represents a return of those contributions and is excluded from gross income under the IRS's Simplified Method. Pension benefits are also typically not subject to the 10% early withdrawal penalty that applies to distributions from IRAs and 401(k)s, though payments made before age 55 upon separation from service in certain governmental plans may have different rules.