Pensions are retirement plans that provide a regular income to individuals after they retire. There are several types of pensions, each with its own characteristics and features.
The main categories of pensions are:
- Defined Benefit Pension Plans: Defined Benefit Pension Plans are traditional employer-sponsored retirement plans. Under these plans, employers commit to paying a fixed, predetermined benefit to retirees based on factors such as salary, years of service, and age at retirement. The responsibility for managing the plan and investment risks lies with the employer. Employees can look forward to receiving a regular monthly income throughout their retirement years, providing stability and peace of mind.
- Examples of Defined Benefit Plans: Union pensions, Multi-Employer Pensions, Pensions through Large Companies
- Defined Contribution Pension Plans: Unlike Defined Benefit Plans, Defined Contribution Pension Plans involve both employer and employee contributions. Employers typically match a percentage of an employee's contribution or contribute a specific amount to individual retirement accounts. Common examples include 401(k) plans in the private sector and 403(b) plans for employees of educational and non-profit organizations. The retirement benefit depends on the total contributions made and the investment performance of the retirement account.
- Examples of Defined Contribution Plans: 401(k), 403(b), Thrift Savings Plan, IRA
- Cash Balance Pension Plans: Cash Balance Pension Plans are a hybrid retirement plan that combines elements of both Defined Benefit and Defined Contribution Plans. Employees have individual accounts similar to a Defined Contribution Plan, but the employer credits a percentage of the employee's salary to the account each year, along with a guaranteed interest rate. This plan offers portability, as employees can take the accumulated balance as a lump sum or an annuity at retirement.
Below you’ll find types of pension plans that fit the above categories:
- 401(k) Plans: 401(k) plans are one of the most common types of Defined Contribution Plans offered by private sector employers. Employees can contribute a portion of their pre-tax income to their 401(k) accounts, and employers may offer a matching contribution up to a certain percentage of the employee's salary. Contributions and earnings in a 401(k) grow tax-deferred until withdrawal during retirement.
- 403(b) Plans: 403(b) plans are similar to 401(k) plans but are typically offered to employees of non-profit organizations, public schools, and certain tax-exempt organizations. They also allow employees to contribute a portion of their pre-tax income to the account, and employers may offer a match or other contributions.
- 457 Plans: 457 plans are tax-advantaged retirement plans available to government employees, such as state and local government workers and employees of some tax-exempt organizations. These plans allow employees to contribute a portion of their pre-tax income to the account, and contributions and earnings grow tax-deferred.
- Individual Retirement Accounts (IRAs): IRAs are an example of a common Defined Contribution Plan. They are usually personal retirement accounts that individuals can open independently. Traditional IRAs offer tax-deferred contributions, meaning contributions are made with pre-tax dollars, and earnings grow tax-deferred until withdrawal during retirement. On the other hand, Roth IRAs use after-tax dollars, and qualified withdrawals are tax-free. Both IRAs have contribution limits and specific eligibility requirements.
- Self-Employed or Solo 401(k): Designed for self-employed individuals and small business owners without employees, Solo 401(k) plans allow higher contribution limits compared to traditional 401(k) plans. They offer both employee and employer contribution options, providing substantial retirement savings potential.
- Government Pensions: Government employees, including federal, state, and municipal workers, are often offered government pension plans. These Defined Benefit Plans provide retirement income based on an employee's years of service and salary history. Government pensions offer secure retirement benefits for eligible public servants.
- Military Pensions: Members of the armed forces who complete the required years of service are eligible for military pensions. Military pensions are similar to government pensions, providing retirement income based on years of military service.
- Thrift Savings Plan (TSP): The Thrift Savings Plan is a Defined Contribution Plan available to federal employees and members of the uniformed services in the United States. Employees can contribute to the plan, and the government may offer matching contributions for certain employee contributions.
Dividing a pension in a divorce can be complicated depending on what type of pension is being divided. Each plan comes with its own set of features, benefits, and considerations. It's essential to understand what is being divided if you are trying to decide which ones to divide and which ones to offset the value of. Seeking advice from an attorney knowledgeable about pensions might be the best way to ensure the right steps are taken during the divorce to protect you.