Pensions 101: What Is a Pension, and How Does It Operate?

January 11, 2018

If you read the previous blog in this series, you’re now armed with a quick and dirty history of the public pension system (TL;DR: The concept of a pension plan, otherwise known as a defined benefit plan, is way older than you think).

OK, so you’ve gotten a general idea of where the concept of an income that continues after one has finished working comes from. But are you still struggling with understanding what a pension plan is exactly? If so, you’re not alone; the topic is ripe for confusion and miseducation—which is kind of the reason we wanted to embark on this in-depth educational series in the first place.

If you’re a public employee in Colorado, chances are high that you receive your retirement benefit through the Colorado Public Employees’ Retirement Association (PERA)—the state’s public pension plan. So, here’s the 411 on how a pension, like that provided by Colorado PERA, operates (spoiler: it’s a pretty cool retirement option).

A pension plan/defined benefit plan provides a fixed, pre-established benefit to employees in retirement. It’s a retirement account in which your employer does all the heavy lifting (not too shabby, eh?), including ponying up the money and deciding where to invest it. What do you do? Well, you need to show up to work, and contribute a percentage of your paycheck to the retirement account—although whatever you pay in to the system will be far less than what your employer pays in on your behalf. You also need to commit to sticking with your employer for a certain period of time in order to become “vested” in your plan; otherwise, you might end up forfeiting some benefits (due to the hybrid nature of Colorado PERA’s plan, this stipulation translates a little differently for our members…but we’ll get into that more in the next blog).

So with a defined benefit plan, I just need to show up to work. Got it. But then what? What do I get when I’m finally able to retire?

We’re so glad you asked. Once you’re eligible to live the good retirement life, you’ll receive from your pension/defined benefit plan a fixed payout as either a lump sum or monthly check. The amount of that payout has nothing to do with how much your employer liked you, or how well your employer’s investments performed. Rather, it’s a function of a basic formula that takes into account, among other things, how long you worked, and how much you earned (often the last year or last few years' average pay). In other words, your benefit is defined by a set formula. Eureka, I get it now!

It’s a sweet deal, but unfortunately, pension plans have largely become a thing of the past—at least when it comes to the private sector. The percentage of workers in the private sector whose only retirement account is a defined benefit plan is about 4% (down from 60% in the early 1980s). In the public sector, though, it’s a different story; traditional pensions are still offered by about 84% of state and local governments—including right here in the Centennial State.

So basically, if you work for a PERA employer in the state of Colorado, you’ve got a pretty good thing going with your retirement benefit. How good exactly? Well, you’ll have to wait until next week to find out…