Eddy’s HR Mavericks Encyclopedia
The world's largest free encyclopedia of HR, with 700+ HR articles and podcasts.
Created by Eddy and our HR Mavericks community.
Pension
Does your company offer a pension? Or is that a 401(k)? Are they the same thing? Which one should you offer and how can you be compliant either way? Read on to learn all you need to know about pension plans.
What Is a Pension?
A pension plan is often referred to as a defined benefit plan in some HR circles. Pensions are typically primarily funded by the employer. Your company guarantees and manages the funds in the pension plans for employees until they reach a retirement age and are eligible to access the funds in their pension account. The important pension plan takeaway is that the employer guarantees the employees will receive a set amount of money once the vesting requirements are met by the participant upon retirement. Some plans require 1 year of service to be fully vested while others offer vesting at seven years. No matter the duration, once that period of time is met, the funds are guaranteed to the employee upon retirement age.
Pension Plan vs. 401(k) Plan
The differences between a pension plan, commonly called a defined benefit plan, and a 401(k) plan, called a defined contribution plan, are substantial, and they will help you keep them separate. The 401(k) plans are not guaranteed funds or considered a stable income, as they depend on where they are invested and the stability of the market when the employee retires. Pension plans require that a set income is established and is guaranteed by the employer. Another difference is that pension plans are managed by the employers and are not transferable when you leave the organization, while 401(k) plans are managed by the employee and can roll into a retirement account at a new organization. More often than not due to these differences, pension plans have longer and more in-depth vesting requirements, like 10% invested after 1 year, 30% after 2, all the way up to 100% vested at 7 years to ensure employees stay with the organization before they have to commit to a large amount for life. 401(k) vesting periods are usually shorter and less complex.
Should Companies Offer Pension Plans?
The decision to offer a pension plan for your organization can take legwork and planning to drill down. Let’s look at some pros and cons of offering this to get you started.
Pros of Offering a Pension Plan
Pension plans can offer great benefits to your organization, let’s review them below.
- Retention. Depending on the duration of the vesting period for your pension plan, employees will be more inclined to stay at your organization longer to receive that lifelong pension benefit.
- Recruiting advantage. While some military, union and state and local government jobs still offer pensions, most private sector companies do not. With the addition of a pension plan to your organization, you’re giving yourself a major recruiting advantage as you search for the top talent.
- Tax advantages. If your organization has followed all the requirements outlined by ERISA and the Internal Revenue Code Section 401(a) that clarify the requirements of pension plans, your organization could receive tax benefits for offering this to your employees.
Cons of Offering a Pension Plan
While we have seen the attractive pros of offering a pension plan, there are also some cons. Let’s consider those below.
- Bankruptcy risk. While most pension plans are insured so that if your organization goes under, your employees' funds are not diminished, the risk of bankruptcy due to the pension requirements can be great. With the amount your organization is investing towards employee pensions, the risk of bankruptcy can increase.
- Employer burden. Due to the nature of pension plans, this can be a greater administrative burden on you as the employer. You’ll want to ensure you have the appropriate parties to assist with ERISA law that regulates retirement benefits, and consistently stay on top of changes.
- Non-transferrable. One of the least attractive parts of the pension plan is that it’s not transferable. As the employer, you’ll have to continue to be the administrator on the plan until the employee can withdraw it at retirement age.
How to Implement a Pension Plan
Now that you understand a bit more about the pension plan, let’s look at the steps to take if your organization wants to implement one for your employees.
Step 1: Consult a Tax Professional
Do not proceed before you have completed this step thoroughly. While you may have done your research on pension plans and read up on the applicable laws and IRS requirements, always get a professional opinion. Reach out to a tax professional with experience in retirement plans and establish the positives and negatives for establishing this for your organization. Lay it all on the line with this individual or organization to ensure you’re moving forward in the right direction.
Step 2: Decide 401(k), Pension or Both
At this step, understand all the reasons why you would move forward with the pension plan over the 401(k) plan or if you want to offer both to your employees. Some organizations that offer pension plans still offer 401(k) plans, as they are mostly run by the employee and the risk to the organization is lower. Evaluate things like the administrative burden to offer pension plans over 401(k) plans, what the load would be if you offered both, and the financial burden this would bring to your organization. Once you evaluate thoroughly, you can move on to the next step.
Step 3: Set Your Budget
Pension plans are funds guaranteed by your organization, so you’ll want to be comfortable with the amount you’re establishing. Your tax professional may have specific recommendations. Take those into account and look at the big picture for your company to establish what would be best. Set a budget you’re comfortable with even if your company hits a rough patch but is still attractive for employees. Perhaps you establish a 5 year vesting period and pay out 10% of the annual salary every month to employees when they are eligible. Ensure this amount would still be feasible for entry level employees as well as highly compensated employees.
Step 4: Establish Guidelines
Once you complete the steps above, you can write the guidelines of your pension plan. Consider how your organization will be making contributions, how you will keep the plan up-to-date with changing laws, who manages the assets and which employees are eligible. Make sure the guidelines are clearly defined and run them by your tax professional to ensure they are compliant with legal requirements. Clearly detail them in your benefits package for employees.
Step 5: Administer the Plan
Now is the fun part! Get to market and administer the plan to employees with excitement! Pension plans are a wonderful benefit to offer your employees. Be sure that as you’re caught up in the regulations and administration work, you can recognize and articulate the wonderful benefit you’re providing.
Best Practices for Pension Plan Administration and Compliance
Let’s review a few best practices for your pension plan to maintain compliance before you set one up for your organization.
Continual Training
It goes without saying, training can be invaluable, especially with something as fluid as pension plans. Provide administrators of the pension plan continual training to further their knowledge, comfort and confidence as they maintain them for your organization. Action Step: Attend an in-person training on pension plans local to your organization. What a great way to get employees involved as a team and learn more about these plans all in one.
Continually Evaluate Effectiveness
While you may have jumped in or believe you’re ready to jump into a pension plan, it may not make sense forever. If you offer a pension plan from 2015-2022, that doesn’t mean you’re locked in to offering it for the rest of your company's existence. Yes, you’re required to honor the pension for the employees from 2015-2022, but best practice would suggest that you evaluate the effectiveness of the plan moving forward regularly. Action step: Run a risk assessment to see how your company is doing on their profits and if the pension plan is providing more pros than cons.
Topics
Shalie Reich
Shalie has over 4 years of experience working in a variety of HR positions and organizations including: working as an HR department "of one", working with a start-up based in Europe, to working in a fully established robust USA based HR department. Shalie has experience in multiple states and countries with all aspects of the HR spectrum. She has a passion to share her knowledge and experience to benefit the HR profession!
Frequently asked questions
Other Related Terms
Eddy’s HR Mavericks Encyclopedia
Pension
Does your company offer a pension? Or is that a 401(k)? Are they the same thing? Which one should you offer and how can you be compliant either way? Read on to learn all you need to know about pension plans.
What Is a Pension?
A pension plan is often referred to as a defined benefit plan in some HR circles. Pensions are typically primarily funded by the employer. Your company guarantees and manages the funds in the pension plans for employees until they reach a retirement age and are eligible to access the funds in their pension account. The important pension plan takeaway is that the employer guarantees the employees will receive a set amount of money once the vesting requirements are met by the participant upon retirement. Some plans require 1 year of service to be fully vested while others offer vesting at seven years. No matter the duration, once that period of time is met, the funds are guaranteed to the employee upon retirement age.
Pension Plan vs. 401(k) Plan
The differences between a pension plan, commonly called a defined benefit plan, and a 401(k) plan, called a defined contribution plan, are substantial, and they will help you keep them separate. The 401(k) plans are not guaranteed funds or considered a stable income, as they depend on where they are invested and the stability of the market when the employee retires. Pension plans require that a set income is established and is guaranteed by the employer. Another difference is that pension plans are managed by the employers and are not transferable when you leave the organization, while 401(k) plans are managed by the employee and can roll into a retirement account at a new organization. More often than not due to these differences, pension plans have longer and more in-depth vesting requirements, like 10% invested after 1 year, 30% after 2, all the way up to 100% vested at 7 years to ensure employees stay with the organization before they have to commit to a large amount for life. 401(k) vesting periods are usually shorter and less complex.
Should Companies Offer Pension Plans?
The decision to offer a pension plan for your organization can take legwork and planning to drill down. Let’s look at some pros and cons of offering this to get you started.
Pros of Offering a Pension Plan
Pension plans can offer great benefits to your organization, let’s review them below.
- Retention. Depending on the duration of the vesting period for your pension plan, employees will be more inclined to stay at your organization longer to receive that lifelong pension benefit.
- Recruiting advantage. While some military, union and state and local government jobs still offer pensions, most private sector companies do not. With the addition of a pension plan to your organization, you’re giving yourself a major recruiting advantage as you search for the top talent.
- Tax advantages. If your organization has followed all the requirements outlined by ERISA and the Internal Revenue Code Section 401(a) that clarify the requirements of pension plans, your organization could receive tax benefits for offering this to your employees.
Cons of Offering a Pension Plan
While we have seen the attractive pros of offering a pension plan, there are also some cons. Let’s consider those below.
- Bankruptcy risk. While most pension plans are insured so that if your organization goes under, your employees' funds are not diminished, the risk of bankruptcy due to the pension requirements can be great. With the amount your organization is investing towards employee pensions, the risk of bankruptcy can increase.
- Employer burden. Due to the nature of pension plans, this can be a greater administrative burden on you as the employer. You’ll want to ensure you have the appropriate parties to assist with ERISA law that regulates retirement benefits, and consistently stay on top of changes.
- Non-transferrable. One of the least attractive parts of the pension plan is that it’s not transferable. As the employer, you’ll have to continue to be the administrator on the plan until the employee can withdraw it at retirement age.
How to Implement a Pension Plan
Now that you understand a bit more about the pension plan, let’s look at the steps to take if your organization wants to implement one for your employees.
Step 1: Consult a Tax Professional
Do not proceed before you have completed this step thoroughly. While you may have done your research on pension plans and read up on the applicable laws and IRS requirements, always get a professional opinion. Reach out to a tax professional with experience in retirement plans and establish the positives and negatives for establishing this for your organization. Lay it all on the line with this individual or organization to ensure you’re moving forward in the right direction.
Step 2: Decide 401(k), Pension or Both
At this step, understand all the reasons why you would move forward with the pension plan over the 401(k) plan or if you want to offer both to your employees. Some organizations that offer pension plans still offer 401(k) plans, as they are mostly run by the employee and the risk to the organization is lower. Evaluate things like the administrative burden to offer pension plans over 401(k) plans, what the load would be if you offered both, and the financial burden this would bring to your organization. Once you evaluate thoroughly, you can move on to the next step.
Step 3: Set Your Budget
Pension plans are funds guaranteed by your organization, so you’ll want to be comfortable with the amount you’re establishing. Your tax professional may have specific recommendations. Take those into account and look at the big picture for your company to establish what would be best. Set a budget you’re comfortable with even if your company hits a rough patch but is still attractive for employees. Perhaps you establish a 5 year vesting period and pay out 10% of the annual salary every month to employees when they are eligible. Ensure this amount would still be feasible for entry level employees as well as highly compensated employees.
Step 4: Establish Guidelines
Once you complete the steps above, you can write the guidelines of your pension plan. Consider how your organization will be making contributions, how you will keep the plan up-to-date with changing laws, who manages the assets and which employees are eligible. Make sure the guidelines are clearly defined and run them by your tax professional to ensure they are compliant with legal requirements. Clearly detail them in your benefits package for employees.
Step 5: Administer the Plan
Now is the fun part! Get to market and administer the plan to employees with excitement! Pension plans are a wonderful benefit to offer your employees. Be sure that as you’re caught up in the regulations and administration work, you can recognize and articulate the wonderful benefit you’re providing.
Best Practices for Pension Plan Administration and Compliance
Let’s review a few best practices for your pension plan to maintain compliance before you set one up for your organization.
Continual Training
It goes without saying, training can be invaluable, especially with something as fluid as pension plans. Provide administrators of the pension plan continual training to further their knowledge, comfort and confidence as they maintain them for your organization. Action Step: Attend an in-person training on pension plans local to your organization. What a great way to get employees involved as a team and learn more about these plans all in one.
Continually Evaluate Effectiveness
While you may have jumped in or believe you’re ready to jump into a pension plan, it may not make sense forever. If you offer a pension plan from 2015-2022, that doesn’t mean you’re locked in to offering it for the rest of your company's existence. Yes, you’re required to honor the pension for the employees from 2015-2022, but best practice would suggest that you evaluate the effectiveness of the plan moving forward regularly. Action step: Run a risk assessment to see how your company is doing on their profits and if the pension plan is providing more pros than cons.
Topics
Shalie Reich
Shalie has over 4 years of experience working in a variety of HR positions and organizations including: working as an HR department "of one", working with a start-up based in Europe, to working in a fully established robust USA based HR department. Shalie has experience in multiple states and countries with all aspects of the HR spectrum. She has a passion to share her knowledge and experience to benefit the HR profession!
Frequently asked questions
Other Related Terms
Eddy's HR Newsletter
Sign up for our email newsletter for helpful HR advice and ideas.
