What Is a Deferred Pension and How Does It Work?
Understand what a deferred pension is, how it's preserved and grows, and the process for accessing your future retirement benefits.
A pension is a retirement plan where an employer promises a specific monthly income amount to an employee upon their retirement. Unlike a 401(k) where employees and employers contribute to an investment account, a pension places the investment risk and management responsibility primarily on the employer.
Understanding Deferred Pensions
A deferred pension is an earned retirement benefit that an individual is entitled to receive in the future but is not yet collecting. This situation commonly arises when an employee leaves a company before reaching the plan’s normal retirement age, or if the pension plan itself undergoes a termination. In contrast, an immediate pension begins payments shortly after an employee retires directly from the employer, without a waiting period.
The most frequent reason for a pension becoming deferred is when an employee changes jobs after being “vested” in their previous employer’s pension plan. Vesting means the employee has worked long enough, typically five years of service, to earn a non-forfeitable right to a future pension benefit. Even though the employment relationship ends, the individual retains a legal claim to the pension benefits earned during their tenure. Federal law (ERISA) establishes standards that protect these earned benefits for private industry pension plans.
Another scenario leading to a deferred pension occurs if an employer terminates its pension plan. In such cases, vested participants’ benefits are often frozen at the point of termination. If the plan is underfunded, the Pension Benefit Guaranty Corporation (PBGC), a federal agency, may step in to ensure that participants receive their benefits, though there are statutory limits on the amount the PBGC guarantees. Individuals might also have a deferred pension if they retired early but opted to delay receiving payments until a later, specified age, as allowed by their plan.
Managing Your Deferred Pension
Once a pension becomes deferred, it continues to exist as a future obligation of the former employer or the plan administrator. The value of a deferred pension can grow over time, though the method of growth depends entirely on the specific rules outlined in the pension plan document. Some plans may credit the deferred benefit with a fixed interest rate, while others might link its growth to investment returns of the plan’s assets. A few plans may also include provisions for cost-of-living adjustments (COLAs), which can increase the benefit amount periodically to help offset inflation.
It is important for individuals with a deferred pension to maintain current contact information with their former employer or the pension plan administrator. Individuals should proactively update their address, phone number, and email whenever they change, as misplaced details can hinder benefit payments.
Pension plan administrators are required to provide periodic statements to deferred participants. These statements usually detail the accrued benefit, a projection of the future benefit at retirement age, and contact information for the plan administrator. Reviewing these communications helps individuals track their benefit’s value and ensures that all records are accurate. The Summary Plan Description (SPD), a document required by ERISA, provides detailed information about how the deferred benefit is calculated and managed.
Receiving Your Deferred Pension
Individuals typically become eligible to begin receiving their deferred pension benefits upon reaching the plan’s stated normal retirement age. Many pension plans also offer an option for participants to elect to receive reduced benefits at an earlier age, such as 55 or 60, provided they meet the plan’s specific early retirement criteria. The exact eligibility ages and reduction factors are detailed in the plan’s official documents.
When it’s time to claim a deferred pension, individuals generally have several payout options. A common choice is a single life annuity, which provides a fixed monthly payment for the lifetime of the retiree. For married individuals, a joint and survivor annuity is often the default option under federal law, unless waived by the spouse; this option provides payments for the retiree’s life and then continues, often at a reduced percentage, to a designated beneficiary after the retiree’s passing.
Some pension plans may also offer the option to receive the entire vested benefit as a single, lump-sum payment, as determined by the specific pension plan’s rules. Regardless of the distribution method, pension payments are generally considered taxable income for federal and potentially state income tax purposes. If a lump sum is received, rolling it over into an Individual Retirement Account (IRA) or another qualified retirement plan can defer taxation until funds are withdrawn from the IRA.