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What Is A Pension? 

A pension is an amount of money paid the government or a private company regularly pays to a person who does not work anymore because they reached a certain age.

Deeper Definition

A pension is a retirement fund that a person receives from their former employer after retiring due to reaching a certain age. Part of the funds used in pension payouts may come from a percentage saved from the employee’s salary during their active years.

Broadly, there are two types of pensions a person may be entitled to when they retire:

1. Defined-benefit plan: This type of pension guarantees retirement benefits for employees. The Defined-benefit plan, otherwise known as a pension plan, is majorly funded by employers. It uses a set of formulas that consider an employee’s salary, age, and tenure to determine the retirement payouts.

A company might offer a plan that pays 1% of the employee’s average salary. This would be for the last five years of their employment for every year they worked at the company. An employee who worked at the company for 30 years and earned an average salary of $70,000. In the last five years would receive a payout of $21,000.

2. Defined-contribution plan: The source of funds in this type of pension is from employee contributions while in active service. In many companies, employees contribute a fixed amount or a percentage of their salary to an account intended to fund their retirements. In some cases, the company will make contributions matching a portion of or all the savings as an added benefit.

For instance, an employee participated in a company’s pension scheme that involved a deduction of 1.5% of their salary. Assuming the employee saved $18,000 from the plan, the company may contribute another $18,000.

Pension Example

Michael worked in a technology company for 20 years. His employment contract stipulates he must work for at least 5 years to be entitled. The pension is 2% of his salary for the years spent at the company. Having worked for 20 years, Michael would receive the benefits. If his average salary is $70,000, he will receive a payout of $24,000.

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