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A pension is a defined benefit retirement plan. In a defined benefit plan, the amount of money the employee will receive is specified and the amount of money contributed can vary. The pension plan also specifies how the employee benefit is calculated. Usually, the benefit in retirement is a function of how long the employee worked for the company, how much the employee earned and how old the employee is when he retires.
Contributions to pension plans can be made by the employer or the employee. Employee contributions usually are made via salary reduction. Employer contributions are made on behalf of the employee to the pension plan. The money of all employees is pooled, and this money is invested for long-term growth and to pay benefits to all retirees.
Vesting is the rate at which
benefits become fully owned by the employee and cannot be forfeited. Employees are always 100 percent vested in their own contributions, but not in the employer's contributions. Vesting schedules vary by retirement plan. They may be graduated so the employee becomes more vested each year until becoming 100 percent vested, or vesting schedules may have "cliffs," which allow the employee to becomes fully vested during a specific year of employment.
For cliff vesting in a defined benefit pension plan, pensions can require that an employee have at least five years of service to become 100 percent vested in the plan. For graduated vesting, the plan can require an employee to work seven years before becoming fully vested. However, the employee must be at least 20 percent vested after three years, 40 percent after four years, 60 percent after five years and 80 percent after six years.