While retirement signals the end of your need to go to work every day, it doesn’t signal the end of your need for income. Intelligent and responsible planning for retirement is essential to being able to enjoy your golden years to the fullest.
There are plenty of retirement savings and investment options, but perhaps the most reliable is a pension. It’s the surest way to provide yourself with a guaranteed income once you stop commuting to work every day. And it’s in your best interest to know how to make the most of one or what to do if you don’t have one.
Aren’t Pensions a Thing of the Past?
Not yet, but this is becoming increasingly true. In the early 1980s, over 80% of full-time workers at large corporations were participating in defined-benefit pension plans. Recent data from 2018 puts the participating number of full-time private-sector employees at just 16%.
Pensions aren’t gone, though. Many public employers still offer them, there are plenty of alternatives, and it’s worth understanding how they work.
What Are Pensions?
A pension is a retirement plan which requires employer contributions in order to fund a pool that will be used for the future benefit of the employee. This often takes the form of a monthly income after retirement.
Some pension plans also allow employee contributions. In these cases, the employee can make voluntary investments in the pension fund. Sometimes, employers will match contributions made by an employee up to a certain dollar amount.
There are two main types of pension plans: defined-benefit pensions and defined-contribution pensions.
Defined-Benefit Pensions
With this type of pension plan, the employee is guaranteed a definite payout upon retirement, regardless of the performance of the investments made.
The employee can usually choose between two payout options: a monthly annuity or a lump sum. Some companies even offer the chance to receive some of the funds as a lump sum and the rest as monthly payments.
The defined benefit pension is uses a formula that takes into account the following information: your number of years of service with the company and your earnings.
The employer is liable for ensuring that employees receive their defined benefits. So, if the assets in the pension plan aren’t adequate to provide the employee with their benefit upon retirement, the company is liable for covering the remaining payment.
This is the traditional pension plan. And 94% of public employees had access to defined-benefit plans in 2018, in contrast to 16% of private-sector employees.
Which is Better: A Monthly Annuity or a Lump Sum?
It’s important to consider this your options carefully. Once you make a decision, it’s final.
Monthly Annuity
Within the category of monthly annuities exists the option for a single-life annuity or a joint and survivor annuity. In the former, you are the only recipient of the monthly annuity. These payments will cease after your death.
The joint and survivor annuity pays a smaller amount each month, but your spouse will continue to receive payments after your death. Another option for providing for your spouse after you pass is purchasing a life insurance policy that will provide for your spouse.
It’s worth mentioning that it is possible for your pension fund to run out of money and your monthly annuity could stop. Fortunately, the Pension Benefit Guarantee Corporation (PBGC) could help you out in this scenario by paying a portion of your monthly annuity. The PBGC is a federal agency that encourages and looks after defined-benefit pension plans in the private sector.
Another thing to consider when deciding whether to take a lump sum or a monthly annuity is inflation. Some pension plans include inflation protection, but if yours doesn’t, the monthly payments you receive will probably end up being less valuable than they were when you retired.
Lump-Sum
The other option for accepting payment for your pension is in the form of a lump sum. There are a number of advantages and disadvantages associated with this option.
One benefit of receiving a lump sum is that you won’t have to deal with the possibility of your pension plan running out of money. This can also be a good option if your pension plan doesn’t include inflation protection — you won’t have to worry about your money losing value over time (provided you do something with it).
With a lump-sum payment, you have the additional benefit of the option to reinvest it. You could even get a higher interest rate on the money, increasing your wealth in retirement.
The potential risk with this option is that it’s up to you to make the right decision with the money. A monthly annuity ensures you’ll have an income for the rest of your life; a lump-sum requires you to make sure that happens.
It’s also important to mention that, unless you put the money into an IRA or another account that offers tax benefits, the entire amount you receive will be taxable. This could potentially put you in a higher tax bracket.
Defined-Contribution Pensions (401k Plans)
The defined-contribution plan differs from the previous plan in that the financial benefit received from the employee in retirement is not guaranteed. Instead, it’s based on the performance of the investments made in the pension plan. These are also known as 401k plans.
In this case, the employer fulfills their responsibility by matching the employee’s contributions to the pension up to a certain percentage or dollar amount. After contributions are matched, the employer is no longer liable for the benefits the employee receives.
This pension plan is much less expensive for the employer and is preferred by many private corporations.
How Can I Get a Pension?
Pensions are unique in their ability to guarantee a monthly income after retirement, and this makes them super desirable. Unfortunately, short of searching for a job with a company that offers a traditional pension, your options are limited to finding alternatives.
Government jobs are those that most frequently offer a pension. Nowadays, most private corporations offer 401k plans instead. While the 401k plan was initially developed as an offer in addition to a pension, it’s now often used in place of one. It’s simply cheaper and less risky for the employer.
If you want the benefits of a traditional pension in retirement, but your employer doesn’t offer one, it’s up to you to figure out how to best fund your retirement. Fortunately, there are quite a few options.
If you want to be sure you’re taking advantage of the best options available to you, you can always seek out expert guidance in planning your retirement.
Traditional Alternatives to Pensions: 401k, IRA, Social Security
Whether or not you have access to a traditional defined-benefit pension plan through your employer, you’ll most likely also have the opportunity to benefit from a 401k plan, an IRA, or social security.
401k Plans
We’ve already spoken briefly about 401k plans, but for many people, they make up a crucial piece of the retirement puzzle.
Even though they require you to assume the risk in investing for retirement, the option to have your employer contribute money on your behalf is an opportunity that shouldn’t be overlooked. In the absence of a traditional pension plan, determining how much of your paycheck you should be contributing to your 401k is something to consider carefully.
Individual Retirement Account (IRA)
An IRA is similar to a 401k, but without employer contributions. IRAs offer great tax benefits that depend on the type of IRA you open.
A traditional IRA defers tax on the money you contribute to the account. This can lower your taxable income for the year and put you in a lower tax bracket.
Contributions to a Roth IRA, on the other hand, are not tax-deductible. Instead, this type of account lets you reap tax benefits in the future. The withdrawals you make from your Roth IRA will be tax-free. This is especially useful if you expect to be in a higher tax bracket when you’re making withdrawals from the account.
Social Security
Social security is another form of guaranteed income in retirement, and it’s provided by the government.
How much money you receive in social security benefits depends on several factors, including how old you are when you decide to start collecting them and how much money you made during your working life.
While you can begin to accept social security benefits as early as age 62, you’ll receive a higher monthly payment the longer you wait, up to age 70. How long you should wait depends on your personal situation, but it’s often advisable to wait as long as possible. You can increase your monthly payments by up to 32% this way.
How much you earned while working also affects how large your benefits are. Social security payments are based on how much money you made during your 35 highest-earning years.
It’s important to remember that social security benefits are taxable. Your financial situation will determine just how much they are taxed.
Guidance on Your Retirement and Wealth Management
However you choose to plan for retirement to protect your wealth, remember that professional guidance will provide you with the best options available to you. The right wealth management partner will make these options clear and easy to understand. This way, you can choose the investments that will serve you best.
Finding a financial advisor who takes the time to get to know you and treats your financial decisions with respect is the wisest move you can make. Schedule a meeting with us here to learn more. We look forward to discussing your goals with you.