About the Pension Guide
In this guide, we cover the basics of pensions: what they are; how much money you'll need to have in order to retire; defined-benefit plans; defined-contribution plans; and what to do if you're not covered by an employer-sponsored plan at all. While this guide provides an overview and general advice, we encourage you to seek the advice of a qualified financial advisor in order to receive specific information about your individual financial situation.
What is a Pension?
Retirement savings plans are available as defined-benefit and defined-contribution plans. Defined-benefit plans are pension plans that pay retirees a set benefit each month after retirement. Defined-contribution plans have a set contribution amount but not a set benefit. According to government statistics, roughly one-half of private sector employees are covered by a retirement savings plan. And twice as many who are covered by a plan are covered by a defined-contribution program than by a defined-benefit program, which for the most part are being phased out by all but the largest of corporations.
As you can imagine, this means there is the potential that 50% of Americans won't have the amount of money they need in retirement. And this just isn't the amount of money they need to be comfortable. It's the amount they'll need for basic living expenses such as food, shelter, and medical costs.
For anwsers to the common pensions questions, visit the Pensions FAQ.
How Much Money You'll Need in Retirement
It's hard to estimate just how much money you'll need to retire because you can't reasonably predict future costs and taxes, and you certainly can't predict how long you'll live. It's also hard to predict if you'll need more or less money in retirement than when you were working. For example, many new retirees, especially those who are relatively young and healthy, may spend more on travel in the early years of retirement, which means they could spend more than they did when they were working. And elderly retirees almost always spend more on healthcare and medical expenses than they did when they were younger.
In general, a good rule of thumb is to have at least 10 times your highest annual salary set aside in retirement savings. If you are fortunate enough to have a defined-benefit plan, don't look past this advice and think you don't have to save money for retirement. Employers who start defined-benefit programs are allowed under certain circumstances to discontinue them. And, it's always possible that an employer will not have enough set aside to pay the obligations for all retirees. While these plans are insured by the Pension Benefit Guaranty Corporation, 100% of funds are not always guaranteed.
In the end, it's up to you to ensure you that you have enough money saved for your retirement needs. Taking steps to put together a budget and meeting with a qualified financial planner are two of the ways you can take control of your finances.
Defined-benefit plans provide for a specific and promised benefit after retirement. The amount of the benefit is usually based on a formula that calculates the number of years of service, highest pay grade achieved and in some cases, highest level of service. For example, a corporate officer may be eligible to receive a larger percentage of his or her highest salary than a non-officer.
For more details, visit the Defined Benefit Plans page.
Defined-contribution plans such as 401(k)s are funded by both the employer and the employee. The employee makes regular contributions via payroll deductions and the employer matches the contribution up to a certain percentage. At retirement, the amount of money that's available will be based on how much has been saved and how well the investments have done. The onus rests squarely upon the shoulders of the employee, not the employer.
Follow these guidelines in order to get the most out of your defined-contribution.
First, make sure you contribute enough to take advantage of your company's matching contribution. Not contributing at least this amount is probably the number one mistake employees make. Always contribute at least the amount of your employer's match. In other words, if your employer will contribute up to 4% of your salary, you must at least contribute 4%. In doing so, you'll maximize the amount of free money you'll be receiving each year by getting an immediate 100% return on your money.
Second, choose funds based on your needs. If you're nearing retirement, consider shifting your investments to less risky bond funds rather than holding only aggressive growth funds.
Third, take advantage of the "catch up" contribution if you're age 50 or over. If you don't want to establish a separate IRA or Roth IRA, make the additional contribution to your employer-sponsored defined-contribution account.
Fourth, diversify your investments. In other words, don't put all of your financial eggs in one basket. Make sure that you are diversified among different asset classes and categories within those classes.
Finally, understand how your own personal level of risk tolerance affects your investment choices. Stay away from highly aggressive funds if you can't sleep at night because you're worried about losing money. Alternately, stay away from ultra-conservative funds if you're young and have decades to go before retirement.
For more details, visit the Defined Contribution Plans page.
Annuities and Personal Pensions
For the 50% of American workers who do not have access to either a defined-benefit or defined-contribution pension plan, an annuity might be the answer for stable retirement income. Sometimes called "personal pensions", annuities are contracts that guarantee a set benefit based on the amount of money that's used to purchase it, the length of the term, and the age of the annuitant. For example, an annuity that guarantees lifetime income will be a set amount each month regardless of how long the annuitant lives.
Annuities that are sold to provide guaranteed income for life offer a predictable stream of income that is protected from market volatility. This is much different than a defined-contribution plan that is subject to market volatility based on the types of investments that have been chosen. Even less risky bond funds are subject to fluctuations in prices and yields, which will determine how valuable the assets are and how much income they provide. Annuities can also be very simple for the annuitant because he or she does not have to manage funds, watch the market, or worry about the underlying investments.
When it comes to pensions, the more you know, the better able you'll be to protect yourself and your investments. If you have access to a defined-benefit plan, make sure you have additional accounts to offset any changes that may occur with that plan. If you participate in a defined-contribution plan, make sure to education yourself about what your employer contributes and the types of funds that are available. Finally, realize that even if you are funding a 401(k) or have a healthy pension plan in place, you should still be funding an IRA or a Roth IRA account each year on the side. If you don't have access to either type of pension, funding an IRA is critical, and you should also consider a personal pension in the form of an annuity.
While we've covered the basics of pensions here, there is much more to developing a solid retirement plan. To make sure you're on the right track, contact a licensed financial advisor. It only takes a few minutes, Start Now.