We have made it to the end of our pension series and today we will take some time to summarize the series. We will walk you through each of the questions we have answered and provide a brief explanation.
Let’s start with a general overview of a pension plan.
What is a pension?
A pension is a defined benefit plan that allows your employer to contribute funds on your behalf to be used for income in retirement. Pensions have historically been a great way for companies to attract and retain top talent and establish loyalty among employees.
The size of your pension fund is determined by a number of factors including your age, your position/role/salary, and time with the company. In general, the longer you work at a company, the better your pension will be.
Taxes are always an important factor in your financial life and your pension is no different. Nearly all of your pension benefits are taxed as ordinary income when you start receiving distributions in retirement. Be sure you include this in your tax planning.
How can you receive your pension benefits?
When you retire, you will have to make some choices in regards to receiving your pension benefits. In general, there are four options to consider:
- Single-life annuity
- Joint and Survivor options
- Period certain options
While you always have the option to take your benefits in the form of a lump-sum, it is important to think about the tax, longevity, and future benefits of that choice. For many people, managing that large amount of money comes with greater risk than reward. It is also important to know that in order to avoid a tax penalty and immediate income taxation, you will need to roll the funds over to an IRA.
Aside from the first choice, all of your distribution options come in the form of an annuity. An annuity is a product designed to provide guaranteed income. With your pension, the annuity income stream will pay you in installments for the remainder of your life.
A single-life annuity offers the highest monthly payment possible but doesn’t take into account your spouse or other dependents. Once you pass away, the payments stop, which can present a big financial burden to your family.
Many couples opt for the joint and survivor options which allow you to select 50% to 100% of your benefit to transfer to your loved one upon your passing. The difference between the 50% to 100% plans lies in the amount of money you get each month.
Period certain options allow you to receive a set amount of money each month while also securing a certain amount of time that your spouse will have access to the monthly benefit should you pass away. Usually, these plans come in 10, 15, or 20-year time frames. This means that if you purchase a 15-year plan and pass away 7 years into that plan, your spouse or dependent will receive your full monthly benefit for the remaining 8 years.
What if your company cuts your pension?
So many workers are faced with a significant drop in their pension benefits from companies freezing or terminating their existing plans. This has presented a huge problem for retirement planning, especially addressing the concern of having enough money to retire in the first place.
If you are in this situation, the first step will be to understand the state of your plan. If there are changes happening to your pension, it will most likely be in the form of freezing or terminating the plan altogether. If your benefits are frozen, that means new employees will not be able to enroll and current employees’ benefits will be suspended until that time, but since the plan is still active all payments (annuity or cash out) will still wait until retirement.
But if a plan is terminated, the employee will generally have the option to take a lump-sum of the money that has accumulated in the account now or defer to an annuity schedule in retirement.
This decision brings about many crucial conversations and considerations for your retirement planning including your current saving ventures, additional income streams, your retirement timeline, your retirement lifestyle goals, and current debt analysis. Be sure to work with your financial advisor to help create a plan that takes your entire financial picture into account.
Should you take a pension buyout?
So your pension plan is terminated or on shaky ground and your employer offers you a pension buyout, should you take it? A pension buyout gives the employee the full balance of their pension as it currently stands and releases the employer from their obligation for annuity payments in retirement.
Many advisors recommend not cashing out your pension balance, but in some cases, it makes a lot of sense. It all depends on you, your current retirement plan, and your goals. The first thing to look at is the stability of the pension plan. If the company isn’t doing well, they could declare bankruptcy and get out of their pension obligations, which has left many people with significantly decreased monthly benefits.
The next thing you will want to think through is your risk tolerance and investment goals. Are you interested in taking the money and investing it yourself or with your financial advisor? Is your current investment strategy working? Would that lump sum enhance or detract from your goals? Taking some time to think through how a lump sum will fit into or transform your investment strategy is a great way to determine if it makes sense for you.
You will then want to assess your life expectancy and overall health. If you are healthy and expect to live a long life, odds are that your annuity payments will give you more money over time than a lump sum will. But if you aren’t healthy or don’t have a long life expectancy, a lump sum could help you achieve the goals you set for yourself in retirement.
The last thing you want to think about is your general propensity for money management. A lump sum gives many people the temptation to spend more money. If this is the case, consider an annuity or working closely with your financial advisor to put a spending plan in place to help.
How does your pension fit into your retirement plan?
Your pension is only one piece of the puzzle. It is important that you diversify your investments to other retirement savings vehicles and work to create a strategy that factors in all of your income channels.
Other forms of income could be:
- IRA (Traditional or Roth)
- Social Security
- Home equity
- Brokerage accounts
- Real estate/rental properties
- Cash reserve
Remember, it is important to create a strategy for all of your income in retirement and we are here to help you do that.
How Goepper Burkhardt can help
We have enjoyed creating this series for you and look forward to pursuing other series like this one to bring you the knowledge, tools, resources, and confidence to create a financial plan that supports your goals, dreams, and lifestyle in retirement.
Give us a call to learn more about our firm and how we can help you today.