Pension plans are likely to be on the endangered species list as a retirement savings vehicle. With fewer companies offering such plans and current companies cutting back or eliminating pensions altogether, it is important that you have a clear idea for the role your pension could play in your retirement saving strategy.
For many pre-retirees, a pension may play a significant role in your retirement plan which is why we are bringing you a series dedicated to answering top questions about your pension including tips and strategies to consider.
Before we dive into that, let’s start at the beginning and outline what a pension plan is and how it works.
The pension basics
A pension plan is a retirement savings vehicle designed to provide you, the employee, guaranteed monthly checks in retirement. The system was created to help employees supplement retirement income after working for a company for many years.
Many companies offered pension plans as incentives to attract and retain top performers. You are likely to find pension plans in government, public service, and larger companies.
A pension plan is unique because the employer contributes money on the employee’s behalf throughout their time at the organization. The amount of money contributed is based on a few factors:
- Your age
- Your length at the company
- Your role, level of responsibility, and overall compensation
In general, pension income grows depending on your role, responsibility, and time with the company. For example, someone working at the same company for 30 years may be entitled to a larger pension than someone who was only there for 10 years.
Each company’s pension is unique but all pension plans must adhere to the rules stipulated by the Department of Labor, which outline the amount of money that an employer is obligated to put away each year in order to provide a defined amount in the future.
Taxes and pensions
Nearly all benefits from your pension plan are taxable. Since you receive a monthly check, that money is taxed as ordinary income making it an important part of your tax planning strategy. Taxes can present many hurdles for new and seasoned retirees, so making a strategic plan will help make your taxes work for you in retirement as opposed to the other way around.
When you start taking your benefit, you will need to determine if you should have taxes withheld from your payment. If a portion of the money was contributed with after-tax dollars, some of your benefits may remain tax-free. Be sure that you know how your unique pension plan is structured to make a tax plan that fits it.
The pension problem
Even though a pension is designed to provide guaranteed income in retirement, that isn’t always the case. If the company declares bankruptcy or the underlying portfolio doesn’t perform as expected, benefits could be cut down or cut out completely.
Most private pensions, however, are insured, which can help the employee retain all or some of their benefits should something happen to the company. In general, a pension offers the employee a far lower amount of risk as opposed to other workplace retirement plans like a 401(k).
With a 401(k), the employee takes on the responsibility of contributing part of their paycheck to the account and inheriting the risk of the investment portfolio. The employer can offer a match, which is often a percentage of the paycheck up to a certain point, but that amount is far less than they would put into a pension.
The power of your pension
As we discussed earlier, this series is designed to educate our readers on understanding their pension and how to make the right choice for using it in retirement. While there are many facets of a pension, over the next couple of months we are going to tackle the following four questions:
- What options do you have for taking your pension?
- What happens when your company gets rid of your pension?
- Should you take a pension buyout?
- How does your pension factor into your retirement plan?
Each of these questions seeks to tackle a different element of your pension plan with the goal to help you better understand and feel more confident in how your pension plan can impact your retirement.
We would love to speak with you about your unique pension plan and how it will fit into your retirement savings strategy. See you here next time as we tackle our first question in the series!