Today, millions of American workers depend on company pensions to help fund their retirement years. Pension benefits, combined with Social Security and personal savings, are the primary components of retirement income.
If you or your spouse are eligible to receive a pension, hopefully, it will figure prominently in your retirement. However, pension laws are complicated, so it is important to learn the facts about your company’s pension plan to make sure you obtain the benefits to which you are entitled.
There are two basic types of pension plans: a defined benefit plan is typically funded entirely by the company and provides a specified benefit. The amount is a percentage of pre-retirement pay that factors in years of service. A defined contribution plan is usually funded by a combination of employer and employee contributions. Total contributions and the investment returns over the years will determine the amount of the benefit.
Questions to Ask
If you are covered under a pension plan, there are some general questions you should ask your employee benefits specialist if you do not already know the answers:
- What are the eligibility requirements? Most defined benefit pension plans require employees to meet age and service requirements before they can participate.
- When do your benefits become vested? In other words, when do your benefits belong to you, whether or not you keep working for the same employer?
- How is your pension benefit amount calculated?
- Will those benefits increase once they begin?
- How much money can you expect to receive? Is that amount “integrated” with Social Security benefits? (“Integration” refers to a practice whereby employers may reduce the amount of pension benefits by the amount of Social Security benefits the retiree is receiving.)
- When can you elect to retire under the plan? How will your pension be affected if you retire early or continue working past age 65?
- Has the employer funded the plan on a regular required basis?
- Has the employer ever asked for a funding waiver from the IRS?
- What happens to your pension benefits if you leave your job for a period of time to return to school, have a baby, care for an elderly relative or other reason?
Decisions to Make
You have three decisions to make when it comes to your pension. They involve:
- Dependent protection. If you are vested and married, a joint and survivor annuity payment option with regular payments continuing on to your spouse after your death may be automatically chosen for you. Many options also entitle benefits for a period certain of 10 or 20 years. In this case, benefits are paid to a beneficiary for this period even if you and your spouse are deceased. Another option might be a single life annuity, for which payments end at your death. Although a single life annuity will provide larger monthly payments than other options, electing this option means that you are gambling on outliving your spouse and his or her ability to survive economically without either you or your pension.
- Lump sum or monthly payments. You may have a choice, at retirement, between regular monthly payments or a lump sum payout of your future pension benefit based on an actuarial calculation.
- Tax treatment. How you receive your pension funds affects the amount of tax that will be due. If you receive your pension in monthly installments, those installments (except for your own after tax contributions) are subject to income tax in the year in which they are received. A lump sum may be taxed all in one year.
Finally, what if you determine the projected amount of your retirement income will not be enough for you to support the type of retirement you want? Taking action now by increasing your personal savings, particularly in a defined contribution plan, can help you reach retirement feeling more financially secure.
If your employer offers a 401(k) plan, for example, consider investing as much as you can afford into the plan if you are not already doing so. Because you invest with pretax money, you can also lower your current tax liability. You might also consider other financial tools to supplement your retirement income, such as IRAs, annuities, mutual funds and/or life insurance.
As you evaluate your pension benefits and other options in preparing for your retirement years, make sure you take advantage of the guidance available from financial, insurance and other professional advisers. Their expertise can prove to be invaluable in helping you determine which option is best for you given your individual situation. IBI
