Financial security in retirement is an important target for most working-age adults. There are many ways to reach that goal. An employer-sponsored retirement plan often comes in the form of a defined contribution plan, where employees contribute pre-tax or Roth dollars from their paycheck to a retirement account and select the investment optionsto help grow the balance. Many employers offer to match a certain level of contributions to encourage participation in the plan (and to provide a valuable employment benefit).
There is another type of retirement account called a defined benefit pension plan. Under a defined benefit plan, the employer contributes to a pool of funds set aside for a worker’s future benefit. Pension income is calculated as a percentage of your salary during your working years. That percentage depends on the terms set by your employer and your time with the employer. A worker with decades of tenure at a company (or government entity) may get upward of 85% of their salary in retirement. An individual with less time under their belt, or with a less generous employer, may only receive 50%.
Both types of plans help employees build toward a successful retirement, but the risk profile of the two is different. Under a defined contribution plan, the employee bears all the risk. After all, it is up to the employee to select the investments for their nest egg, and the ultimate benefit or account balance is not guaranteed. With a defined benefit plan, the risk rests primarily with the plan sponsor. For more deferred compensation information, be sure to read our previous article on the topic.
There is a lot of talk in the news about the dwindling access to pension, so if you have one, consider yourself fortunate. Pensions grew in popularity during World War II and became mainstays in benefit packages for government and unionized workers. While pension plans remain common in the public sector, they have mostly been replaced by defined contribution plans in the private sector.
Types of Employee Compensation and Pensions in the United States
It is critical to understand your benefits even before you embark on that daunting and exciting first day at a new job. It is estimated that about 30% of total compensation comes in the form of benefits[i]. Health insurance, life insurance, and paid time off are important, and so too is an opportunity to grow your nest egg.
A solid pension plan sponsored by the employer can supplement other retirement savings, such as investments in an Individual Retirement Account (IRA) and Roth IRA. If the individual leaves the employer, he or she can roll over the pension account into an IRA (if the plan allows for it and those benefits have been fully vested).
While 401(k) plans and pension plans may be some of the more common retirement savings plans, you may have other options available to you. Hybrid and cash balance plans are defined benefit plans in which the company promises to make certain payments to the employee in the future, with a defined contribution feature in which the account balance is shown to the plan participant as an accrued benefit. An employee often receives an annual employer contribution based on his or her salary, and the account earns interest over time.
The Keogh plan (or HR10, which is the term that the IRS uses for this type of plan) is a plan available to self-employed individuals. It features both defined contribution and defined benefit features. These plans allow for employee and employer contributions that can be made. Many sole proprietors use the Keogh plan as their primary retirement plan. The account can hold stocks, bonds, mutual funds, and ETFs.
Other types of qualified retirement plans include the SIMPLE IRA and SEP IRA. These accounts are established by small businesses and individuals who are self-employed. When discussing deferred compensation plans, it is critical to understand the difference between qualified and non-qualified plans.
A qualified plan meets the requirements of the Employee Retirement Income Security Act (ERISA); 401(k) or 403(b) plans are good examples. Qualified plans are required to have contribution limits, be open to any employee of the company(subject to certain restrictions) and be beneficial to all. They are also more secure, being held in a trust account.
A non-qualified plan is a written agreement between the company and an individual employee. Based on that agreement, a specific portion of the employee’s compensation is set aside, invested, and then given back to the employee in the future.
Employers who establish retirement plans for employees must adhere to the IRS’s Requirement of Permanence, whereby the government mandates that the plan is assumed to be ongoing and not temporary. This policy should reassure plan participants that their accounts are as secure as reasonably possible.
Importance of Retirement Planning
There are so many retirement plans, but the goal is the same across the retirement plan spectrum: to help position each employee for a financially stable retirement. Much of the benefit of retirement savings accounts lays in their automation. Once set up, the account will receive contributions without any direct involvement from the employee.
This arrangement makes it easier to save diligently and consistently during your working years. A successful retirement does not happen by accident. It takes years of work and a thoughtful plan. Saving for retirement early and leveraging a pension plan at the onset of one’s career are powerful ways to maximizing these employment benefits.
Pension Planning: Do I Need a Financial Advisor?
Driving away from the office for the very last time may seem like the ultimate joyful and stress-free event, but it is just the 50-yard line in your journey. You still have your entire retirement ahead of you. Careful planning must be done. In fact, many retirees struggle with the distribution phase. Shifting from saving to spending mode can be difficult, and there could be tremendous benefit in working with an experienced financial advisor.
That’s where SYM Financial Advisors can help. Our retirement planning and execution capabilities allow clients to enjoy retirement, understand their lifestyle needs, and address the new patterns of saving versus spending. Our financial advisors can help diversify your asset mix to present what we believe is the optimal balance of risk and return for you.
Our team is also mindful of taxes. SYM Financial Advisors can recommend tax strategies that can potentially lower the overall tax burden on retirement assets and income, so that you can enjoy your pension to the fullest. Managing taxable pension income and capital gains from other investments can help lower your tax bill in retirement.
SYM Financial — Pension Planning
SYM Financial Advisors is here to help. We can be your pension and retirement planning coach to ensure you make it not just to the 50-yard line, but all the way to the end zone to win the retirement game and achieve financial independence.