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Taking Charge | Defined Benefit Pensions
If there’s a good old plan, this is it.
If you’re part of a defined benefit pension plan, your employer puts money into a retirement fund in your name, chooses the investments the fund makes, and handles all the administrative details, including making the payments.
What You GetDefined benefit means that you get a specific amount of money when you retire. The amount is determined by a formula set out in the plan itself. Generally, it factors in your final salary, the number of years you worked at the job, and your age when you retire. Some plan may provide as much as 30% to 50% of your final salary at the standard retirement age of 65. There’s no law, though, that commits your employer to selecting a specific percentage or dollar amount when the formula for the plan is set up. If you retire early, you’ll probably receive less than you would have been eligible for at 65. If you work longer, the amount could be larger since you’ll benefit from added contributions. If you’re relying on your pension for a big chunk of your retirement income, you’ll probably want to take those factors into account. Income Options
When you’re ready to start collecting your pension, you’ll often have a choice about how to take your money. To figure out what’s best, you have to consider how much regular income you’ll need, the other income sources you can count on, and the tax implications of your choices. You should be able to get advice from your personnel office, but you’ll probably also want to discuss your options with your tax and financial advisors since your decision will have an impact on other areas of your financial life. Remember: You can’t change your mind. Once you’ve made a pension payout decision, there’s no going back. Time Pays
Defined benefit pensions reward time on the job. Employers frequently calculate the amount you’ll get by multiplying the years you’ve worked by .015, and then multiplying the result by your final salary. Based on this formula, the number of years you work can have a bigger impact on your pension amount than your final salary. For example, if your final salary were $55,000 after 30 years on the job, you’d get a bigger pension—$24,750 a year—than a co-worker earning $72,000 who’d been there 20 years—$21,600. A few years before your actual retirement date, you should be able to get an estimate of the amount you’ll receive by asking your employer. Though you might get an additional raise, you can be fairly confident that the final amount won’t be less than the estimate. The Inflation Dilemma
One of the biggest problems with defined benefit pensions is that when the fixed payouts stretch over a retired person’s lifetime or a husband and wife’s joint lifetime, they’re vulnerable to inflation. Corporate pensions and most pensions provided by educational, medical, and other not-for-profit institutions are rarely indexed for inflation. Unlike Social Security, where your benefit increases every year, your pension amount is likely to be set in stone. That’s one reason people sometimes choose a payout option that lets them invest for growth, using mutual funds, variable annuities or direct stock purchases. Integrated Plans
Integrated plans are pensions with a wrinkle. These plans count some of your Social Security income as part of your defined benefit, and reduce the pension amount you receive. While this policy may seem unfair, it’s legal because it recognizes that the employer contributed half of your Social Security taxes. So it pays to check if you’re part of such a plan. If you are, you’ll have an even greater incentive to build an investment portfolio that will help make up the difference. A Changing Landscape
Defined benefit plans are less common than they once were, as employers move away from the practice of providing guaranteed retirement income. One reason may be the complex rules that can make administering such a plan difficult. In addition, some existing pension contracts are being renegotiated, so that new employees will be eligible to receive less at retirement and will qualify at a later age. In addition, some traditional ways of boosting final salary to increase pension amounts, such as extra overtime and across-the-board cost of living increases, are being eliminated.
