DBP Annuities...
A pension, also called a defined benefit plan, is a form of an annuity that is offered by employers to their employees. Annuities can provide a steady, fixed amount payment, with pensions lasting for life. Pensions are typically funded with a combination of employer and employee contributions taken directly from paychecks. Pension plans allocate contributions to investments and use the proceeds to fund current pension payments. The amount paid by a pension will usually depend on factors such as how long the employee worked and their level of pay. In addition to company pensions, Social Security (SS) is another form of an annuity.

Pension Pitfall
As SS was not designed to be the sole source of income during retirement, pensions can help bridge the cash flow shortfall left by SS alone. However, fewer workers are fortunate enough to have a pension. For decades, employers have been moving away from providing pension plans, replacing defined benefit plans with defined contribution plans such as the 401k. In 1980, 38% of private sector workers were covered by a pension plan. Now, that number has fallen to around 15%. Public sector workers such as teachers and union members currently make up the majority of pension-holders. Also, like SS, pensions do not replace 100% of your salary. For the average American, advisors commonly recommend having around 80% of your working-years income during retirement. For some, a pension combined with SS may be adequate, while others will need to fill the gap from other income sources.

Three Legged Stool
Researchers, as well as pension providers for institutions and the Social Security Administration, consistently recommend having another source of income in retirement in addition to SS and pensions. For example, the Employees Retirement System of Texas (ERS) states that in addition to a pension, “employees are encouraged to contribute to personal retirement savings”. They also state a pension is “only one part of a financially secure retirement”, and is “unlikely” to support retirees by itself. The ERS also states that retirees should “plan to have at least two other sources of income in retirement”. The combination of a pension, SS, and income from personal retirement assets is often called the three-legged stool. The importance of this third leg, personal investments, is perhaps effectively and directly described in a joint publication released by the Department of Labor, the Social Security Administration, and the Centers for Medicare & Medicaid Services. The document says “if you have a 401(k) or other retirement savings plan at work, sign up and contribute all you can.” It goes on to say “don’t touch your retirement savings” and “the longer you leave the money there, the more time it has to grow”.

Make a Plan…
For around 40 percent of Americans, SS is the only source of income they receive in retirement, which reveals that many do not plan for retirement. Those who are fortunate enough to have a pension will have less of an income gap to fill in retirement. Many employers who mandate pension plan participation also offer defined contribution plans, such as 401k or 403b plans. Using these work-based accounts or individual IRAs to invest for retirement may be a good way to strengthen the third leg of a retirement portfolio. However, even if a pension combined only with SS is adequate, a plan is still needed to confirm it will be enough and to provide a guide for spending. Creating a retirement plan will provide an opportunity to answer questions such as:
How much will your pension payments be and when do they start? What are your other sources of income besides your pension? How much will you need in retirement compared to how much your pension will pay? Working with a financial professional to make a retirement plan may be helpful in exploring potential possibilities.

April 3, 2024