A Guide to Pensions & Retirement Benefits

How much do you really know about retirement benefits?

If you’re like most Americans, it’s not that much. In fact, most of us have fairly poor “retirement literacy,” especially when it comes to the finer points of retirement benefits.¹

That may not seem like a big deal, but it can give rise to all sorts of landmines in the future, possibly derailing your retirement plans and goals. It could also impact your quality of life and your opportunities to live your best life in retirement.²

To minimize the risks of that happening, this guide to retirement benefits and pensions breaks down the ins and outs of various types of income for retirees, covering key points, including:

• What are retirement benefits?
• Types of retirement benefits
• Advantages of pensions
• Disadvantages of pensions
• Tips for choosing a retirement plan

This guide to retirement benefits can get you up to speed with some fundamentals in less than 10 minutes.

What Are Retirement Benefits?

Retirement benefits are financial resources designated as income for someone who has worked and started their life as retirees. Typically amassed while in the workforce, retirement benefits are intended to replace wages, and they can come from various sources, including:

• Government programs, like Social Security
• Employer-sponsored plans, like pensions and 401(k) plans
• Personal savings and investments, like IRAs

The primary goal of retirement benefits is to ensure financial security for individuals when they are no longer earning a regular income from employment. This financial security helps retirees maintain their standard of living, cover essential expenses, and enjoy their retirement years without the stress of financial instability. Retirement benefits are crucial for addressing various needs, such as healthcare costs, housing, daily living expenses, and leisure activities. Additionally, these benefits provide a safety net against unforeseen circumstances, such as medical emergencies or economic downturns. By carefully planning and utilizing these benefits, retirees can achieve a more predictable and stable financial future, allowing them to focus on enjoying their retirement rather than worrying about financial constraints.

Types of Retirement Benefits

Retirement benefits can take various forms, with some of the more common types including:

• Pensions: Pensions are typically employer-sponsored retirement plans that provide a fixed income to retired employees, based on their salary and years of service. As a specific type of retirement benefit, pensions are often associated with “vesting” periods, and they can be paid on a monthly basis or in lump sum payments.
   
• 401(k) plans: These plans allow employees to save and invest part of their salary, often with matching contributions from their employer. The funds in these accounts grow tax-deferred until they are withdrawn during retirement.
   
• Individual retirement arrangements (IRAs): As investment vehicles for saving independently of an employer, IRAs can offer various tax advantages while diversifying retirement benefits and an overall investment portfolio. Essentially, that can make IRAs a viable way to build a substantial nest egg.
• Roth retirement accounts: Roth retirement accounts provide unique tax advantages by allowing investments to grow tax-free.
  • Roth IRAs: Contributions to Roth IRAs are made with after-tax dollars, which means withdrawals during retirement are tax-free, provided certain conditions are met. This can be particularly advantageous for individuals who anticipate being in a higher tax bracket during retirement.
  • Roth 401(k)s: Similar to traditional 401(k) plans, Roth 401(k)s allow employees to contribute a portion of their salary. However, contributions are made with after-tax dollars, and qualified withdrawals in retirement are tax-free. Employers can also match contributions, but the match goes into a traditional 401(k) account.
• More: Employee stock plans, special annuities, and government pensions are just a few of many other types of retirement benefits. Some sectors, like the public service and non-profit sectors, can have their own distinct options here too.

Well-rounded retirement plans tend to include multiple income streams, providing for more than one type of retirement benefit to support an individual’s financial future.

Now, let’s take a deeper dive into pensions specifically, looking at their pros versus potential cons.

Advantages of Pensions

Pensions are among the more popular types of retirement benefits for good reason. These financial plans have long been a cornerstone of retirement security, providing a reliable source of income for many retirees. Unlike other retirement savings plans, pensions are designed to offer a steady, predictable stream of income that can last throughout one's retirement years. This stability is a significant factor in their popularity. Specifically, some key advantages of pensions include that they are associated with:

1. Steady income streams: Traditional pension plans can provide “guaranteed” income in retirement. Unlike other retirement savings plans that depend on market performance, pensions can offer a more stable, predictable source of income, ensuring financial security throughout retirement.
    
2. Employer contributions: Pensions are typically funded by employer contributions, which means employees do not have to put as much of their own money into pension plans when compared to other retirement savings plans, like 401(k)s or IRAs. This can significantly ease the financial burden of building up pensions during working years.
    
3. Risk mitigation: With pensions, the investment risk is generally borne by the employer or the pension plan provider, not the employee. The flip side of the coin here is defined contribution plans (DCPs), which tend to put the investment risk on the individual while making more volatile markets particularly challenging.
    
4. Spousal and survivor benefits: Many pension plans offer spousal and survivor benefits, providing a means for the retiree’s spouse or dependents to continue to receive income in the event of the retiree’s death. This feature can provide additional peace of mind and financial security for many retirees and their families.

Pensions, therefore, represent a crucial element of retirement planning for many individuals. The guaranteed income, employer contributions, risk mitigation, and spousal and survivor benefits collectively make pensions a highly valued component of financial security in retirement. These advantages highlight why pensions remain a preferred choice for many retirees seeking a stable and reliable income stream. As the landscape of retirement planning continues to evolve, the enduring benefits of pensions underscore their importance in ensuring long-term financial well-being for retirees and their families.

Disadvantages of Pensions

As useful and crucial as pensions can be in a retirement plan, there may be some potential drawbacks associated with these types of retirement benefits. As useful and crucial as pensions can be in a retirement plan, it is important to acknowledge that they may come with certain potential drawbacks. These disadvantages can impact the overall effectiveness and flexibility of pension plans, especially when compared to other types of retirement benefits. Understanding these drawbacks is essential for anyone considering relying heavily on a pension for their retirement income. Those can include:

1. A lack of portability: Pensions are often tied to a specific employer, making them less portable than other retirement benefits. In the event of frequent job changes, employees could lose out on pension benefits they’ve accrued with previous employers.
    
2. Funding and solvency risks: Pension plans can rely on the financial health of the sponsoring organization. If a company is under increasing economic challenges or financial difficulties, the risk of underfunded pensions can spike.
    
3. Limited control: Employees have little to no control over how pension funds are invested, as these decisions are typically made by the pension plan administrators. This lack of control can be less than ideal for anyone who prefers a more hands-on approach to managing their investments.
4. Low Return on Investment – In our experience pensions often offer a low internal rate of return on investment, many times between 3%-4% annually. That means, instead of annuitizing the pension and taking payments, you could instead take a lump sum option and invest the proceeds on your own. All you would need to do to create the same payment stream would be to annualize the very low return baked into the pension.

While pensions offer numerous advantages, it is important to be aware of their potential drawbacks to make informed retirement planning decisions. Considering factors like portability, funding risks, control over investments, and the rate of return can help individuals evaluate whether a pension aligns with their financial goals and circumstances. By understanding both the benefits and limitations, retirees can better navigate their options and ensure a secure and well-rounded retirement strategy. Balancing a pension with other retirement savings plans may provide a more flexible and resilient financial future.
 

Inflation risk: Many traditional pension plans do not automatically adjust for inflation, meaning the purchasing power of the pension income can erode over time. Without cost-of-living adjustments or other retirement benefits, retirees may find their pension income insufficient to cover rising expenses in the future.

With these disadvantages, it’s essential to keep in mind that:

• Different people may be more or less vulnerable to these possible drawbacks.
• There may be options for limiting or mitigating these disadvantages to leverage pensions in retirement plans with optimal success.

Tips for Choosing a Retirement Plan

The right retirement plan for you may not be the same as what’s best for your friends, colleagues, and anyone else. That’s because retirement can be a deeply personal event, influenced by individual goals, financial situations, and lifestyle preferences. Crafting a retirement plan that aligns with your unique needs and aspirations is crucial to ensure a fulfilling and secure retirement. The plans and steps you take in the lead-up to retirement can be crucial in setting the stage for your post-work life.

To help you make prudent moves now, use these three tips to dive into — or reconnect with — retirement planning:

1. Assess your financial goals: What do you want in retirement? Where do you want to be and what do you want to do when you retire? Consider your answers to these questions to start pinpointing your goals, expected expenses, and lifestyle in retirement. This can begin to dial in your big-picture objectives while showing you which savings instruments could be more beneficial.
    
2. Understand the fine print: Before opting into any retirement plan, get familiar with the terms, conditions, and key rules regarding contributions, withdrawals, loans, and penalties. Each retirement plan has its own set of regulations that can significantly impact your retirement savings. For instance, understanding the contribution limits helps ensure you’re maximizing your savings potential without exceeding legal limits. Knowing the rules about withdrawals, such as required minimum distributions (RMDs), can help you avoid hefty penalties and taxes. Additionally, some plans offer loan provisions that allow you to borrow against your savings under specific conditions, but these loans often come with strict repayment terms. By thoroughly understanding these details, you can make more informed decisions and avoid common pitfalls that could jeopardize your retirement income.
    
3. Diversify: To minimize any potential risks, diversify your retirement savings across different types of accounts. This can potentially provide some insulation from market fluctuations and other uncertainties. Diversification means spreading your investments across various asset classes, such as stocks, bonds, real estate, and cash equivalents, to reduce risk. Each type of investment reacts differently to market conditions, so a mix can help balance your portfolio's overall performance. For example, if the stock market experiences a downturn, your bonds or real estate investments might not be as affected, helping to stabilize your overall retirement savings. Additionally, consider including both tax-deferred accounts, like traditional IRAs or 401(k)s, and tax-free accounts, like Roth IRAs, in your portfolio. This mix can provide flexibility in managing your tax liabilities in retirement. By diversifying, you create a more resilient financial strategy that can adapt to changing market conditions and personal needs.

Retirement benefits can shape your life as a retiree, offering financial stability, reliable income, and more comfort in your post-work life. No matter when you start retirement planning — or when it’s time to take a fresh look at the plans and strategies you’ve been relying on — the more you know about retirement benefits, the better.

Beyond that, turning to a trusted financial professional can help too, keeping you on track as life changes, so you’re better prepared to set yourself up for your dream retirement.

SOURCES

1. https://www.theamericancollege.edu/knowledge-hub/retirement-income-literacy-study
2. https://insights.theamericancollege.edu/rils-key-findings/knowledge-areas

This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.