The literacy of retirement plans pays off to your prospects
April was Financial Literacy Month, and why you’ve probably seen financial planning articles like: B. Set goals, track expenses, increase savings and understand concepts like “diversification” and “compound interest”. Some articles may even have suggested that by following the authors’ advice, you can “become a millionaire” by the age of Social Security.
While these articles might be helpful, the Pension Rights Center takes a different route. Instead of the standard advice, we offer a multi-part series that discusses financial issues that you may not find elsewhere, to tell you what you need to know when you have access to a retirement plan at work and hope you have one To have a safe and dignified retirement one day.
In this first part of the series (the rest continues online at pension-rights.org) we will answer one of the top five questions that people looking for a secure retirement often ask us. Unless otherwise stated, answers refer to company or union sponsored private pension plans. We believe that knowing financially about your retirement savings will pay off for your future.
Question: What is a retirement plan and how does it differ from a retirement plan like a 401 (k)?
For employees who are entitled to benefits, a retirement plan (also known as a defined benefit plan) is the best financial tool available to help them achieve a secure retirement. Pension plans are set up by an employer (or a group of employers and a union) and typically provide a lifelong income at retirement age based on the number of years you have worked and a percentage of your salary. Employees don’t have to choose whether to put money in most private retirement plans. The employers pay the contributions as part of the wage package.
Unfortunately, fewer employers these days offer defined benefit plans. They are most common in unionized private sector sectors, as well as with state, local and federal employers. In a recent briefing report, the RRF Foundation for Aging said, “The private sector has not adequately supported worker savings and pensions, which are seen as a critical pillar of late-life security, are becoming rarer.”
Retirement plans such as 401 (k) s (also known as defined contribution plans) provide benefits based on the amounts deposited and the investment income. Since these savings accounts are designed to provide retirement income, early withdrawals before the age of 59 usually result in a penalty tax of 10%. To encourage contributions, many employers offer to adjust the contributions of their employees.
An important difference between a retirement plan and a retirement plan is who bears the risk of potential investment loss. In a retirement plan, an employee typically chooses between various investment options and bears the risk of loss. In other words, individual workers need to decide if and how much to contribute, what investment strategies to use, and then develop a sensible strategy to ensure their money lasts through the retirement years.
In a retirement plan, that risk rests entirely with those who fund the plan, usually with the employer, who has to pay a certain benefit according to a formula set by the plan’s advisors, regardless of how the plan’s investments go. Federal Pension Benefit Guarantee Corp. provides coverage for most defined benefit plans that are unable to pay what they promised. This protection covers an employee’s pension benefits up to a specified limit. If a plan elects to sell the plan assets to an annuity insurer that it is legally entitled to, the pensioners’ annuity payments are made by the insurance company. If the insurance company defaults, retirees receive protection up to the limits prescribed by their state’s insurance guarantee fund.
There is no federal or state insurance coverage for assets in retirement plans.
The Department of Labor has an information sheet that explains the differences between retirement and retirement plans, with-profits, and 403 (b) plans. You can find this at https://www.dol.gov/general/topic/retirement/. Types of plans.
David B. Brandolph is the Senior Communications Advisor for the Pension Rights Center. For more information and the continuation of the series, visit pensionrights.org.