PENSIONS AND OTHER DEFINED BENEFIT PLANS
As the name suggests , defined benefit plans provide the retired employee with a fixed (“ defined ”) monthly payment . Each organization will have its own formula for calculating the monthly benefit , but it ’ s typically based on such factors as years of service with the company , role and compensation . Most defined benefit plan benefits are taxable as ordinary income .
For retirement planning , the biggest advantages to defined benefit plans are that the monthly benefit is fixed and guaranteed . Because the amount is fixed , you know exactly how much you can expect every month in retirement , regardless of how the stock market is performing . Most plans are also insured by the federal government through the Pension Benefit Guaranty Corporation , so even if your company cannot meet its financial obligations , the PBGC will step in as needed .
If you have a defined benefit plan , it ’ s especially important to understand the details , including eligibility requirements , vesting and what happens to your pension if you retire early or switch jobs . In some cases , your pension benefit might be reduced when you begin to take Social Security .
Divorce and Widowhood If your spouse has a pension and you are a beneficiary , you can request a summary plan description from your spouse ’ s employer . That description would provide a list of benefits , including potential survivor or other benefits in the event of the death of your spouse . If you and your spouse divorce , you still might be able to secure a portion of your spouse ’ s pension benefit through a qualified domestic relations order . Contact your spouse ’ s plan administrator for a list of all QDRO requirements .
ANNUITIES
Social Security and pensions aren ’ t your only options for generating income for life . Annuities can provide monthly or annual income as well , although they are a complicated retirement savings instrument that ’ s not for everyone .
All annuities are built on a basic premise : The buyer purchases an annuity , and in return , the insurance company would provide guaranteed payments back to the buyer . Within that structure though can be a wide variety of options . With a fixed annuity , you know exactly how much the payments coming back to you will be , which can simplify the planning process , while income from variable annuities will fluctuate with the market , increasing the potential for return but also risk . With an immediate annuity , you would pay the insurer a lump sum ( like a retirement nest egg ) and start collecting payments right away , while with a deferred annuity , you don ’ t start receiving payments until a specified date , which gives your investment time to grow . And the variations only grow from there .
Two of annuities ’ biggest advantages are the potential for guaranteed income for life , no matter how long you live , and that taxes are deferred until you withdraw , giving you some measure of control for tax planning purposes . But they can also be very complex , carry substantial fees and are typically illiquid investments , often charging a hefty surrender fee should you decide you need to withdraw funds sooner than anticipated . Distributions are also taxed as ordinary income , as compared to the tax-friendlier capital gains rate . For these reasons , it might be prudent to first sit down with a Baird Financial Advisor and explore how annuities could fit in your financial plan .
The biggest difference between a defined benefit plan ( such as a pension ) and a defined contribution plan ( such as a 401 ( k ) or employee stock ownership plan ) is the source of funding : Businesses are responsible for funding and managing their defined benefit plans , while for defined contribution plans those responsibilities fall to the employee .
DEFINED BENEFIT PLANS DEFINED CONTRIBUTION PLANS
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