Another One Bites The Dust
Pension plans used to be the norm with companies offering retirement. Don't you remember your grandparents talking about that pension?
Well, folks, they're going the way of the cowboy and the nickel newspaper. I read this week that yet another company is doing away with their longheld pension plan. Are they kicking their employees to the retirement curb? No. But are they altering the retirement environment for those employees? You betcha.
To understand the difference between what was and what is for this well-known-but-unnamed company, it is important to understand that there are basically two categories of retirement plans: defined contribution (DC) plans and defined benefit (DB) plans.
The most straightforward plan is the defined contribution plan. In short, the retirement benefit is DEFINED by the amount of money contributed to the plan. DC plans are generally known by the Internal Revenue Service tax codes that permit them, such as 401(k) or 403(b). Employees make pre-tax contributions to their own retirement accounts. Employers can, though they don't have to, add contributions or match what employees contribute, but it is the responsibility of the employee to manage his or her own investments. Most DC plans offer a choice of mutual funds or other investment vehicles, and the IRS typically allows penalty-free (though not tax-free) withdrawals after age 59-1/2.
In short, for those who have a DC plan, the money in their plans at the time of retirement is the money they have to live on, short of Social Security income and other personal savings. Without wise planning with a financial professional, there is nothing to prevent those dollars from surviving less time than the retiree.
A defined benefit plan, also known as the traditional pension, was once offered by many employers but is increasingly rare today in the private sector. It pays a retiree a specific benefit based on years of service and salary level, and it pays until the retiree dies. In some cases, the payouts will continue for a spouse or other beneficiary.
Monies in a DB plan are usually contributed both by the employer and the employees, although an employer can choose to contribute without requiring participation on the part of the employees. Funds are pooled and investments managed professionally. The employees, themselves, do not have a voice in fund management.
Here in the Golden Triangle area, we have many state employees who participate in the Mississippi Public Em
ployees Retirement System (PERS), which is a DB plan. Benefits in the PERS system are based on three factors: years of service credit, highest four years' compensation, and age at retirement. Though each person's situation is unique, the basis of a DB plan is framed around pooled risk. Upon retirement, employees receive a lifetime benefit, regardless of the total of any individual contributions to the plan.
Another important difference in a DB plan is that it often includes a cost of living adjustment. Those familiar with PERS retirees have heard of that annual gift-from-above otherwise known as the "13th check." This is simply an annual cost of living adjustment.
In summary, a traditional pension provides a stream of income for life, while the revenue from a 401(k) or other defined contribution plan is gone when the money runs out. But while having a defined benefit pension is not foolproof - The money in the plan is only as good as the solvency of the company - neither is having a defined contribution plan a threat that you will run out of money. A qualified financial professional can help you to ensure that your retirement money will last as long as you do. Regardless of what kind of plan you have in place, depending on any one source of retirement money - putting all your eggs into one basket - is never wise.