Although not yet extinct, the defined benefit pension plan has long been a vanishing species among retirement planning vehicles. As defined contribution pension plans proliferate, especially the ever-popular 401(k) plan, defined benefit pension plans are either being scaled back or eliminated altogether. If you are one of the fortunate American workers whose employer still offers a defined benefit pension plan, careful understanding of the plan is mandatory. Without it, you may be lead down the primrose path to retirement disaster.
Typically, your parents may have retired solely, and securely, on Social Security and a pension from their lifetime employer. They simply didn't need to save any additional money, such as through a 401(k) or IRA, to supplement their retirement. Those of you who are covered under a defined benefit pension plan may mistakenly assume the same for yourselves. Before you do, consider the following:
Financial and retirement experts contend that you should retire on at least 80% of your current income. Although some older and government-sponsored defined benefit plans may have offered up to 100% of income at retirement, today more than likely they provide between 25% and 49% of income at retirement.
Fine, you say, Social Security can help fill in that gap. This is true but it won't get you from 25% of income at retirement to 80% of income at retirement. Plus, many defined benefit pension plans are integrated with Social Security. That is, Social Security will not increase your retirement income; your defined benefit pension plan retirement payments will be reduced by your Social Security. In other words, if an integrated defined pension benefit plan offers 25% of income at retirement, this 25% of income will be made up of both Social Security and income from the pension plan.
In addition, you probably will not qualify for the entire percentage offered by your defined benefit pension plan unless you satisfy the terms of employment, for example, retirement at age 65 after at least 25 years of employment. Anything less will reduce your retirement income percentage. Consequently, although most defined benefit pension plans allow early retirement beginning at age 55, it may also be at a reduced percentage of income.
Finally, some defined benefit pension plans, even if offering a high percentage of income at retirement, are fixed income plans. That is, it will not increase annually to keep pace with inflation. With such a plan, the spending power of your retirement dollars will shrink, year after year.
The lesson here is that, before relying too heavily on your defined benefit pension plan to carry the retirement burden, you must discover the following:
- What is the percentage of income provided at retirement?
- How do you qualify for the maximum percentage?
- Is it integrated with Social Security?
- Do the retirement payments increase annually?
If the answers to these questions are unsatisfactory, you need to supplement your retirement plan. The usual way to do this is through additional savings. If your employer offers a supplemental 401(k) plan you're in luck. If not, either request that they adopt one, or explore other vehicles for saving for retirement. Even if a 401(k) is available, it still may not be enough to fully complement your retirement planning. With the help of a financial planner or tax advisor, some of the numerous other supplemental savings plans might be the right picks for you.
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