Planning for retirement is an important part of planning for your life-long financial health and that of your loved ones. If your employer offers them, pension plans can be an important component of your retirement planning that will allow you to provide for yourself and your family into old age.
But what exactly is a pension plan? What are the benefits associated with it?
What is a pension plan?
A pension plan is a savings account to provide for you (and possibly your loved ones) over the long-term after retirement. It allows the beneficiaries to maintain a standard of living similar to the one they had when they were actively working.
A pension plan is offered by many employers to help employees plan and put money aside for retirement. After retiring, employees typically receive a portion of that pension plan for the rest of their lives.
Given that it can be tough for most of us to prioritize saving for retirement when we have other, more pressing needs and desires in the immediate future, pension plans can be an excellent tool to help save for a vital, often-neglected need.
Generally, there are two different types of pension plans available:
Defined benefit plans
In defined benefit plans, the employer offers a formula based on your years in the company, earnings, and the age you decide to retire in order to determine how much you will be paid in retirement. These plans are pretty clear cut, and employees don’t have to make decisions related to investing or how much of their salary they wish to put into retirement.
Defined contribution plans
These are a bit more complex and flexible. Over time, your company pays into your retirement fund, usually according to a percentage of your salary that you agree upon when you sign your contract. Additionally, in some defined contribution plans, you can pay a chunk of your salary into your retirement fund, which your company may match (up to a certain level).
Benefits of pension plans
There are a number of benefits associated with opting into your employer’s pension plan.
For example, if you opt into a defined contribution plan and your employer is one of the many that offers to match or pay a percentage of the salary that you dedicate towards your retirement fund, you essentially receive a bonus with every payment, no strings attached. Who doesn’t want free money?
Pension plans also have tax-related benefits. Aside from the incredible proposition of receiving free money, contributions to pension plans are also not subject to being taxed until they are withdrawn in your retirement. In other words, you will not be taxed twice for the benefits funneled into your pension plan.
A variety of pension plans exist to accommodate the unique situations of each person. For example, there are a variety of joint and survivor annuities available to ensure that a surviving spouse can access all or a portion of their late partner’s retirement benefits in the event that they pass away before those benefits run out.
The bottom line
Pension plans are an important component of your retirement goals. If your employer offers one, they can be a big piece in your retirement plan puzzle. While retirement may seem out of reach of millennials, with careful planning and a long-term orientation, it is possible to create a fruitful future for yourself.
Check out the rest of the Academy library to learn how investing can help your money go even further!