Pension policies can vary with different organizations. Because important pension-related decisions made before retirement cannot be reversed, employees may need to consider them carefully. The following calculations can help evaluate three of the most common situations.
Lump Sum Payout or Monthly Pension Income?
There are mainly two options regarding how to receive income from a pension plan: either take it out as a lump sum payment, or have it slowly released in a stream of cash flows over time until the retiree passes away (or in some cases, until both the retiree and their spouse passes away).
Single-Life or Joint-and-Survivor Pension Payout?
Single-life pension means the employer will pay their employee's pension until their death. This payment option offers a higher payment per month but will not continue paying benefits to a spouse who outlives the retiree. In contrast, joint-and-survivor pension payout pays a lower payment per month, but when the retiree dies, the surviving spouse will continue receiving benefits for their remaining life.
Should You Work Longer for a Better Pension?
It is possible for some people to postpone retirement for several years for more pension income later. Different people have different mentalities regarding retirement. Use this calculation to see which option is preferred financially.
Pensions are funds that employers (sometimes employee or government) contribute to as a way of saving for retirement. Upon retirement, money can be drawn from the pension pot or sold to an insurance company to be released as income cash flows at specific time intervals until death (an annuity). Please visit our Annuity Calculator or Annuity Payout Calculator for more information or to do calculations on annuities. In U.S., the main advantage of a pension as a vehicle of saving for retirement lies in the fact that pensions provide tax shields for money placed into them as well as any subsequent earnings on investment.
When people throw around the term "pension plan," the defined-benefit (DB) plan is typically what they are referring to. In this type of pension plan, employers guarantee that their employees who elect to take part in it are promised a defined amount upon retirement, regardless of the performance of the investments involved. Employers become fully responsible for these future payments to their employees; even if the company goes underwater, is bought out by another company, or goes through any major overhaul, employees still have legal rights to their share of their DB plans.
Income is usually determined by several variables pertaining to each unique employee including their age, earnings history, years of service, etc. As for accrual rate, benefits normally grow slow early in an employee's working life, and accelerates down the road.
In U.S., DB plans have been heavily scrutinized recently and their use has declined in favor of their counterpart, the defined-contribution (DC) plan. While the public sector still houses most DB plans in existence today, the golden age of DB plans seems to be long gone. Private sector DB plans only make up 4% of all retirement accounts today - down from 60% in the early 1980s. Too much of the success of DB plans depends on volatile factors, such as whether they quit or get fired, or whether the company goes belly up (this could explain why the public sector still offers them since it is unlikely for them to go under). In order to realize the biggest benefits of these plans, a person would have to stay with their company for 25 years, which is increasingly uncommon today. Also, plans are subject to being "frozen" for a variety of reasons. That is, some or all employees covered will stop earning some or all of the benefits from the point that plans are frozen and onwards into the future. This can happen due to many different reasons, which may include rising healthcare costs due to increased lifespans, or unfavorable interest rates.
DB plans in the U.S. do not have contribution limits.
In this type of pension plan, employers make specific contributions to each of their employees' pension plans as they themselves contribute to it. Employer contributions are usually matched dollar-to-dollar up to a certain percentage of income. In U.S., the most common defined-contribution plan today is the 401(k). Refer to the 401(k) Calculator for more information and to do specific calculations regarding 401(k)s.
Unlike their counterpart the DB plan, investments and the subsequent earnings income here are heavily dependent on the performance of investments within the plans. As a result, participants are allowed some control over their benefits; each individual can choose where their dollars are being invested. Most will likely tie their funds to a diverse, managed portfolio containing stocks, bonds, and various financial instruments. Others can choose to take more active investing roles if they prefer. Therefore, for the most part, tenure or age has little to do with the accrual of benefits during any certain period in the DC plan (unlike DB plans), and only affect performance of investments for that period. Also unlike their counterpart, DC plans have high mobility; an employee with high turnover among many different companies can still retain the same DC plan the entire time.
DC plans are now the most popular pension plans in the world, especially in the private sector. In 2014, 33% of all private sector workers in the U.S. participated in only DC plans, while a meager 2% participated only in DB plans.
Today, in U.S., very rarely is the term "DC plan" contextually used to refer to pension plans. As a matter of fact, in casual conversation, they are more likely to be referred to by their programs, such as "401(k)" or the "457 plan", which is a tax-advantaged deferred-compensation plan available for public and private sector workers.
The three calculators above mainly designed for the Defined-Benefit Plan.
Single-Life or Joint-and-Survivor Plans?
Single-life plans pay a monthly benefit for the remainder of the beneficiary's life, but as soon as they pass away, pension payments halt. A drawback to this is that surviving spouses will be left without a major source of income. Unsurprisingly, this option is most commonly used by retirees without spouses or dependents that require financial support. However, there are exceptions for single-life pensions that have guarantee periods; if the retiree passes away within the guarantee period (usually five or ten years), dependents are eligible to receive income until it ends. Monthly benefits with guarantee periods tend to be lower.
On the other hand, joint-and-survivor plans have the retiree's spouse as an additional beneficiary for a total of two, and monthly benefits continue until both beneficiaries pass away. Because the benefits from a joint-and-survivor plan must try to outlive two beneficiaries, they are generally lower monthly amounts than those of a single-life pension.
Upon the death of the first spouse, the surviving member will receive a certain percentage of the original payout, and this is called the survivor benefit ratio. This is determined at the beginning of the payout phase. Common survivor benefit ratios are 50%, 66%, 75%, and 100%, which is the same payout as if both members are surviving. As an example, given two retired spouses who receive $1,000 from a joint-and-survivor plan with a 50% survivor benefit ratio, if one of them passes away, the survivor will begin to receive $500 (50%) payouts from then on.
1. Cost-of-Living Adjustment
While the cost-of-living adjustment (COLA) is mainly used in the U.S. Social Security system, it plays an important role in each of these three calculations regarding pension plans. Due to inflation, prices of goods and services are expected to rise steadily over time, and the COLA helps to maintain the buying power of retirement funds that have grown for decades. Generally, it is the norm to gradually increase pension payout amounts based on the COLA to keep up with inflation. If no such adjustment is desired, just use "0" as the input.