Company Pension Plans

The prevailing view of retirement experts is that if you have a chance to participate in an employer-offered plan, go for it! Unlike individual retirement accounts, there are much higher limits on how much pre-tax money can be directed to employer-offered plans. There are two types of plans offered by employers: defined benefit plans and defined contribution plans, with a definite shift occurring in businesses from one to the other. Some employers offer both.

The more traditional pension plan, known as a defined benefit plan, offers retired employees a predictable sum of money upon retirement. It can be distributed in one lump sum or, more typically, can be paid out, usually monthly, in regular installments over time. The pension amount is usually based on the salary earned by the employee over the course of her career, often using the five highest, or last, years as the basis for computation. The retiree receives a percentage of the former base salary. Defined benefit plans are usually backed by the federal government.

In some cases, a retiree has the option of having payments continue to be made to his surviving spouse in the event his death comes first. The tradeoff is that all payments from the plan will be lower with the expectation that the retirement fund will need to last longer. Should the spouse die first, the employee has lost a gamble and will continue to receive the lower payments for the remainder of his life. However, some plans have a “pop-up” provision that restores the pensioner's monthly income to the level had he not elected a survivor benefit. Check with your HR department.

Defined Contribution Plans

The other type of company plan is known as a defined contribution plan. You have probably heard of the 401(k), which is the most common type. The difference between a defined contribution and defined benefit plan is that a defined contribution plan is in fact a savings plan with no guarantee that a specific amount of money will be available at the time of retirement. The success of a defined contribution plan in meeting your retirement goals will be based on:

  • How much you invest

  • How long you invest

  • How well your particular investments do over time

The federal government's role for these plans is to be sure that the employer does not misuse the funds and that a mix of different types of funds is offered. There is no government backing of the monies in these accounts.

The Employee Benefits Security Administration (EBSA) of the Department of Labor offers the following pointers for making the most of a defined contribution plan:

  • Study your employee handbook and talk to your benefits administrator to see what plan is offered and what its rules are. Plans must follow federal law, but they can still vary widely in contribution limitations, investment opportunities, employer matches, and other features.

  • Join as soon as you become eligible.

  • Put in the maximum allowed.

  • If you can't afford the maximum, try to contribute enough to maximize any employer-matching funds. This is free money! Study carefully the menu of investment choices. Some plans offer only a few choices, others may offer hundreds. The more you know about the choices, investing, and your accumulation goals, the more likely you will choose wisely.

  • Many companies match employee contributions with stock instead of cash. Financial experts recommend that you don't let your account get overweighted with company stock, particularly if the account makes up most of your retirement nest egg. Too much of a single stock increases risk.

  • Plan fees and expenses reduce the amount of retirement benefits you ultimately receive from plans where you direct the investments.

Keep in mind that it's in your best interest to learn as much as you can about your plan's administrative fees, investment fees, and service fees. Read the plan documents carefully. You may want to call the EBSA at 866 444-3272 and request a copy of their booklet A Look at 401(k) Plan Fees.

Movement Away from Defined Benefit Plans

The nature of how and where work gets done continues to evolve. Whole new industries explode onto the marketplace seemingly overnight. The Internet has completely changed the way information is shared and commerce is done. When American companies selling gear for backwoods exploration have their backpacks made in China and customer service calls answered in Calcutta, you know the corporate terrain has changed. One result of this corporate evolution is that working an entire career for the same company is not very likely.

Even the biggest of the big companies evolve, merge, or disappear. Think of Exxon and Mobil, which merged to become Exxon Mobil, one of the largest companies in the world — or Enron, which grew rapidly and then imploded.

At the same time, corporations have been slammed with trends impacting their retirement policies that could not have been fully anticipated. People are living longer, so pensions are becoming more expensive for the sponsoring company. Many of these defined benefits plans also have promises of paid health insurance premiums associated with them. These have become crippling costs in some industries, such as airlines and automakers. It is critical that you understand the net effect, which is that the responsibility of planning for a financially secure retirement is shifting from the employer to the workers.

The good news is that companies are supporting their employees by providing savings vehicles to get them safely to and through the “after work” years. One way companies are helping their employees is by offering a more generous contribution to their 401(k) plans, while at the same time putting a freeze on the traditional pension plans. Younger workers stand to benefit a bit more than those closer to retirement with this switch, but those right on the brink of retiring can close the gap with some modest contributions from their pre-tax dollars.

Tax Advantages

Much like the individual retirement account options, employer-sponsored savings plans offer tax deferral to monies invested in them, enabling them to grow more. The compounding magic unfolds just as well in these accounts. Since the monies invested in these accounts come from pre-tax earnings, the pinch in take-home pay will be softened. Assuming you will be in a lower tax bracket when you begin to withdraw from this type of account, you will come out ahead after taxes.

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