There was a time when retirees could count on guaranteed lifetime income from Social Security and an employer pension to fund their golden years. Today’s retirees still enjoy Social Security income, but very few have access to a pension. In 1998 nearly 60 percent of Fortune 500 companies offered a pension. As of 2015 fewer than 20 percent offer one.1
As employers have shifted away from the pension, also known as a defined-benefit plan, many have adopted the 401(k). Known as a defined-contribution plan, a 401(k) allows employees to save for their retirement and may create a reduced financial obligation for employers.
As an employee, it may be difficult to know which plan is best for you. You may be in a position where you’re deciding between new jobs, in which one offers a pension and the other a 401(k). Or perhaps you have both a pension and a 401(k) among your retirement assets, and you’re not sure how to plan for them. Below are a few key points to consider as you plan for your retirement:
Pensions are known as defined-benefit plans because the outcome of the plan, or the benefit, is certain. Your employer pays you a retirement benefit after you exit your career. That benefit amount is determined by a number of factors, including career earnings, length of service, age and more. It’s the employer’s responsibility to fund the plan and pay the promised benefit.
Pension benefits are usually guaranteed* for life, but there could be other payment options available. For example, you may be able to take your benefit in a discounted lump sum upfront. Another option could be to take a reduced annual benefit amount but extend the payment over the lives of both you and your spouse.
Obviously, pensions are appealing because they provide guaranteed and predictable income. However, pensions may offer little in the way of growth opportunity. Your income could be flat, which may be problematic as inflation increases your spending over time.
In a defined-contribution plan, like the 401(k), the contribution—rather than the benefit—is certain. The employee determines how much money goes into the plan. The benefit is unknown, because it depends on long-term growth and future contributions. You control how much money goes into the plan, but you can’t control exactly how much comes out in the future.
Your 401(k) contribution is made with pretax dollars, which reduces your taxable income. Your employer may also make a matching contribution. You then invest those funds according to your goals and risk tolerance. All growth is tax-deferred as long as the funds stay in the account. Your withdrawals are then taxed as ordinary income.
One of the challenges with a defined-contribution plan is that the withdrawals aren’t guaranteed. It’s possible that you could drain your assets because of market losses or excessive spending. If you outlive your money, there may be no safety net. Defined contributions may also give you greater upside opportunity, however, and they allow you to control how much money you put toward retirement.
You could work with your financial professional to take advantage of aspects of both plans. For example, you could use a 401(k) to accumulate assets, but then use a different vehicle to generate guaranteed lifetime income.
For instance, upon retirement you could roll your 401(k) into an IRA, and then use a portion of those funds to purchase an annuity. Many annuities have guaranteed lifetime income features that give you a predictable income stream that will last as long as you live. You get the upside savings potential of a 401(k) with the consistent income you may want in retirement.
Ready to plan your retirement strategy? Let’s talk about it. Contact us today at Carstens Financial Group. We can help you analyze your needs and goals, and then develop a plan. Let’s connect soon and start the conversation.
*Guarantees, including optional benefits, are backed by the claims-paying ability of the issuer, and may contain limitations, including surrender charges, which may affect policy values.
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