A Guide to Pensions Plans

Brian Clouden
Vice President

Pension Plans date back to 1875 and were a mainstay for American workers for many years. Most people would get a job and stay with a company for their entire careers until retirement and could count on having a pension to support them through their retirement years. Over the past two decades or so, companies offering traditional pensions have declined significantly. According to a recent report, traditional pension plans offered by Fortune 500 companies have declined by 86% between 1998 and 2013.

What is a Pension Plan?

A pension plan is a type of retirement plan where an employer sets aside money for an employee and invests that money on an employee’s behalf. Once the employee retires, that money is either paid out to the employee as a stream of regular monthly payments or is some cases, as a lump sum. Depending on the plan, there may be additional benefits to the employee’s spouse or children upon the passing of the employee. The amount of the pension is typically determined based on three conditions:

1) Years of service
2) Age of the employee
3) The annual compensation earned by the employee

Pension plans can be available in both the Private & Public Sector. Public sector pensions typically cover employees of federal, state & local governmental entities such as law enforcement, fire fighters and educators.

Private Sector vs Public Sector

In recent years the use of traditional pension plans in the private sector has declined significantly. Employers were not prepared for the dramatic increase in life expectancy which forced them to pay out benefits much longer than projected which caused significant financial stress on the employer. Furthermore, employers no longer want the liability of managing the employees’ pension money. As such the responsibility of saving for retirement has mainly been transferred from the employer to the employee.

Fortunately for Public Sector employees, most are still covered by traditional pension plans. In New York State, when you join the public retirement system, you are assigned a tier based on your date of membership. There are 6 tiers in the Employee Retirement System (ERS) and 5 in the Police & Fire Retirement Systems (PFRS). Your tier determines your eligibility for benefits, formula used in the calculation of your benefits and service crediting.

401K vs Pension

As traditional pension plans have declined the use of 401k’s has exploded especially in the private sector. The main differences are:

1) Funding

Traditional pension plans are funded by the employer while the 401K is funded by the employee. In many cases, the employer will offer some level of matching contribution. If you have a 401K you should at least put in the minimum amount that you need to get the full employer match.

2) Control

In a traditional pension the employer is responsible for contributing the amount of money they need to and investing the money to be able to meet their pension obligation. In a 401K the employer makes the plan available and offers an array of investment options. It is the employee’s responsibility to fund the plan and choose how to invest their money.

3) Vesting

Both pensions and 401K’s typically have some sort of vesting schedule. In a pension plan you typically need to meet certain requirements to become vested. In a 401K the vesting schedule only applies to the employer’s contribution while the employee’s contributions belong to them.

4) Portability

Every pension plan is different in regards to portability. Assuming you are vested, if you leave your job they may offer a lump sum payout which you could either take in cash or roll into an IRA. Or you may simply leave your funds in the plan and wait until you retire to begin drawing at retirement. In regards to a 401K, if you separate employment, it is your money. Some plans will force you to exit the plan and take the money or roll the money over into an IRA or your new employers 401K if allowed. Some plans will let you keep the money in the 401K plan. A word of caution to anyone taking the money in cash. In most cases the money will be taxable and there may also be IRS penalties to contend with.

If you are separating employment for any reason, you should sit down with a qualified financial planner to discuss your options. Obviously, every situation is different and there are a number of important decisions you need to make. Don’t go it alone. To set up a complimentary consultation to review your options please call our office at 716-674-6700.

For more information on pension plans, listen to my interview with Clay Moden on 106.5FM WYRK.

WEEKLY SEGMENT ON WYRK

You can catch our weekly Plan.Protect.Invest. segment live on WYRK 106.5FM at 7:20am every Wednesday. Each week we will have a Sgroi Financial planner on with Clay Moden and the WYRK morning show to discuss financial topics to educate and help their listeners.
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