Planning for retirement and securing life insurance is essential to a comfortable future. But where to start?
Regardless of age, the earlier you begin retirement savings, the more your investments will grow. The earlier you start planning for life after work, the more you can enjoy it. The best way to start is with an employer-sponsored retirement plan.
Old-fashioned defined-benefit pension plans, which promise a fixed monthly income for life, are becoming increasingly rare. Those offering them, particularly in the public sector, often cut those benefits to save money. For those with pensions, it’s essential to understand their retirement and insurance benefits options and decide how best to receive these benefits. One important choice to consider is whether or not to take a lump sum or choose a stream of monthly payments (also known as an annuity payout). The decision to take a lump sum or continue receiving payments can have significant tax consequences, so it is essential to seek the guidance of an experienced financial professional.
If you decide to accept a lump sum, it is essential to consider how this will affect your ability to pay taxes in the future and your investment strategy. It’s also a good idea to evaluate whether or not this is the best option, given your life expectancy and potential beneficiaries.
Generally speaking, it’s more appropriate to elect a joint and survivor pension payment option. This will provide you with a lower monthly payment than a straight-life option. Still, it will guarantee your spouse or other beneficiary a percentage of your retirement benefit payments for the rest of their lives.
Another thing to remember when evaluating pension payment options is whether or not the pension fund offers inflation-adjusted returns. This is an essential feature to look for, as it will ensure that the value of your pension payments will rise over time.
If you’re a business owner, there are several different ways that you can contribute to your retirement plan, including a SEP IRA. This type of account is similar to a traditional IRA in that contributions are pre-tax, and the investments grow tax-deferred until they’re removed in retirement. However, this is only viable for those with enough self-employment income to qualify. Those who don’t find investing in a retirement account such as a 401(k) or an IRA more beneficial.
Defined Benefit Plans
The most common types of retirement plans include defined contribution plans, such as 401(k)s and savings and thrift plans, and defined benefit plans, such as pensions. Defined benefit plans guarantee a fixed retirement payment based on a formula, such as your years of service and salary history, at the time of retirement.
Contributions from employers fund most pensions. These funds are invested in a pooled investment fund. If the fund experiences poor investment returns or you retire before your anticipated life expectancy, your benefits may be reduced. The plan sponsor or employer, legally obligated to make up any shortfalls, bears the risk of a reduction in your pension.
A traditional defined benefit pension provides you with a monthly payout that is calculated using a specific formula. The payout is typically based on your years of service and your average salary for the last year you worked with the company, but different employers use different calculation methods. You can also see pension payouts based on a percentage of your total preretirement earnings or the average salary over your entire career with the company.
These payments can be made either as a lump sum or as an annuity, a monthly stream of income that will continue for the rest of your life. Depending on how the payment is structured, it can be taxed differently at different times. If you receive your pension as a lump sum, it will be taxed at the time of distribution.
In addition to defined benefit plans, you can also find profit-sharing plans and employee stock ownership plans (ESOPs). These plans provide a way for companies to reward their employees for positive performance. These projects are most common in smaller companies and can effectively attract and keep highly skilled employees.
Defined Contribution Plans
In a defined contribution plan, your employer sets aside money on your behalf in individual employee accounts for retirement purposes. You can contribute a percentage of your salary to these accounts on a pre-tax basis, and employers may also provide matching contributions. Your contributions can be invested in a wide variety of investment options. Your retirement account balance grows tax-deferred until you withdraw it from your employer’s plan or roll it over to a traditional IRA or another employer-sponsored retirement plan.
Defined benefit plans promise participants a specific dollar amount when they retire, based on a formula that factors in your salary and years of service with the company. An annuity company typically administers these types of pension plans. Depending on your preference, you can receive the payments as a straight life annuity, which pays you monthly until you die, or a joint and survivor annuity, which pays you and your spouse as long as you live.
The employer often subsidizes these pension plans, which can be a valuable incentive for employees to stay at the company longer. However, they can also be volatile due to the reliance on investment returns to meet projections, which often need to be made more explicit. In some cases, if the returns fall short of expectations, the employer must make up the difference with a cash contribution.
Many businesses have switched to defined contribution plans from defined benefit plans because they are easier to administer and less susceptible to market ups and downs.
Those plans, known as defined contribution or DC pensions, include profit sharing and money purchase plans, 401(k) plans, individual retirement arrangements (IRAs), and two types of small business retirement savings plans that are commonly offered, called safe harbor 401(k) contributions and simplified employee pensions (SEPs).
Employers typically manage and fund defined benefit plans, but they can also require participants to contribute funds voluntarily. Defined benefit plans are more complex to manage than defined contribution plans, and they can be subject to actuarial uncertainties even with the best software tools.
Deferred Annuity Plans
Annuities are popular tools for people looking to create a pension-like income stream for their retirement. While these can be a great choice, it’s essential to understand that there are better tools than these. A deferred income annuity (DIA) is a type of annuity that pays you regular payments or a lump sum at a future date rather than immediately. These are becoming increasingly common because they can help supplement other sources of retirement income, such as Social Security. DIAs also can provide guaranteed lifetime income, which is especially useful for people diagnosed with a terminal illness or approaching retirement age.
Unlike the immediate annuity, funded with a single lump sum payment, a deferred annuity has two phases: investment and a payout. During the investment phase, you invest a fixed sum of money and earn interest. This is similar to an IRA, but there are no contribution limits. However, you can only access the funds in the annuity in retirement, at which point you can withdraw them without paying a surrender charge or penalty.
There are many different types of annuities, including indexed and variable annuities. If you’re considering investing in one, comparing rates and fees carefully is crucial. These can significantly impact your returns. In addition, some grants have a minimum death benefit that will be paid to your heirs if you die while the contract is in force. Sometimes, you can combine a deferred annuity with other retirement savings accounts to increase your overall wealth and reduce the impact of fees. For instance, you can invest in a deferred annuity and transfer funds from your traditional 401(k) into that account. If you do so, you’ll pay taxes on the portion of the assistance considered earnings but not on the principal. This can lower your tax liability and help you grow your retirement funds faster.