What is a defined-benefit pension plan?
A defined-benefit pension plan is a retirement plan where the employee benefits are calculated based on a set formula, which includes salary history and length of employment. These benefits are normally guaranteed for life and rise slightly to factor in cost of living increases. Plan benefits are made available to employees once they reach a certain age, or once they have fulfilled the required criteria, such as a certain amount of years worked. However, there tend to be restrictions on when and how an employee can withdraw from the plan without penalties.
These plans are called “defined-benefit” plans because the factors used to determine the amount received at retirement are known ahead of time, and according to the IRS, “provide a fixed, pre-established benefit for employees at retirement”. This is different from other retirement plans because normally your payouts at retirement would be dependent on the amount you contributed and the growth of the account. With a defined-benefit plan, the employer is responsible for managing the plan and the investment decisions, and for assuming all the risk. Since the employer is responsible for all risk, even if the account does not perform well, they are still required to pay the predetermined amount to the retiree.
Payment Options
There are a few payment options for when you are ready to retire. The option that you choose should be planned and thought over carefully, since it will affect the amount you receive:
- You can take a single-life annuity, which will pay you a fixed monthly benefit until death;
- You can choose to have a qualified joint and survivor annuity, which means you can receive a fixed monthly benefit until death, and then your spouse will continue to receive these benefits until their own death; or
- You can take the full amount as a lump sum payment, which will provide you a single payment of the total amount of your benefit.
Frozen Defined-Benefit Plans
Since defined-benefit pension plans tend to be costly for employers, many companies have stopped offering them as a retirement option. Some companies that previously offered them, are now phasing them out through either a “soft freeze” or a “hard freeze”. A “soft freeze” means that no new employees can join the plan, but workers already participating in the plan can continue to accrue their benefits. The other way is through a “hard freeze”, which is where a company closes the plan to new employees, but also freezes the benefit accrual for existing plan members. Since there is always the risk of your employer putting a “hard freeze” on your defined-benefit plan, you should make sure that you have a retirement plan (link to article on why it is important to have a retirement plan)in place.
Conclusion
When it comes to your retirement, you can never be too careful. When deciding which payment option is correct for you, please make sure to contact a certified financial planner to help you make the best decision for your individual circumstances. Westco Financial Group cares about your retirement and is happy to help you feel ready for the next chapter in your life. Call or email at (516) 593-5070 or clientsvc@westcofinancialgroup.com to set up your complimentary appointment today!