Pensions and Retirement

Pension plans are an organized method of saving for retirement that go beyond the individual’s own means of savings. Due to a number of factors, people’s motivation and capability of saving for retirement differs, where many may be unprepared and could benefit from some assistance.

This is what pension plans do, they assist people in putting together at least some sort of minimum sized income flow to be used in their retirement years.

There are two types of pensions, publicly administered pensions, where the government collects the premiums and administers the benefits, and private pension plans, administered by one’s employer.

Public pension plans are set up to provide people with a safety net, so that when their income stops they are able to access at least some income, and hopefully enough to keep them from living in squalor. In many countries, those whose income falls below a certain threshold, including going to zero, are eligible for social assistance payments, and the goal of pensions are to look to have individuals participate in avoiding this by forced contributions during their working years.

Private pension plans have a similar agenda, although they do come with more flexibility. In this case, the employer will contribute all or part of the contributions to the plan, and this at least has the appearance of a benefit to the employee, a gift to them by the employer in other words.

Of course, these contributions are factored into total compensation, and in essence these contributions are made in lieu of additional salary, but to many people, employer contributed benefits just seem like free money so they look very favorably upon it.

These pension contributions, whether they be forced by the government or guided as handouts by employers, do serve the interests of the employees though, as when one retires one does need to look to replace at least a good portion of their previous income.

This money needs to come from somewhere, and pensions do represent a plan to help manage one’s finances in retirement to various degrees. Since we are only looking to replace a portion of the lost income in retirement, it is not the case what we have to worry about overdoing this, where we are deferring too much present income to retirement, beyond what will be needed. On the contrary, pensions In themselves will not replace all your income and many people look to supplement this with savings of their own outside their pension plans.

Publicly Administered Pensions

With a publicly administered pension plan, governments will collect premiums for the pensions by having employers remit a portion of an employee’s payroll. This is collected similar to payroll taxes, only in this case the money collected doesn’t just go to the government’s general fund, but instead to one dedicated to providing for pension income in retirement.

The goal here is to seek to provide people with a minimum amount of income should they retire without any savings or means of income, and these benefits may also be paid out prior to one’s normal retirement age if one becomes unable to work due to a disability. In a sense the person does become retired when this happens, although the retirement would not be based upon one’s age.

These benefits are capped, and although they do tend to vary according to how much an individual has contributed during their working life, this is not a progressive system where the wealthy subsidize the less well off by paying more, and one’s benefits proceed according to their total contributions.

This makes this a real pension plan and not just another form of taxation, and the fact that this is administered by governments, this should at least add some real reliability to the plan. In actual fact though, many people worry about these pensions more than they worry about their private pensions, and even may assume that they will never be able to collect once they retire, due to the pension plan going broke.

These fears tend to be overblown though, for instance with concerns about U.S. Social Security payments, and while we will see a shortfall at some point, this will not mean that people will not be able to collect their pensions at all.

These pensions always collect money, so they never really become unable to pay anything. What is likely to happen here is that one’s pension may become reduced as a means to balance the books, where for instance one may only be paid out 75% of their pension benefits instead of 100%.

Governments can use other means to manage these shortfalls, such as extending the entitlement age. While it’s not that people should not be aware of these projected changes, we don’t just want to say that we can’t rely on these pensions at all, as many assume.

What is clear though is that one should not merely rely on government administered pensions as their sole source of income, and if possible at all, we should look to add other income sources, including any employer sponsored pension plans as well as our own savings.

Employer Sponsored Pension Plans

Many employers, but certainly not all, offer their employees a pension plan, where the employer not only administers the plan but contributes to it on behalf of the employees as well.

Since these contributions are indeed a component of overall compensation, they generally cover jobs that are at least decently compensated for. In other words, they involve jobs that often will provide the means where the employee makes enough to be able to save for retirement, and instead of paying a certain amount to them, some of this is set aside for them in a pension.

Jobs that are lower paying will often not come with a pension, due not having enough room between what the employee requires as salary and what the employer is willing to pay them. The overall compensation may only be enough to subsist on, so if part of that were set aside for a pension, this could leave the employee without the necessities of life, or may involve a wage below minimum wage standards.

Jobs of a more temporary or contract basis don’t normally come with pension benefits either, because pension plans are longer term commitments, so the employment needs to be one that is at least likely to be maintained over a certain period of time.

There are allowances made if one wants to change employers, where they don’t lose their pension, but if a job only was to be done over a short period of time, it really wouldn’t make sense to have them participate in the company pension plan, which is at least supposed to be for when they retire from the company, years down the road.

Types of Pension Plans

Depending on the pension plan, the employer may contribute the entire amount of the premium, meaning that the employee does not choose anything here. Often though, the employee will choose to contribute a certain amount to their pension, with the employer matching it at a certain level.

Depending on the country, these pension contributions by the employee may involve tax advantages, such as deferring the tax payable on the employee’s contribution to the pension, to be paid later when the benefits are received. This has the added advantage of assessing the tax rate based upon when the money is needed and one’s income typically drops, and usually ends up having the retiree pay less tax than if it were taxed when the money was earned.

There are other schemes where the income that the pension earns over the years may be exempt from tax, where taxes are not deferred on contributions, but withdrawals are made tax free.

Both of these schemes have their particular advantages which depend upon one’s circumstances, and as a general rule, the closer that you are to retirement, the more it makes sense to defer it, and the further out it is, the more it makes sense to look to exempt the income from the pension from taxation.

If one is contributing to a straight pension, often times the amount that is contributed is not considered taxable, although the benefits are when paid out. This is often the case with publicly administered pensions, not private ones, which rely on other tax deferral schemes.

Other Features of Pensions

Pensions are either set up as defined benefits or defined contributions. Defined benefit pensions define what the pension amounts will be, regardless of how well the pension fund does. This provides retirees with a known benefit amount that they can rely on, and these pensions may even be indexed to inflation to make their benefits even more stable.

Defined contribution pension plans are more like a mutual fund, as the benefits that get paid out depend upon the performance of the money that has been invested in the pension plan. It used to be that defined benefit pension plans used to be the most common, but this has changed in recent years, and now most of them use the defined contribution scheme.

It sounds better though if we describe this as a defined contribution plan, but a more correct description would be variable benefits as opposed to defined benefits. This distinction is not lost on pension plan members though as they obviously prefer defined benefits. Employers of course prefer variable benefits due to the risk to them of having to cover investment shortfalls with defined benefits, and lately, they have had their say a lot more in deciding this.

Public pension benefits are always paid out over time, as an annuity, while private pension plans often give people more flexibility, to take out the benefit amount in a lump sum as well as in an annuity. This is not always the case though and it depends on the particular pension plan.

Pensions of any type are certainly a great idea to help prepare us for our retirement years, where we almost always will benefit from them, and the only people that really don’t are those who are so well off that they may be disentitled from receiving the benefits.

Pension income only represents a portion of what will be needed in retirement though, and while this may represent a good chunk of it, we must also look to make up for whatever shortfalls occur by looking to other means to replace enough of our income once we stop working.