Scooping Up That Pension Money
Retirement planning doesn’t necessarily have anything to do with ‘Retiring’.
It’s really not even fair to say that everyone wants to invest for their retirement – plenty find so much meaning in their work that they’ll never stop as long as they’re alive.
But retirement planning is a good baseline. It gets you to think in long time horizons. In this article, we’re going to back up a little and talk about the structural ‘big picture’ of pension planning, and how that can work towards your overall investment plan.
Defined Benefit Plan v.s. Defined Contribution Plan
In the grand ‘ol era of post world war economic growth, big companies had this idea of taking care of their employees. You’d work for one company like General Motors, and when you retire, they would give you a pension check for the rest of your life.
The company would do a calculation based on your recent wage, years of service, and a few other factors. They’d come up with a number, and you’d get paid that until you died, and sometimes until your husband/wife died.
This is what they call a Defined Benefit Plan. Retirees would get a stable income that required no thinking or planning on their part.
Problem was, people started living longer.
At one time, retirement age was 65, and the average lifespan was 68. Now people live decades longer than that and the company is on the hook for those payments. Not so surprisingly, less companies do this now. Military pensions, Government employees, and some of the big guys in the corporate world go this route.
Investing is about balancing risk and stability – and some people want much more stability. If you go this route, you’ll never worry about income. Some people are so anxious about losing money that investing is more terrifying than public speaking, on a roller coaster, with raging bulls right behind you.
With Defined Benefit Plans, you can build your investment wealth on a platform of stability. All you need to do is work for the right employer for your entire career – and the risk averse person probably wants to do this anyways.
If this is you, you can start your career planning around who’s got this this kind of pension, and settle into a life of quiet, consistent growth.
Defined Contribution Plan
The version businesses now prefer is the Defined Contribution Plan. In this model, they agree to fund employee’s retirement with a predetermined amount (based on wages usually) that then gets invested into the market. This is how 401(k) and IRA accounts work.
There’s a variety of ways this can be set up, but a common one is for employers to set up a 401(k), employees will voluntarily have a portion of their paycheck withheld and invested, and the employee will match that investment (up to a predetermined amount).
So every paycheck, you pay some, and they pay some.
The main difference here is that these funds are now invested in the market – so they are subject to the same ups and downs as the market as a whole.
Meaning that when you retire the employer isn’t on the hook the way they were in defined benefits plans. For the employee, it could work out better or worse depending on where the funds were invested and depending on the strength of the market when the funds are being withdrawn.
The different kinds of defined contribution plans all have slightly different setups, but in general you can say that you’ll have more control over where your funds are being invested, you’ll get tax benefits, and you’ll have more mobility to move between employers.
There’s also some options to use that money without incurring a penalty to pay for a home or for higher education. But overall, this is a good consistent option to build up long term wealth around your other plans
Defined Benefit Plans have generally worked out in the favor of employees over that of employers. Hence the reason they are little by little being fazed out. But in that process, they are being grandfathered out. So if you get in now, or are already in one, they will maintain the plan for you, but the people that follow won’t be able to take advantage.
Defined Contribution Plans are a good second place. If your workplace offers them (and many do) it’s extra money going into your accounts on top of your regular wage. More options mean more planning, but if you’re smart that can work in your favor.
IRAs are available for those that don’t have employer pension plans at all, it just means it’s solely funded by you. They work great, just there’s no extra money being dumped in by your boss. If you’ve got neither of the above, you should look into one of these.