Employer Sponsored Pension Plans
A lot of people are counting on their workplace pensions to make up the majority of their retirement funding. The most common employer sponsored pensions will fall into one of the following two categories.
Defined Benefit Pension Plan
⦁ A defined benefit means you know exactly what your pension amount will be at retirement
⦁ The benefit is based on a formula such as: 2% x average earnings in the last 5 years x years of service (maximum 35)
⦁ The benefit is not based on investment returns, so you are not at the mercy of poor management, investment choices, or market timing
⦁ Employee and employer make contributions
⦁ Employer is responsible for any shortfalls needed to pay employee pension for life
⦁ Employers are moving away from defined benefit pension plans because of astronomical costs
⦁ A benefit might be calculated using the following formula: Pension = 2% x average yearly earnings in the last 5 years x years of service (to a maximum of 35)
⦁ Dana worked for the government for 30 years when she decided to retire at age 60. During the last 5 years, her annual salary averaged $60,000 a year.
⦁ Her yearly pension would be: 2% x $60,000 x 30 years = $36,000 ($3,000 per month)
⦁ If she waited to retire at age 60, her pension would be: 2% x $60,000* x 35 years = $42,000 ($3,500 per month)
⦁ *This figure may be higher if her salary increases in the last 5 years of working
Defined Contribution Pension Plan
⦁ Contributions are ‘defined’, because both the employee and employer know exactly how much they will contribute each year
⦁ Contributions are based on a percentage of your earnings
⦁ Employers often match the employees contributions
⦁ Pension plans that involve profit sharing or stock ownership are included in this category
⦁ The risk – You don’t know what your pension will be at retirement because it depends on the investment performance of the contributions.