Last Week’s Question of the Week: What percentage of Americans die without a will? Is it 10% or 55%?
ANSWER: 55% of Americans die without a will or estate plan.
HOST: When people are getting ready retire, I suppose they may have questions about possible pensions they may be receiving?
KLAAS FINANCIAL: Yes, we don’t always spend a lot of time discussing pensions on this program because for many people these days, pensions are not as prevalent as they used to be.
However, some of our listeners will be receiving a pension, so we thought it was important to educate everyone.
In the heyday of pensions in 1980, roughly 38% of workers had one. But as recent as 2017, only 18% of private-sector workers had access to a pension, and just 15% participated in one (according to the Bureau of Labor Statistics.) Over time, the number of private-sector workers who have access to a pension is largely expected to trend toward zero.
Why are there so few private-sector pensions left? One of the biggest reasons is the substantial risk that they bring to an employer. For obvious reasons, making a promise to pay a worker large sums of money after they retire — which could be 35 years from today — is a very risky thing to do.
Pensions do remain relatively common in the public sector (government jobs), as most full-time state and local government workers are enrolled in a defined benefit retirement plan, and public-sector workers are about five times as likely to have access to these pensions.
A pension is just one of many types of retirement plans. We generally categorize retirement plans as being one of two types: A defined benefit plan (DB) or a defined contribution plan (DC).
- If your employer promises to pay you $3,000 per month after you reach age 65, that’s a defined benefit plan. Your employer made a promise to pay you a certain amount of income in retirement. The benefit to you ($3,000 per month) is defined. When people use the word “pension,” they’re almost always referring to a defined benefit plan.
- If your employer offers to put $5,000 into your 401(k) every year, that’s a defined contribution plan. A defined contribution plan is an individual account. Your 401(k) is yours, and yours alone. Your employer isn’t guaranteeing that you’ll receive a certain amount of money at retirement or that your retirement account will be worth anything at all when the time comes. Instead, it’s giving you a defined contribution now, which you can invest however you please.
HOST: So how is someone’s pension calculated?
KLAAS FINANCIAL: From an employee’s perspective, pensions are simple. At a certain age, the employee will receive a certain amount in benefits, usually based on their ending salary and how long they worked for the company. The basic equation is typical of how most pensions calculate benefits for employees:
Average Salary × Years of Work × Benefit Multiplier = Pension Benefit
To give you an illustrative example, if an employee earns $60,000 per year in the last few years of work, has worked for the company for 25 years, and has a benefit multiplier of 2%, then he or she would receive $30,000 per year in retirement ($60,000 × 25 years × 2% = $30,000). This simple method for calculating benefits is used by virtually every defined benefit plan. Though there may be slight differences — some plans use the worker’s average salary over the last two years, while others use the average of the last five years — this is the basis for how most pensions work.
Your pension benefits will be subject to a vesting schedule which is an incentive program determines how much you would get depending on how long you have been with the company. For example, you may have to work for the employer a minimum of five years before you would be eligible to receive a pension. Your company determines in advance what this schedule will be, so check with the human resources person to find out how long you have to work there to get benefits. (Note: Any money you put in voluntarily is always vested immediately.)
HOST: What should I know before I retire, with regards to the pension choices that I may be offered?
KLAAS FINANCIAL: Yes, so when you go to retire and you are vested in your pension plan, you will have to choose how you want to receive your pension benefits. Remember that once you sign the paperwork the agreement is usually irrevocable from that day forward so carefully study the numerous distribution plan choices that your pension benefit plan offers and find the one that fits your joint financial needs. We would recommend that you consult with your financial advisor because this is a very important decision.
Common pension choices include:
- Single Life (usually the highest payout; ends when you pass away with no residual going to spouse or estate)
- 50% Joint and Survivor (take a lower monthly payout now, but upon your death, your surviving spouse will get 50% of your current benefit)
- 100% Joint and Survivor (usually a lower amount of benefit now, but upon your death, your surviving spouse will continue to get your same benefit)
- Life with 10 years certain (payment is guaranteed to paid out for a minimum of 10 years and will continue as long as you live, but if you die prior to 10 years, the payments would continue through year 10)
- Lump Sum rolled into an IRA (offers the most flexibility) with this choice you can choose your own investments and determine how much income you would like on a monthly basis. Upon your death, the remaining value of the account goes to your beneficiaries.
Tread carefully! If you choose a life-only annuity payout from your pension plan it means when you die, the income stops. If you are married, and you both rely on this pension annuity income, this could leave your spouse in a difficult financial situation. To avoid this situation, you may want to choose a joint life pension payout. Below is a real-life example of one woman’s pension benefit distribution choices to give you a sense of what $$ can look like amongst different distribution choices.
Sample Pension Benefit Distribution Choices
Retiree Sara: Female age 62 with 30 years of service
- Single Life: $1,741
- 50% Joint and Survivor: $1,560
- 100% Joint and Survivor: $1,414
- Life with 10 years certain: $1,620
- Lump Sum: $256,660
HOST: What happens when I begin distributions from my pension… do I have to pay taxes?
KLAAS FINANCIAL: Most pension benefits are federally taxable. When you begin taking pension income, you’ll need to determine if you should have taxes withheld from your pension payments. It is best that you plan on paying taxes on any pension income you will receive.
However, there may be EXCEPTIONS: If after-tax money was contributed to the pension, a portion may be tax-free. Sometimes with pensions paid due to disability, a portion of the benefit may be tax-free.
When we are discussing state income taxability, it does matter where you live.
In the STATE of WISCONSIN, income from retirement accounts, including pensions, or distributions from IRAs or a 401(k)s, are fully taxable at rates ranging from 4% to 7.65% **However, income from a government pension (for example the Wisconsin Retirement System) is not taxable. NOTE: ** Social security is not taxed in Wisconsin.
If you’re getting a pension in retirement, you may prefer to live in one of the locales where pension income is NOT TAXED: Alaska, Florida , Illinois , Mississippi , Nevada , New Hampshire , Pennsylvania , South Dakota , Tennessee , Texas , Washington, and Wyoming.
Another question we get sometimes is “Can a Pension Plan Be Terminated?” If your employer offers a pension, they can decide to terminate it. In such a situation your accrued benefit usually becomes frozen; meaning you will get whatever you’ve earned up to that point, but you cannot accumulate any additional pension income.
In some cases, pension plans were managed poorly and were not able to pay out all of the promised benefits. If the pension plan was a member of the Pension Benefit Guaranty Corporation (PBGC) then in this circumstance, some benefits are protected for pension plan participants.
Catch C.J. Klaas and Maleeah Cuevas on Money in Motion every Thursday on Madison's 1310 WIBA from 8:05-8:35am.