Last Week’s Question of the Week: As a result of recent events with COVID-19, when must you have filed your 2020 taxes? Is it April 15th or July 15th of 2020?
ANSWER: July 15, 2020
HOST: When we are getting ready to retire we have a lot of options in front of us. Today you are discussing when a person has a pension, and how to make best choices, correct?
KLAAS FINANCIAL: Yes. Back in the 1980s, roughly 38% of workers had a pension. According to the Bureau of Labor Statistics in 2017, only 18% of private-sector workers had access to a pension, with only 15% participating. The trend of the number of private-sector workers who have access to a pension is largely expected to move closer to 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 will 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.
A pension is just one of many types of retirement plans. We generally categorize retirement plans as being one of two types: either defined benefit (DB) or a defined contribution (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 401k every year, that’s a defined contribution plan. A defined contribution plan is an individual account like 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: What should I know before I retire, with regards to the pension choices that I may be offered?
KLAAS FINANCIAL: 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. Your traditional pension plan is designed to provide you with a steady stream of income once you retire. That’s why your pension benefits are normally paid in the form of lifetime monthly payments. Increasingly, employers are making available to their employees a one-time payment for all or a portion of their pension. This is known as a lump-sum payout option.
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 will 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.
HOST: So, if I am offered a lump sum option on my pension, should I consider taking it?
KLAAS FINANCIAL: There are several considerations before accepting a lump sum:
- If you choose a lump-sum payout instead of monthly payments, the responsibility for managing the money shifts from your employer to you. In addition, you increase the risk of outliving your money, and losing your money due to bad investment advice, fraud, or poor stock market performance.
- Will you be at risk of running out of money? The monthly payment option offers steady lifetime income, which substantially reduces your risk of running out of money later in life. This is especially important if either you or your spouse is in good health or if either of you has a family history of longevity (for example, you have close relatives living into their 80s or older). However, a lump-sum payout, however, might make sense if you are in critically poor health, or if you and your spouse already have enough income to cover your basic living expenses.
- Are you taking your pension in a lump sum because you’re worried that you may not live long enough to get back what you’ve earned? The monthly pension payment still may be a good choice if you are concerned about the retirement security of your spouse or other beneficiaries. Most plans allow you to provide monthly benefits to your spouse or another beneficiary after your death through something called a joint and survivor payout option.
- Where can you find more information about your payout options? Ask your employer for your pension plan administrator contact information. Your plan administrator will provide you with more specific information about your payout options.
HOST: What happens when I begin distributions from my pension? Will 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 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 and is it protected?”
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.
With regards to protection, typically, pensions are insured by the Pension Benefit Guaranty Corporation (PBGC). This is a federal agency created by the Employee Retirement Income Security Act of 1974 (ERISA) to protect pension benefits in private-sector defined benefit plans In the event your company declares bankruptcy or can’t make its payments, this federal agency guarantees your payments up to a certain amount. Your pension payments are also protected against certain creditor claims. To find out if your pension plan is covered, and the PBGC’s guarantee limits please go to pbgc.gov to check.
This Week’s Question of the Week: Typically, the Pension Benefit Guaranty Corporation (PBGC) guarantees protection of what type of retirement plans. Is it 401ks or Pensions?
Catch C.J. Klaas and Maleeah Cuevas on Money in Motion every Thursday on Madison's 1310 WIBA from 8:05-8:35am.