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For any individual, whether in the early or advanced stages of his or her career, financial planning is very important. However, financial planning should not be limited to daily living expenses or short-term goals; long-term goals also need to be considered. It is important to save money for one’s “golden years” so that one may enjoy a good standard of living, even in old age. A pension is a major source of income in this period. Pension provides security after retirement, so that one can enjoy life without stress related to monetary matters.
Pensions In The United States
A pension is a fixed amount paid to an individual on a regular basis, usually after retirement. In the United States and most developed countries, employers play a significant role in shaping the pension plans of their employees. Usually, a pension account is maintained by an employer to provide a fixed payout after the service of the individual ends. Although sponsoring pension plans is not obligatory for employers, the U.S. government encourages employers to do so by providing them with benefits. So most government employees and some private employees are under the coverage of at least one pension plan. Most of the rules governing pension plans are regulated by the Internal Revenue Service, along with the Labor Department and the Pension Benefit Guaranty Corporation. These federal agencies try to ensure that employers contribute to maintaining financially healthy plans and set requirements to which employers must adhere.
In the United States, researchers on retirement describe a “three-legged stool” that is important to achieving financial security after retirement. The first leg of this stool is Social Security benefits, the second is pension income, and the third is individual savings. A combination of these three ensures a stress-free life after retirement. Social Security is one kind of social insurance system that ensures guaranteed income for an adjusted cost of living during retirement years. However, Social Security has not been designed to fully fund the living needs of middle and upper-middle-class individuals in America. This brings the need of pensions and individual savings. There is a significant difference between pension income and the supplemental savings of the individual. A person receives pension income as long as he or she is alive, whereas it is possible to outlive savings. So it is possible that a person has run out of savings in old age, but he or she can stay assured that he or she will receive pension income as long as he or she is alive.
Why Pensions Are Important
Retirement puts a stop to regular wages or salary earned by a person, but one still needs money to support oneself, one’s partner, and one’s family. Money is also necessary for maintaining a decent standard of living after retirement. A pension ensures that one does not face financial woes and poverty in old age. Over the past decades, there has been a significant decline in family support provided to aged members of families. Studies reveal that while there has been an increase in the life expectancy of males in the United States, there has been decline in average number of years worked by an individual. Without significant support from family, it has become difficult to finance an extended period of retirement, leading to financial difficulties. Income security in old age is one of the most pressing issues faced by society today.
Defined Benefits And Defined Contribution Plans
Retirement plans in the United States can primarily be divided into defined benefits (DB) plans and defined contribution (DC) plans. In DB plans, contributions are made by the employer on behalf of each employee. Employees have the option of adding to the contribution from their own pockets. The accumulated contribution of all employees is managed by professional asset managers and is invested in different assets. These plans come with benefits like spouse protection and disability benefits, along with a guaranteed payout for life after retirement. In DC plans, employees create their individual accounts and make contributions. Thus, all investment decisions are made by the individual and the risk of investment lies on his or her shoulder. These plans come with options of a lump sum payment or monthly payment, but it is not necessary that payment is for lifetime. Plans like 401(k), 403(b), employee stock ownership, and 457 plans come under DC plans.
Details Of Pension Plans In The United States
A pension is a type of DB plan and is a company retirement plan. In DB plans, the risk of investment rests with the employer while the employee receives a specific amount after retirement. The amount received by an individual depends on his years of service, his salary, and a fixed percentage rate. In several companies, the employees need to serve for a fixed number of years before they become eligible for a pension plan. If an employee leaves a particular employer, the pension plan stays with the previous employer. Employer-sponsored pension plans are covered by Pension Benefit Guaranty Corporation, the federal agency. In the United States, there is a sharp difference in pension plans for public-and private-sector employees. State and local pension plans are DB plans, and coverage offered by them is almost same. Private sector pension plans are more inclined toward DC, mostly under 401(k) plans. Though both plans are aggressively funded, their coverage and benefits are not similar. Public pension plans offer several benefits, including adjusted cost of living after retirement, while there are hardly any benefits in the private-sector plans.
Pensions In The United States
Until a few decades ago, the DB plan was the only option for employees to save for pensions. However, after 1993, a higher percentage of employees participated in DC plans. While almost 70 percent of the workforce is covered by a pension plan in the public sector, this figure is 50 percent in the private sector. Individual plans like the 401(k) were introduced to supplement income after retirement and not to replace group pension plans. However, several employers in the private sector have replaced group pension plans with individual savings plans. Because the returns generated on individual savings are not very high, it has resulted in devastating effects on the lives of people after retirement. Retirement life without a pension is likely to result in poverty and a financial crunch in later life. Also, these people need to significantly reduce their living expenses and may end in liquidating their assets to cover their living expenses. Pension plans have an influence on the rate of saving in the United States because accumulated pension funds are a significant part of financial markets. By substituting individual saving plans with group pension plans, it is possible to bring more funds to the financial market. Not only will it help the performance of the economy but individuals will have a better return on their savings income.
Though over the years there has been an increase in the number of employees covered by pension plans, there is still a large gap that needs to be filled. There is no single method or plan that can fill this gap. It needs a combination of techniques like recognition of benefits of group pension plans, special tax incentives for pension funds, and other wage control methods. With the changing social, demographic, and economic conditions in the United States, it is important that pension plans evolve and adapt to changing conditions. A person may risk his or her financial future post retirement by under or overestimating the extent of the income he or she will require after retirement. Every working individual has several questions related to pensions and how they work. These questions and doubts need to be clarified so that they can understand the importance of regular pension contribution in different forms. Pensions have the power of changing the living conditions of retirees and ensuring that they truly enjoy their golden years.
- Kotlikoff, Laurence and Daniel E. Smith. Pensions in the American Economy. Chicago: University of Chicago Press, 1983.
- Poterba, James, Steven Venti, and David A. Wise. “The Changing Landscape of Pensions in the United States” (NBER Working Paper No. 13381, September 2007). http://www.nber.org/papers/w13381 (Accessed December 2014)
- Samwick, Andrew A. and Jonathan Skinner. “How Will 401(k) Pension Plans Affect Retirement Income?” American Economic Review, 94/1 (2004).