Pensions Essay

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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.

Bibliography:

  1. Kotlikoff, Laurence and Daniel E. Smith. Pensions in the American  Economy. Chicago:  University of Chicago Press, 1983.
  2. 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)
  3. Samwick, Andrew A. and Jonathan Skinner. “How Will 401(k) Pension Plans Affect Retirement Income?” American  Economic Review,  94/1 (2004).

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