5 Things Most Americans Don't Know About Pensions
A pension is a retirement plan that provides workers with a guaranteed stream of income after they retire. Unlike a 401(k), where employees contribute and manage their investments, traditional pensions are typically funded and managed by employers.
Pensions can provide some security, but many Americans don’t fully understand how they work. Here are five things experts say most Americans don’t know about pensions.
1. Most Pensions Function Like Annuities
Most consumers don’t realize that pensions are essentially annuities, as your money is converted into an annuitized stream of income, according to Jarad Stolz, vice president of insurance sales and associate chief underwriter at Diversified Insurance Brokers.
“When you annuitize an annuity, you lose full control over your funds and only receive a payment back from the chosen plan,” Stolz explained.
And sponsored plan holders offer consumers only a small handful of options, with little to no customization.
“In many aspects, you can roll your lump sum pension into a private annuity and shop the market for more flexibility, strong benefits, higher guaranteed income, more control and NOT annuitize your money by locking it up,” he added
According to Stolz, the key is knowing you don't have to accept the pension company's structure.
2. You Don’t Automatically Own Your Pension Until You Are Fully Vested
This is an issue Cody Schuiteboer, president and CEO of Best Interest Financial, encounters repeatedly, which costs people tens of thousands of dollars.
“Most people think that because they invested in the pension and worked a couple of years, they own their pension. They don't,” he said.
Pension benefits typically vest over time. Depending on the plan, you may need to remain with an employer for several years before earning full ownership of your pension benefits.
“A defined benefit pension plan can require up to five years for cliff vesting, which means that leaving the job before becoming 100% vested can result in a pension holder losing everything in the plan to the employer,” Schuiteboer explained.
There’s also graded vesting, in which employees earn ownership of their pension benefits gradually over several years rather than all at once, he added.
3. Pensions Often Have More Restrictions Than People Expect
Pensions don’t provide much flexibility and people tend to focus on what a pension provides and not its restrictions.
Pension plans do offer a choice at retirement between taking a lump sum and electing monthly payments, but that’s where any flexibility ends, according to Alex Langan, chief investment officer of Langan Financial Group.
“Most pension elections are permanent. When you sit down at retirement and choose your payout option, that decision stays with you for the rest of your life. There's no changing your mind later because circumstances shifted,” Langan said.
4. Most Pensions Do Not Keep Pace With Inflation
Pensions don’t keep pace with inflation.
“Most private pensions pay a fixed monthly amount for life. No adjustments, no cost-of-living increases, just the same number every month from the day you retire until the day you die,” Langan said.
This may not mean much to you early in retirement, but as you age, a pension that covered expenses in year one of retirement may cover a much smaller share later on.
“This doesn't make a pension a bad thing. It means a pension should be one part of an income strategy, not the whole strategy,” he added.
5. Early Retirement Can Permanently Reduce Pension Benefits
If you retire earlier than planned, this could permanently reduce your pension benefits.
“Depending on the specific plan, retiring five years early could reduce your payment by roughly 25% to 35% or more, not for those five years but for the rest of your life,” Langan explained.
Reduction rates vary by plan, but according to Langan, most apply a reduction of about 5% to 7% per year before retirement age.
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
More From MoneyLion: