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Arbitrary Retirement Plan Rules, Part 4: Employer Pension Plans

January 28th, 2011 · 4 Comments · Retirement Planning

An employer pension is getting to be quite rare these days. Pensions are retirement plans that, traditionally, an employer would fund on behalf of the employee. These are quite easy to understand and many of the arbitrary rules are similar, if not the same, as the arbitrary rules for annuities. This is because pensions use annuity contracts to make payments to employees when they retire.

An employer pension is a retirement plan where your employer sets aside money for you and then pays you an income, or a large sum of money, when you retire. The employer has a few different ways to fund a pension.

First, the employer may set aside money from your paycheck. You won't normally notice it, since the employer simply advertises a lower base salary for you. They called this arrangement "deferred compensation." The employer sets aside money for you and an investment firm manages the money. At retirement, you receive a few options for payment.

Another way to set up a pension is through a fully insured plan called a 412(i) plan. A 412(i) plan is funded with fixed life insurance and annuity policies. Since the insurance policies are guaranteed, so is your retirement income.

In both cases, your pension is what's called a "defined benefit plan." These plans pay a stated benefit that is known in advance. In other words, you'll know long before you retire what your pension amount will be.

Regardless of how the pension is set up, you are allowed a couple of different options at retirement:

First, you may take your pension as a lifetime payment. This means that all of the money you receive from your pension is paid out to you, and only you, over your lifetime. When you die, your spouse won't receive a dime from the pension--even if you die the day after you retire.

A second option is a certain and continuous benefit option. This means that pension benefits are paid out to you for your lifetime. But, there is a period certain component for your beneficiary. If you die within a stated time period that you choose, then your spouse gets the benefit for the rest of the period. So, if you elect to receive this payment option, you choose a 5, 10, or 15 year benefit for your spouse. If you choose a 10 year benefit, and you die in year 7, then your spouse receives your payments for another 3 years and then payments stop. If you live past the 10 years, then you keep receiving your payments for life, but your spouse gets nothing when you die.

Another option you may choose is a joint and survivor annuity. This option pays you a fixed monthly benefit for your lifetime. When you die, your spouse may receive 50, 75, or even 100 percent of your original pension benefit. Obviously, how much you choose to leave your spouse affects your benefit. The more you leave to your spouse, the less you will be paid during your lifetime.

A joint and survivor "pop up" option allows you to leave a benefit to your spouse when you die, similar to the joint and last survivor. Your spouse may receive 50 or more percent of your benefit option. But, you must take a reduced benefit for this (just like you do with the joint and survivor benefit). The difference here is that you get your full benefit option back if your spouse predeceases you. 

The last most common option is a lump sum amount. This means that you get to take a large lump sum amount in lieu of payments. The lump sum constitutes what would have been paid out to you over your lifetime. You get to invest this money and/or spend it however you choose.

With the lifetime payments and the lump sum, you are generally required to have your spouse sign a waiver saying that when you die, your spouse won't get anything from the pension plan.

Like other retirement plans, pensions are restricted to normal retirement age rules (they cannot pay out a pension prior to your normal retirement age). A pension also must comply with a plethora of rules set down by the Employee Retirement Income Security Act (ERISA).

Here's where the fun begins. ERISA sets down the laws which include:

...when an employee must be allowed to become a participant, how long they have to work before they have a non-forfeitable interest in their pension, how long a participant can be away from their job before it might affect their benefit, and whether their spouse has a right to part of their pension in the event of their death.

They also tell you what you can and can't buy with your money, when to eat, sleep and you know what else., I'm kidding. They don't do any of those things. If you want to know more about pension plans, the IRS has a lengthy snooze-fest of a publication you can read (publication 575).

This post is part of a series on retirement plans. Want to read more? Here's the rest in the series:

Arbitrary Retirement Plan Rules, Part 1: 401k Plans

Arbitrary Retirement Plan Rules, Part 2: IRAs

Arbitrary Retirement Plan Rules, Part 3: Annuities

Arbitrary Retirement Plan Rules, Part 4: Employer Pension Plans

Arbitrary Retirement Plan Rules, Part 5: A Solution

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