Did you know that almost half of adults approaching retirement age may not be financially prepared to retire? With inflation making waves and the unexpected costs that come with living, it’s important to start planning early.
A pension fund might be an essential tool for preparing for retirement depending on your employer. What is a pension fund and how can you plan for retirement with one?
Keep reading to find out.
What Is a Pension Fund?
A pension fund accumulates capital that is to be paid out as a pension for employees after they retire.
They typically involve aggregating large sums of money for investments in stocks and bonds. In return, they generate profit.
Pension funds are managed by companies/employers. The goal of this fund is to ensure workers have enough money to cover their pensions after they retire.
This defined benefit plan allows employees to receive pension payments based on a percentage of their average salary. Employers pay this amount throughout the last few years of employment.
Upon retirement, employees will receive monthly benefits through this traditional pension plan. How long an employee worked for the company is also taken into account for the monthly payments.
How Do Pension Funds Work?
Traditional pension plans, aka pension funds, have been slowly disappearing from the private sector. Government workers and other public sector employees are the largest groups with working pension funds.
Private pension plans aren’t as gracious as public employee pension plans.
Private pension plans rarely have an escalator to adjust for inflation so the benefits might decline over the years. Public pension plans, on the contrary, typically have a cost of living escalator.
Pension Plan vs. 401(k)
When you think of a plan for retirement, a 401(k) might come to mind. This is because 401(k) has become the more popular option for employer-sponsored retirement.
With this plan, employers guarantee a certain percentage of an employee’s salary if the employee contributes first.
A 401(k) is a defined benefit plan with no guaranteed benefits during retirement. The retirement income you receive depends on the amount you and your employee contribute to the account plus the performance of the investments.
Pension plans guarantee a benefit and are primarily employer-funded even though employees may contribute. Employers may or may not contribute to a 401(k) as they are primarily employee funded.
Investments are primarily employer-directed so the employer holds all of the investment risks with a pension plan. In contrast, employees hold the investment risk because investments are employee-directed in a 401(k).
The critical difference between the two is how the investments are managed. Money in a pension plan is pooled together and invested together.
Each employee chooses their own investments from a list that the employer often provides.
How to Plan for Retirement
Most times you don’t have a choice in the plan your receive from your employer. However, there are steps you can take that can help with retirement planning no matter what plan you have.
It’s best to start planning early but it is never too late to begin. The earlier you start planning, the more time your money has to grow.
These are the active steps you can take when you decide to start building your retirement fund:
Calculate How Much Money You Need
How much money do you need to retire? This is the first question to ask yourself to plan for retirement.
The amount of money you need to retire is a function of your current expenses and income. If you believe those expenses will change in retirement, you’ll need to calculate accordingly.
The general advice is to replace up to 90% of your annual pre-retirement income through Social Security and savings.
Consider Your Financial Goals
If retirement isn’t your only financial goal, you’ll need to consider your plans during this process. For example, the following are common financial goals people have to or want to reach in their lifetime:
- Paying down credit card debt
- Paying down student loan debt
- Building an emergency fund
- Buying a house or car
Try to save for retirement at the same time you save for your financial goals. You can create a budget to help you do both.
If your employer matches your retirement contributions, it’s important to keep adding to your retirement account.
Learn About Other Retirement Plans
Nowadays, having a 401(k) is common but there are some workplaces that don’t offer a workplace retirement plan. If this is the case, you can open your own retirement account.
You can also have a 401(k) through your employer and combine it with other retirement options. Investing in alternatives is becoming more common for employees.
Some of the other retirement plans that could work for you are:
- Traditional IRA
- Roth IRA
- Self-directed IRA
- SEP IRA
- Simple IRA
- Solo 401(k)
There’s not a ‘best’ retirement plan but if you find one with tax advantages and additional incentives, you’ll be happy with your choice.
In many cases, individuals prefer a 401(k) because of the matching contributions from an employer.
The Bottom Line
Learning about a pension fund might get you excited about retirement planning because it comes with a lot of benefits. Funds are guaranteed by your employer when you retire, unlike the funds in a 401(k) plan.
The downside is that pension plans aren’t as common as they once were. You’ll likely find an employer that offers a 401(k). Use this plan to boost your retirement funds while taking care of other financial obligations.
It’s never too early to start planning for retirement so use this guide to get started now! Come back to our blog for more posts like this.
