If you have a Defined Benefit Pension Plan (DB Pension), you likely have questions about how it works and how it interacts with your overall financial plan. In our latest Question From Clients video, Kelley Doerksen, CFP® explains some of the key information you need to know about these plans.
It’s common to have a pension from your employer that you contribute to and know very little about! Especially if you contribute to a “Defined Benefit” pension (often referred to simply as a DB pension). While each pension is unique, let’s look at 6 similarities:
1. Predictable Income for a Lifetime
Once retired and your pension begins, a DB pension will pay you a set amount of income for your lifetime. Some pensions also offer indexing, which will increase your income by some percentage of inflation.
2. Income for spouse or partner on death
Many DB pensions allow you to choose if your pension will continue to be paid to a spouse or partner in full upon the death of one of the pensioners, or if it will continue at a reduced rate. The choice you make at retirement will influence the amount of pension income you receive for life.
Most DB plans allow you to choose a guarantee period. This is not related to how much time you will receive your pension income for (remember, these plans pay for life), but relates to how long a death benefit would be made available to your beneficiaries upon death of the pensioner(s).
4. Commuted Value (lump sum transfer) is an option
When you leave the plan, either due to retirement or leaving the employer, most plans allow you to take a commuted value (lump sum). This lump sum can be transferred in part without immediate tax penalty to a LIRA (Locked-in Retirement Account), however often there is also a taxable portion to consider. You should always make sure that any immediate tax hit does not erode the assets available to you in such a way that you cannot equal your predicted pension income. This is a complex decision, and assistance from your financial planner will be valuable.
5. You are making contributions
Nearly all Defined Benefit pensions require a contribution from the employee as well as the employer. In fact, most DB pensions have relatively large contribution requirements of their employees in the range of 10 – 11% of your gross salary. You can be assured that the employer contributes at least as much as you do.
6. Limited Reporting
Many DB pension holders receive a statement only once annually. This is different than what you may be used to with your investment reporting. Since your value from a DB pension comes from the income you will be provided with at retirement, there is little need to receive more frequent statements as the ‘value’ is related to your years of service (and other factors), not specifically investment returns.
If you have questions about how your Defined Benefit Pension interacts with your overall financial plan, please reach out to us and one of our financial planners would be happy to walk you through your specific details.