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Pension annuities in the US provide retirement income for workers, funded by employee and employer contributions. Retirement benefits fall into defined benefit or defined contribution plans, with options for duration and survivor benefits. Payments can be made over a specified period or as a lump sum to the retiree’s estate.
Pension annuities in the US have generally been established for the purpose of providing retirement income for workers. Employers can create them for the benefit of their employees, or unions can offer them for the benefit of their members who work for different participating employers. Most are funded by a combination of employee and employer contributions, although a small percentage is funded entirely by employers. The benefit is generally paid monthly to retirees who meet minimum age and years of service standards, and may be adjusted periodically to account for the cost of living. Some pension plans pay their retirees directly; others buy retirement pension annuities from an insurance company.
Retirement benefits paid by pension annuities generally fall into one of two categories: the defined benefit and the defined contribution. A defined benefit plan pays a monthly amount generally based on the retiree’s earnings and years of service. In the United States, a very common formula is 2.5% of average earnings over the last two years of service for each full year of service, capped at 75% or 80% of final earnings. Under the plan, after 20 years of service, a worker who meets the minimum age requirements would receive 50% of her average earnings for the last two years before retirement.
A defined contribution plan, on the other hand, accumulates all contributions made on behalf of an employee, plus earnings. The employee’s monthly benefit is based on actuarial assumptions of the retiree’s life expectancy. This approach is very similar to more modern retirement savings plans such as the IRA, 401(k), and 403(b). In many cases, both defined benefit and defined contribution plans may allow participants to withdraw their contributions plus interest as a lump sum at retirement, in exchange for a reduced benefit based only on employer contributions.
Pension annuities can also be classified according to the duration of their benefits. Whether it is a defined benefit or a defined contribution, the benefit is generally paid over the life of the retiree, although some pay only for a specific period of time and then end. However, if the retiree is married, the spouse must be included in the calculations. In states that allow such an option, if the participant selects the plan that pays 100% of the unmarried benefit, the spouse receives no benefit once the retiree dies. Most pension plans typically offer four or five additional payment formulas designed to provide income to the surviving spouse after the retiree’s death.
Plan participants generally select from among the different options when they first enroll in the plan, but they can change their selections at any time. Married participants generally must obtain the consent of their spouses for any selection that reduces the surviving spouse’s benefit. However, once monthly pension payments begin, the election generally becomes irrevocable.
Participants generally worry that the pension plans to which they have contributed will pay them or their spouses at least what they themselves have contributed, plus any earnings. The problem is that the funds that have been contributing to their pension plans over the years do not go back to the employer or the insurance company in case they die soon after the pension payments begin. To address this concern, pension annuities provide for payments over a “specified period.” If the named beneficiaries, the retiree and spouse, die before the end of the specified period, payment is made to a named third beneficiary until the specified period expires, or a lump sum is paid representing the unpaid balance of the annuity to the retiree’s estate.
Smart Asset.
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