Retirement Benefits

Retirement Benefits

Retirement Benefits

The first contingent of baby boomers turned 65 a few years ago. This presents two challenges for employers. First , employers are taking steps to entice older workers to keep working in some capacity.

Second, retirement benefits such as federal Social Security and employer pension/retirement plans like the 401(k) are big issues.

Social Security

Most people assume that Social Security provides income only when they are older than 62, but it actually provides three types of benefits. The familiar retirement benefits provide an income if you retire at age 62 or thereafter and are insured under the Social Security Act.

Second are survivor’s or death benefits. These provide monthly payments to your dependents regardless of your age at death (assuming you’re insured under Social Security). Finally, disability payments provide monthly payments
to employees who become disabled totally (and to their dependents) if they meet certain requirements.

The Social Security system also administers the Medicare program, which provides health services to people age 65 or older. “Full retirement age” for non-discounted Social Security benefits traditionally was 65—the usual age for
retirement. It is now 67 for those born 1960 or later.

A tax on the employee’s wages funds Social Security (technically, “Federal Old Age and Survivor’s Insurance”). Recently, the maximum amount of earnings subject to Social Security tax was $118,500; the employer pays 7.65% (including Medicare) and the employee 7.65%.

Pension Plans

Pension plans provide income to individuals in their retirement, and just over half of full-time workers participate in some type of pension plan at work.

We can classify pension plans as contributory versus noncontributory plans, qualified versus non qualified plans, and defined contribution versus defined benefit plans. The employee contributes to the contributory pension plan, while the employer makes all contributions to the noncontributory pension plan.

Employers derive certain tax benefits (such as tax deductions) for contributing to qualified pension plans (they are “qualified” for preferred tax treatment by the IRS); non qualified pension plans get less favorable tax treatment. As with all pay plan components, employers should ensure retirement benefits support their strategic needs. For example, set guiding principles such as “assist in attracting employees.”

With defined benefit pension plans, the employee’s pension is specified (“defined”), in that the person knows in advance his or her pension benefits. A formula usually ties the pension to a percentage of the person’s preretirement pay (for example, to an average of his or her last 5 years of employment), multiplied by the years he or she worked for the company.

Due to tax law changes and other reasons, defined benefit plans now represent a minority of pension benefit plans. However, even younger employees now express a strong preference for defined benefit plans. Some companies, such as Union Pacific, offer them as employee retention tools

Defined contribution pension plans specify (“define”) what contribution the employee and employer will make to the employee’s retirement or savings fund. Here the contribution is defined, not the pension. With a defined benefit plan, the employee can compute what his or her retirement benefits will be upon retirement.

With a defined contribution plan, the actual pension will depend on the amounts contributed to the fund and on the success of the fund’s investment earnings. Defined contribution plans are popular among employers due to their relative ease of administration, favorable tax treatment, and other factors.

Portability—making it easier for employees who leave the firm prior to retirement to take their accumulated pension funds with them—is easier with defined contribution plans.

In any case, CEO retirement packages tend to dwarf the average employee’s. For example, when Target’s CEO stepped down recently after a huge credit card breach, he walked away with retirement plans worth more than $47 million, plus a $7.2 million severance payment and $4.1 million from vested stock awards.

Cash Balance Pension Plans

With defined benefits plans, to get your maximum pension, you generally must stay with your employer until you retire—the formula takes the number of years you work into consideration. With defined contribution plans, your pension is more portable—you can leave with it at any time, perhaps rolling it over into your next employer’s pension plan. Without delving into the details, cash balance plans are a hybrid; they have defined benefit plans’ more predictable benefits, but the portability advantages of defined contribution plans. The employer contributes a percentage of employees’ current pay to the employees’ pension plans every year, and employees earn interest
on this amount.

 

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