Pay As You Go Pension Plan

  

Categories: Retirement

A “pay-as-you-go pension plan” is a pension plan that we pay into, um...as we go.

If that sounds simple, it is. In theory, anyway. It works like a 401(k): we tell our employer how much of our paycheck we want to contribute (or we contribute one lump sum amount every year), and it automatically goes into our pension plan. Then when we retire, boom—we’ve got a pension.

The part where it can get a little complicated is when we have to choose which type of pension plan we want to invest in. But if we work for a private company with a private pension plan, these are choices we’re probably going to have to make. It’s like investing in a mutual fund: do we want to be more aggressive, aiming for higher returns but risking greater losses? Or do we want to play it conservative and stick to a nice, comfortable predicted earnings rate? And what about when we retire: do we want to get everything we’re owed all at once, or do we want it to pay out over time, like an annuity?

Not all pay-as-you-go pension plans have this many options. In fact, sometimes there might be one option: here is the one pension plan, and if we want in, we sign up, and that’s it. But just as with any other investment, we should definitely make sure we know what we’re getting into before we...get into it.

Related or Semi-related Video

Finance: What are Pension Liabilities?23 Views

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finance a la shmoop. what are pension liabilities? okay so if you haven't seen

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our James Cameron directed and shmoop academy award-winning video called

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what is a pension, we'll watch that first. before you continue. okay hi welcome back. [link to pension video]

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a pension liability is not that different from a liability owed by any

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corporation or even an individual. the corporations and governments both

00:30

provide pensions for their employees. very roughly an employee making say 75

00:36

grand a year might get 10% of a salary a year in pension contributions from the

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employer. while pensions are divided into two

00:43

flavors. there are defined contribution pensions - one flavor of a 401k plan. in a

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defined contribution plan the employee contributes say 10% of their salary and [defined contribution pension defined]

00:55

in this case that would be 7,500 bucks. and the employer might match it. that is

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the employer takes 7,500 bucks off of their total salary that is calculated

01:03

for taxes so the employee instead of being taxed on 75 grand a year gets

01:08

taxed on sixty seven thousand five hundred they then defer the 7,500 bucks

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they put into their 401k plan and well they'll still pay taxes on it eventually [equations on screen]

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when they take it out but presumably when they're old and retired and poor

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and thus likely to pay lower tax rates than they would in their heavy working

01:28

high tax hike tax rate era at the peak of their careers. so the employee saves

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seventy five hundred bucks there or at least puts it away, and the employer

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matches that 75 with seventy five hundred of its own. so from the employers

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perspective that employee does not just get a seventy-five thousand dollar [equations on screen]

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salary they cost the employer 75 grand plus another seventy five hundred bucks

01:50

of 401k pension matching expenses or eighty two thousand five hundred dollars.

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and the employer pays it grumbling and wondering when the next version of robot

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comes out so they can replace this worker ,well what happens to those

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savings. well, employers usually provide employees with a menu of investment

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choices they can hold all cash, they can invest in high-growth relatively risky [list of investment options shown]

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funds, they can invest in balanced growth and income funds and so on and so on.

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well the employee gets to choose from a supermarket of investment fund choices

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or even buy individual stocks in their pension. the key takeaway at the

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end of however many years or decades of working the employee is able to take out

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from their pension whatever value that pension has accrued to be worth over

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that time period. easy. in a defined contribution fund there is essentially [flow chart]

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no pension liability. no pension liability to the corporation other than

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each year doing the matching thing on that salary. okay?

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the employee bears the stock market risk just like everyone else. the big

02:52

controversies you read about in the press revolve around the benefit flavor

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of a pension, 2nd flavor here, called a defined benefit plan. in a defined

03:02

benefit situation a number of irresponsible financial dealings take [types of pensions listed]

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place where taxpayer money is often just given away with no thought of fiduciary

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duty or obligation to ,you know being respectful of the taxpayers hard-earned

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money. a given government worker works for the state for 30 years eventually

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making a hundred grand a year at the end having received pension contributions

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all along the way just as in the defined contribution system that corporations [equation on screen]

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use as outlined above .only in a government defined benefit program the

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employee is guaranteed a minimum rate of return in many situations. that is the

03:41

employee is guaranteed say 10% a year in investment returns even if the stock

03:47

market is flat or down or bad for 7 ,10 15 ,years whatever. that happens all the

03:53

time, yet the taxpayers on the hook to give

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them that guaranteed 10 percent a year compound rate. well at a 10 percent of [flow chart]

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your compound rate after seven years well let's say the actual stock market

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return was only 7 percent and the employee lagged 3 percent a year each

04:10

year compounded well that would be a lot that the state would then owe them so

04:15

that's one flavor of pension liability that could likely bankrupt California

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and Illinois at some point not too far away because the pension liabilities [California and Illinois pictured.]

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there are enormous. and it gets worse there are other irresponsible things the

04:28

states have done like guarantee retirement return minimums or investing

04:32

pension money in dead stock beanie babies. it was a really bad investment by

04:37

CalPERS there huh. so yeah pension liabilities are a

04:40

totally simple easy to understand uncontroversial thing and while they

04:44

can't possibly have an adverse effect on the world around us right? sorry hard to

04:49

keep a straight face there. [man talks out the side of his mouth]

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