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Optimizing Your Pension Choices for Approaching Retirement

A recent Gallup poll determined that, 42% of low-income respondents will rely on Social Security and part-time work to help them through their “golden years”. Surviving on Social Security alone is difficult if not impossible but unfortunately many are relying on it.

Overall, those nearing retirement age today, i.e.  50- to 59-year-old nonretirees still see Social Security as having a major role in funding their retirement with S.S. essentially tied with 401(k) plans as the major source of retirement funding and S.S. is the top-rated source among nonretirees aged 60 and older.

Although most young adults don’t expect to rely on Social Security, if they fail to plan ahead they may end up just like their less wealthy predecessors.

On the other hand, 65% of wealthier not-yet-retired Americans have taken responsibility for their own future and plan to use investments, 401k’s, IRA’s and pension plans to fund their retirement and 44% of middle income earners will do so.

pension choicesThe old saying, “Fail to plan and you plan to fail”  applies especially when it comes to retirement. One of the most common reasons for people to seek financial management assistance is to help them plan for financial security during retirement.  In years past, this financial security was based on a company sponsored pension fund; however, there are other ways to accrue and manage a pension entitlement even if you are a self-employed entrepreneur rather than an individual who has pursued a steady career with a single organization. This website provides information for U.K. freelancers and self-employed individuals, including advice about financial issues such as pension choices and setting up companies.

Pension Choices at Retirement

Many people working for larger companies take advantage of a company pension plan (or pension “scheme” in the U.K) as it is a good way to build up a “nest egg”. If your company has a “matching program” you should try if at all possible to contribute the maximum allowable for matching as otherwise you are giving up free money.

If you are self-employed, there are also plans specifically for you as well, which include a broad range of personal pension options.  In the U.K. these are defined contribution schemes, group personal pensions, and self-invested personal pensions, among others.  In the U.S. you have IRAs, Roth IRAs, and private Annuity plans. The IRS provides a list of possible pension choices and different retirement plans.

In the United Kingdom and most other western countries, there is also a state pension for those people who have made National Insurance contributions throughout their working life. Even if an individual has accrued a substantial pension entitlement through a company scheme, they still have possibilities to explore when it comes to managing their pension fund to their best advantage. In many cases, a transfer between different schemes is possible until at least a year before the normal retirement date of the valid scheme. By using the option of transferring from a company scheme to a personal pension, an individual may gain greater flexibility with the way they can use their hard-earned pension pot. They may even find that they can gain greater benefits on the basis of different investment terms.

In the U.S., the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) made 401k and IRA plans more portable, so they can be transferred as long as it is done properly. The key is to transfer directly between the plans and not have the money sent to you first. If you don’t follow the letter of the law you could be liable for the 10% early withdrawal penalty. The basic rule is that you have 60 days to put the money into another plan but 10% is a big hit to take and you don’t want to risk a paper work snafu so it is much safer to simply have the funds transferred directly from one fund to the other. That way if there is some delay, the funds will still be in the original retirement plan and you won’t risk accidentially having it out for more than 60 days.

Annuities and Enhanced Terms Annuities

In the months immediately before retirement an individual should receive a statement from the pension provider to inform him or her of the value of their pension and their distribution options. This could be guaranteed income from the plan or in the form of a purchased annuity.  At this point, individuals in the U.K have the chance to explore the open market pension annuity option.  Rather than simply making the offered annuity purchase, it is possible to shop around to find a better rate or better terms to suit an individual’s particular retirement needs.

For example, another possibility at this stage may be to take out an enhanced annuity.  This is an annuity that takes certain lifestyle and medical factors into account to calculate a life expectancy, and which can therefore potentially provide a larger income than a standard annuity. For example, an individual who retires early from a final salary pension scheme due to poor health may be able to benefit from the terms of an enhanced annuity.  In one such case, the final pension package was even doubled by the enhanced terms.

Deferring the Purchase of an Annuity

Individuals who do not need to take their pension entitlement immediately may benefit from deferring their purchase of an annuity. Very often, there will be a fixed period of time before the deferred annuity can be taken, and then the individual will have flexibility in deciding when to start drawing on the guaranteed income. The longer you wait before beginning the payout phase the higher your income payments will be. This is for two reasons, first you will be older and thus the actuaries figure the period they will have to pay you will be shorter and secondly you funds will have had longer to grow and multiply.

Review Your Pension Choices Regularly

Throughout your working life you should take time to review your pension choices at least once year. Determine what is best for you during that particular year based on your current financial situation.  For instance, if your taxes will be low due to higher medical bills or a college tax credit you might consider investing in a Roth IRA because you won’t need the current tax break and a Roth IRA allows you the advantage of not only tax free income accrual but also tax free distributions as well. In other words, by investing after tax money you save taxes on the dristribution end (which will hopefully be much larger) while a standard IRA saves you money on the front end but requires you pay taxes on the distribution (but not during the accumulation).  Retirement planning and pension choices is just that “planning” and is not a one time decision. You should review it regularly to be sure you are still on the right track as your situation changes.

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Image courtesy of basketman / FreeDigitalPhotos.net

About Tim McMahon

Work by editor and author, Tim McMahon, has been featured in Bloomberg, CBS News, Wall Street Journal, Christian Science Monitor, Forbes, Washington Post, Drudge Report, The Atlantic, Business Insider, American Thinker, Lew Rockwell, Huffington Post, Rolling Stone, Oakland Press, Free Republic, Education World, Realty Trac, Reason, Coin News, and Council for Economic Education. Connect with Tim on Google+