Most people's ideal situation for retirement is having the same income and standard of living as
they did before, but without having to work for it. I mean, why retire if you have to
significantly downgrade your lifestyle, right? Social Security's guaranteed checks might seem
like the answer, until you find out that they actually usually only replace 40 percent of your
pre-retirement income. If you were earning $5,000 a month before retirement, then Social Security
would only give you about $2,000 per month. Losing over half of your income is sure to put a dent in
anyone's retirement plans. Luckily you're not just stuck with Social Security. You can supplement it
with other sources of retirement savings in order to bring your income up to its pre-retirement
levels. Some options, like pensions and annuities, actually follow the same set monthly paycheck
style that Social Security does. So you can easily combine them to form a stable, reliable source of
income in your golden years. In this video we're going to go over what pensions and annuities
actually are and how they're different from each other, so that you can better decide which
options are best for you so that you can start saving for retirement soon. Let's get into it.
Pensions are a benefit that some employers offer, where the expectation to save up for retirement
falls on the shoulders of the employer instead of the employee. Your employer promises to contribute
a certain amount to a pension fund every month. Then when it's time for you to retire,
you'll receive a specified amount from that pension fund, typically based on how long you were
working there and how much you were making prior to retirement. For example, perhaps your contract
states that your annual pension will equal one percent of the highest salary you received for
each year you were employed there. Then you know from the time you start your job how your
pension will be calculated, and that you could do two things to increase your pension. Perform
well to earn raises, and work there as long as you can. This is why pensions are also known
as defined benefits plans, because the amount that your pension benefit will provide you is
defined right from the start. The payment that you receive could come in one of two different forms.
If you prefer to have full control over your money, you can choose to accept your pension
as one total amount, known as a lump sum. Once you receive your lump sum, you could do whatever you
want with it. Throw it into a personal savings account for safe keeping and a little interest.
Invest it in successful stocks and bonds to watch the money balloon quickly, or if you don't really
need the money yourself, you could place it into a college fund for your grandchildren.
But taking the lump sum does have some inherent risks to it. The biggest one being is that the
money you got from the lump sum could just run out one day. Maybe you withdrew too much
from your savings. Maybe you had a few really bad Investments, or maybe you did all the math
right but then you ended up living way longer than you expected to. The whole point of a pension is
to fund a comfortable retirement, and that all stops the moment the money runs out. So what do
you think? Would you rather have full control of your pension money? Or does the risk of suddenly
not having anything left just scare you too much? If you feel that the risks associated with taking
the lump sum far outweigh the benefits, then don't worry. There is another option for you.
You can also accept your pension as an annuity. An annuity is a set payout each year, usually
split into monthly checks. You don't have as much control over your full pension, but you can still
do whatever you want with the monthly amount you do get. Any of the money that isn't earmarked
for bills can still be put in a savings account, invested for large returns, or placed in a college
fund for your grandkids, and the best part is that annuities are a steady paycheck for life.
You won't have to worry about outliving your funds, because the monthly checks are guaranteed
to just keep coming ,even if you end up living to be 200 years old. Deciding between taking
the lump sum or the annuity payments is really a judgment call on how long you think you're going
to live. I mean, if you don't think you're going to live that long, might as well take the lump
sum and use the money while you can. But if you expect to live for several more decades,
then having a guaranteed steady source of income can help keep you going without ever running out.
Having Social Security payments on top of a pension, whether it be through a lump sum,
or through more monthly payments, could fund your retirement. But of course there's a catch. See,
pensions have kind of gone out of style. Because both contributing to and managing pension funds is
done on the employer's dime, pensions can cost those employers a lot of money. Some companies
and government jobs will still offer pensions, but most have done away with them to cut costs.
These companies have replaced employer-funded pensions with employee funded retirement accounts,
such as 401ks. You're going to learn about those in the next couple of lessons. So what do you do
if you're not one of the lucky few with a job offering you a pension? How do you still make
sure that you have guaranteed retirement income? Well, as pensions started going out of favor,
a new form of guaranteed retirement income came up to replace it, and that is the retirement annuity.
Wait, hold on. So we went from talking about annuities to talking about annuities.
Yeah, it's a little confusing I'll admit. This is actually why a lot of people think that pensions
and annuities are the same thing, but they're not. See, the word annuity just means a set
amount paid annually. Pensions can give you the payouts in an annuity style, but so can retirement
annuities. And in fact, this style of payment is so integral to the retirement annuity that they're
named after it. The main difference between a pension and a retirement annuity is who pays for
it. Like I said before, a pension is paid by your employer. So once you sign your employee contract,
you really don't have to worry about a pension until you retire and you can start collecting
those checks. Even if you're receiving the benefit in the form of an annuity, that doesn't change the
fact that the money you're receiving is money that your employer stashed away for you. On the
other hand, a retirement annuity is purchased from an insurance company by you, not your employer,
in order to ensure your income after you stop working. This is meant to replace your income,
and so the payout is in the form of monthly payments, just like a paycheck. There are two
different kinds of retirement annuities: immediate annuities and deferred annuities. Immediate
annuities are paid out to you immediately. These are more for people who have just retired and
have just realized that their savings might not be enough. With an immediate annuity,
you pay the insurance company a lump sum, usually a large chunk of your retirement savings, and your
monthly payments will begin sometime within the next year. Often as quickly as a month later.
Deferred annuities are used to plan ahead towards retirement. You pay smaller amounts
for the annuity over several years, and then when you retire it flips around and you start receiving
your annuity checks from the insurance company. If you're ever given the choice between a pension
and a retirement annuity, it's usually the better choice to accept the pension rather than purchase
the annuity. The big reason is right there in the wording. It's better to accept the pension that
your employer is offering to pay for you, than it is to purchase an annuity with your own money.
Also, fun fact, pensions are actually insured by the Pension Benefit Guarantee Corporation. So if
the company you're working for ever goes under, you are still guaranteed your pension. Retirement
annuities, though, have limited protections. So if the insurance company that you bought the annuity
from goes under, then your money might not be 100% protected. The value of your annuity could
go down, and you may have to wait a while without monthly payments before those protections kick in.
If you choose to purchase a retirement annuity, make sure you do your research beforehand and
pick an insurance company that doesn't look like it's going to go under anytime soon. Rather than
receiving a fixed income, many people prefer to play the odds with retirement accounts known
as defined contribution plans. In a defined contribution plan, you contribute some of the
money from your salary into a fund, and then that fund gets invested for hopefully high returns.
When you retire, all those returns, or losses if you are unlucky, are yours to keep. You can
contribute to a defined contribution plan using either pre-tax or post-tax money. What does this
all mean? Well, in the next few lessons we're going to learn all about those pre and post-tax
retirement accounts, starting with the pre-tax accounts in our very next lesson. See you then.