Retirement may seem like a distant goal, but planning now will put you in better shape when you do finally stop working. The best way to save for retirement is through a pension plan. Whether you're starting out in your career or approaching retirement age, you need to understand how pension plans work and how to make them work for you. Here’s a beginner’s guide to saving for retirement with pension plans.
1. Know What a Pension Plan Is
A pension plan is a retirement savings plan that pays you a regular income when you retire. There are two main types of pension plans:
- Defined Benefit Plans: These plans guarantee a set amount each month after you retire, based on your salary and years of service. It’s a predictable benefit—you know how much you will get in retirement.
- Defined Contribution Plans: You and your employer contribute a set amount to an individual account, and the retirement amount depends on how the investments perform in that account. These plans are more variable but give you more control over where your money is invested.
2. Start Early to Profit from Compound Interest
The earlier you start saving for retirement, the longer your money has to grow. Even small contributions add up thanks to compound interest—interest earned on your original contributions plus interest on previously earned interest. Start early and let this growth work for you.
If you start saving at 25, you'll have 40 years of growth before retirement. Waiting until 35 gives you 30 years, meaning you’ll have to save more each month to reach the same goal.
3. Know Your Employer's Pension Plan
If you work, ask if your company offers a pension plan. Some employers match contributions to your retirement fund for defined contribution plans. This is essentially free money—use it! For example, if your employer matches 50 percent of your contributions up to a certain percentage of your salary, try to contribute at least that much to maximize your retirement savings.
4. Consider Individual Retirement Accounts (IRAs)
You might also open an individual retirement account (IRA) outside of your employer-sponsored pension plan. There are two types of IRAs:
- Traditional IRA: Contributions are deductible, but withdrawals in retirement are taxed.
- Roth IRA: Contributions are made with after-tax dollars, but qualified withdrawals are tax-free in retirement.
IRAs give you more control over your investments and can supplement your pension savings. They’re particularly useful if your employer has no pension plan or if you want to save more than your workplace plan allows.
5. Diversifying Your Investments
Use a pension plan, IRA, or both to diversify your investments. Diversification means spreading your investments among different asset classes—stocks, bonds, real estate—to reduce risk. When one investment underperforms, others may fare better, balancing out the performance of your overall portfolio.
As retirement approaches, you may want to shift your portfolio to more stable investments to protect the money you’ve saved. Younger investors can afford to take on more risk by buying higher-growth stocks.
6. Set Realistic Retirement Goals
Setting realistic retirement goals is crucial. Consider what lifestyle you want in retirement and how much money you will need to live that lifestyle. Some key considerations include:
- Where you want to live: Living costs vary widely by location.
- How much you want to spend: Include living costs, healthcare, and leisure expenses.
- When you want to retire: The sooner you retire, the more you will need to save.
Knowing your retirement goals will help you determine how much you need to save each month.
7. Monitor Your Progress Regularly
Keep track of your pension plan and retirement savings regularly. Review your account statements and adjust your contributions or investment strategy if your investments aren't performing as expected or if your goals change.
8. Take Advantage of Tax Benefits
Many pension plans and retirement accounts offer tax benefits for contributions or tax-free withdrawals in retirement. Make sure you understand the tax advantages of your plan and make the most of them. Contribute enough to get the full employer match—it’s free money!
9. Speak with a Financial Advisor
If you’re unsure which pension plan or retirement savings strategy is right for you, consider speaking with a financial advisor. An advisor can help you develop a retirement plan that reflects your goals, risk tolerance, and current financial situation.