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How US pension plans work and who insures them

When it comes to calculating how much pension you will need to live on during retirement, the rule of thumb is 80% of what you are earning now. For example, if you are earning $50,000 per year now, you will need approximately $40,000 per year in retirement.

Most of us do not entirely understand the varying options and differences between the types of US pension plans. For instance, what is the difference between a 401k and single-employer pension plan? What is the difference between a Defined Contribution Plan and a Defined Benefits Plan? You also need to know more about those plans with regard to protection, taxes on retirement, which states offer tax exemptions and if you are an expat, in which countries do you not need to pay US taxes on your retirement income.

How do pension plans work?

The American Express company was the first to have an established private pension plan in the US in 1875. However, today pension plans have become less pervasive. A Towers Watson report stated that from 1998 to 2013, the number of Fortune 500 companies offering traditional pension plans have declined by 86%, from 251 to 34.

So how does it work? The employer puts aside a fixed percentage of the employee’s salary in a retirement savings account and invests on the employee’s behalf.

At the end of the term, the employee chooses to receive a lump sum or regular pay-outs i.e. once a month, annually etc.

Pension plans are calculated based upon the number of years spent in employment, age and annual income.

There are two main different types of pension plans available in the US. One is guaranteed by the Pension Benefits Guarantee Corporation and the other one isn’t.

Defined Contribution Plans

A defined contribution plan is an employer-sponsored plan with an individual account for each participant.

These are invested in places such as the stock market and returns are credited to or deducted from the pension plan.

Defined contribution plans have become more widespread over recent years and are now the dominant form of plan in the private sector.

These plans are NOT insured by the Pension Benefits Guarantee Corporation. They are also NOT insured by the FDIC (the Federal Deposit Insurance Corporation), as they only insure deposits not investments. FDIC only insures up to $250,000. Even if you have $1 or 10 million in your bank account, and your bank goes bankrupt - you will only receive up to $250,000. The FDIC does insure money market accounts and CDs in your 401k but only if they are held at a financial institution that is FDIC insured.

Some examples of the defined contribution plans are 401k, profit sharing and the Individual Retirement Account (i.e. Simple IRA, SEP IRA).

Defined Benefits Plans

The statutory definition of defined benefit encompasses all pension plans that are not defined contributions and therefore do not have individual accounts.

This is what is referred to as pension in the US.

The two main types are the Single-Employer Pension Plan (SEPP) and Multiple-Employer Pension Plan (MEPP) which are protected by the Pension Benefits Guarantee Corporation. Read below about PBGC and how much they guarantee.

The ERISA (The Employee Retirement and Income Security Act) has established the Pension Benefit Guaranty Corporation to insure the pension plans of over 44 million private sector workers and retirees.

The Pension Benefit Guaranty Corporation

Facts about PBGC:

  • PBGC does not insure profit sharing and 401k plans.

  • PBGC does not cover professional service employers including lawyers and doctors with less than 26 employees.

  • For plans that end in 2019, workers who retire at age 65 can receive up to $5,607.95 per month (or $67,295 per year) under PBGC's insurance program for single-employer plans.

  • The maximum monthly guarantee for the multiemployer program is far lower and more complicated ($12,870 a year as of 2017 for a participant with 30 years of credited service).

  • For the multi-employer plans, the amount guaranteed is based on years of service. For plans that terminate after December 21, 2000, the PBGC insures 100 percent of the first $11 monthly payment per year of service and 75 percent of the next $33 monthly payment per year of service. For example, if a participant works 20 years in a plan that promises $19 per month per year of service, the PBGC guarantee would be $340 per month, rather than $380.

  • A second example, which exceeds the $44 monthly payment per year of service, would be if a participant works 20 years in a plan that promises $100 per month per year of service. The PBGC guarantee would be $715 per month, rather than $2000.

  • In the fiscal year of 2018, PBGC added 58 more failed single-employer plans, bringing its inventory to 4,919 plans, and paid $5.8 billion in benefits to 861,000 retirees in those plans.

  • The single-employer program protects 30 million workers and retirees in 22,000 pension plans.

  • The multi-employer program protects 10 million workers and retirees in 1,400 pension plans.

  • The PBGC will not fully guarantee benefit improvements that were adopted within the five-year period prior to a plan's termination or benefits that are not payable over a retiree's lifetime.

  • Click here: ( to see the changes for plans that fail in 2019 (not before).

  • The multiemployer guarantee varies based on the retiree's length of service.

  • The single-employer plans are indexed and revised annually based on the retiree’s age or payment form.

  • If an employer fails to make the minimum contributions, then they face a 10 percent taxon the amount that it fell short.

Social Security

We need to make it clear that this is NOT considered a pension. Everyone who pays taxes on their income is eligible for Social Security retirement benefits, but you need to have worked for at least 10 years.

While you work and earn income, you and your employer each pay 6.2 percent of your earnings into the Social Security system. If you are self-employed, you pay both the employer share and your employee share. Although you pay into the system while working, your benefit amount in retirement is not determined by how much you and your employer contribute. Instead, the following three factors determine how much you’ll get:

  • How long you work

  • How much you earn

  • What age you are when you file for benefits

Let's take a look at how each of these factors impact how much you'll get.

To qualify for Social Security retirement benefits, you must have 40 credits or 10 years of work where you paid into the Social Security system. You can earn up to four credits a year by earning $5,200 during the year.

Click here to calculate your social security benefits.

Retirement Income Tax

In retirement, you have to pay tax on your retirement income.

You will still continue to pay taxes in retirement. Taxes are calculated on your income each year as you receive it, much like how it works before you retire. It's important to estimate the amount of taxes you'll pay in retirement so you can budget for it and set up your tax withholdings (or quarterly payments) in advance.

According to the RetirementLiving Information Center: "Statesthat exemptpension incomeentirely for qualified retireesare Alaska, Florida, Illinois, Mississippi, Nevada, New Hampshire, Pennsylvania, South Dakota, Tennessee, Texas, Washington, and Wyoming."

For US Expats

Social Security Tax

If you move to one of the following countries, your Social Security benefits will not be taxed by the US: Canada, Germany, Egypt, Ireland, Israel, Italy (only if you are an Italian citizen), Romania, UK. If you live in any country not on this list, your U.S. Social Security will be taxable based on the same rules as in the U.S.

State Tax

Retirement income and Social Security are exempt from state tax if you live abroad. If you do not have rental properties in your former state then for most states, you will be completely exempt from state filing obligations. Certain states will require that you continue filing after retiring abroad even if you do not have state taxable income. Examples of such states are VA, CO and MD.

As a retiree abroad, the most likely reason for potential state tax filing requirementsis from US rental properties. If you have rental properties, you will likely have a state tax obligation (some states do not have state tax filing obligations i.e. Texas, Nevada and Florida).

If you have a US pension, in the year you turn 70.5 years of age , you will be required to take Required Minimum Distributions (RMD) from your IRA or 401(k) plan. You may choose to withdraw only the minimum or more. The amount you must withdraw is determined based upon your age and account value.

Failure to withdraw the RMD will put you at risk of an excise penalty equal to 50% of the amount you should have withdrawn.

When determining how much to withdraw, you need to take into account your gross income.

The amount of tax due on pension distributions will depend upon the total taxable income of the retiree. If this income is below the taxable level, then plan distributions will remain tax free.

For more information on tax for US expats click here: (

For more information on US taxation on UK retirement pensions click here.

Looking for retirement income solutions?

The 12-month fixed income plan is a good solution as it offers you an 8.5% interest per year paid directly to your bank account. You can live on your interest income without touching your capital.

Over the last 3 years US citizens and residents have been using this plan to diversify some of their retirement savings. They use it to either grow their savings for retirement or for retirement income.

Building a carefree retirement is possible and it’s never too late. Simple strategies and commitment is all it takes.

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At Crewinvest we simply take available investment solutions that we think suit for the retirement saving purposes. We have no access to your funds and we do not charge you any fees. If you wish to speak to one of our retirement experts, contact us. You can run through your situation with them and see what options you have.

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