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If you have a traditional pension from your employer, you’re in a rare and rapidly shrinking club.
Only 14% of the private workforce has access to one of these gold-plated corporate perks, according to the Bureau of Labor Statistics (1).
However, you’re much more likely to be covered by a pension if you’re already retired or working for a government agency, according to Congress and the Federal Reserve Bank. (2)
Those lucky enough to have access to these plans can rely on an additional source of income in retirement that goes beyond Social Security and your personal nest egg.
However, this special perk also puts you in a unique tax situation. Here are the four critical things you must know if your golden years include a pension.
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1. No inflation protection
A pension is a safe and reliable source of income in retirement. But in many cases it is not adjusted for inflation. That means you could receive a fixed amount every month for the duration of your retirement and steadily lose purchasing power over time.
To be fair, many public-sector pension plans have cost-of-living adjustments (COLAs), according to the National Association For State Relay Administration (NASRA) (3). But corporate pensions generally don’t offer such adjustments.
This could have major implications. Assuming an inflation rate of 3% means your purchasing power declines by more than a third within 10 years. If you have a pension without inflation protection, you need to adjust your retirement plans accordingly.
2. Pension pushes you into a higher tax bracket
Not only does a pension add to your taxable income, it’s also a source of income that you cannot control.
Once the monthly payments are set, there's little you can do to change or delay them. That means you could be pushed into a higher tax bracket permanently. This could also make more of your Social Security taxable and trigger Medicare’s IRMAA surcharges.
Depending on your state of residence, you could also owe state taxes. According to AARP, only 15 states fully exempt pension payouts from state-level taxation. (4)
There’s not much you can do to adjust this income, but you could plan ahead and start implementing strategic moves like a Roth IRA conversion to mitigate the long-term tax consequences on your retired life.
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3. Survivor benefit election
For many married workers, a key priority is ensuring their spouse continues to receive income after they pass away.
Fortunately, most pension plans offer a survivor benefit, which provides ongoing payments to a widowed spouse, according to the Pension Rights Center. (5)
A spouse must consent before losing their survivor benefit in a defined benefit pension plan. Many waive it without realizing the impact or by mistake, sometimes due to language barriers or unclear forms. Fraud and forgery can also occur, especially in troubled relationships.
Couples should review and complete retirement documents together and verify with the plan. Spouses can request plan records anytime, as once the benefit is waived and the participant dies, it cannot be recovered.
4. Investment strategy
While a typical retirement investment plan is more conservative and focused on generating cash flow, people with a pension can be more flexible with their approach.
For instance, you could decide to put more of your assets in stocks that do not pay dividends to lower your taxable income. You can also make long-term investments focused on capital appreciation because you have a steady source of cash flow from your pension to rely on.
Focusing on long-term growth also allows you to optimize estate planning. You can leave behind a sizable legacy for your loved ones by maximizing investable assets, while living off the regular cash flow from your pension.
Put simply, you have more room to invest when your retirement plan includes a robust pension.
A pension can be a great perk. But if you don’t plan for this special source of income appropriately, you could face higher taxes and some missed opportunities in retirement.
Fortunately, if you haven’t retired yet, you have plenty of time to plan for this. Reach out to your employer and a financial planner as soon as you can to understand how the pension fits into your broader retirement plan.
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Article sources
We rely only on vetted sources and credible third-party reporting. For details, see our editorial ethics and guidelines.
U.S. Bureau of Labor Statistics (1); Congress.gov (2); National Association For State Relay Administration (NASRA) (3); AARP (4); Pension Rights Center (5).
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
