A] Prelude*
* For more general and detailed information about U.S. Pensions and type of retirement plans, feel free to visit our dedicated webpages:
• https://expatpensionholland.nl/usa-expat-pensions
• https://expatpensionholland.nl/global-pillars-systems
Over the past few decades, a significant shift has occurred in the landscape of retirement planning in the United States. The traditional “Defined Benefit” (DB) retirement plans, commonly known as pension plans, have become increasingly rare.
These plans provided retirees with a guaranteed benefit, typically in the form of a fixed monthly or yearly payment. In their place, “Defined Contribution” (DC) plans, such as 401(k) plans, have become the norm. (An IRA is also such an example but that is on a personal level outside of the occupational sphere.)
These plans focus on specified contributions, with the eventual retirement benefits depending largely on the performance of the investments made with those contributions.
In a Defined Contribution plan like a 401(k), employees contribute a portion of their salary, often matched to some extent by their employer, to an individual account. This account is then invested in various financial products, such as stocks, bonds, and mutual funds according to the personal risk profile of the participant.
The amount available for withdrawal during retirement depends on how well these investments perform over time. This creates uncertainty, as future benefits are not guaranteed and can fluctuate with market conditions.
Many individuals find the security of a Defined Benefit plan more appealing. Pensions require little effort from the employee once established and provide a predictable, stable income stream in retirement. However, obtaining a pension through employment has become increasingly difficult. These plans are now mostly confined to public-sector jobs, such as those in federal, state, or local government positions.
Teachers, military personnel, police officers, firefighters, and workers in heavily unionized industries are among the few who can still expect pension benefits. In the private sector, the prevalence of pensions has dwindled dramatically. According to the March 2021 National Compensation Survey by the Bureau of Labor Statistics, only about 15% of private-sector workers had access to a pension.
Given the decline of traditional pensions, individuals seeking regular and reliable income in retirement might consider annuities as an alternative. An annuity is a financial product offered by insurance companies. It involves paying a lump sum or a series of payments in exchange for regular income payments in the future. There are various types of annuities, each with distinct features, advantages, and disadvantages.
B] Types of Annuities
- Immediate/Deferred Annuities: Immediate annuities start providing payments shortly after a lump sum is paid. Deferred annuities, on the other hand, begin payments at a future date. Deferred annuities generally cost less and are designed to provide income later in life, helping to ensure that retirees do not outlive their resources. For example, one might purchase a deferred annuity that begins payments at age 80 or 85.
- Fixed/Variable/Indexed:
- Fixed annuities offer guaranteed payments for a specified period, often for the rest of the policyholder’s life. These payments are based on the prevailing interest rates at the time of purchase.
- Variable annuities provide payments that fluctuate based on the performance of investments chosen by the policyholder. While they offer the potential for higher returns, they also come with greater risk.
- Indexed annuities link payments to the performance of a specific index, such as the S&P 500. They aim to offer a balance between the security of fixed annuities and the growth potential of variable annuities.
Each type has its own set of pros and cons, fees, and risk levels. It is crucial to conduct thorough research and consider seeking advice from a financial advisor before purchasing an annuity.
C] Additional Considerations
When considering annuities, it is wise to choose companies with strong credit ratings and solid reputations to mitigate the risk of financial instability. Annuities can be purchased using funds from tax-advantaged retirement accounts or personal savings.
There are also options to customize annuity contracts, such as having them provide income for a spouse’s lifetime or including cost-of-living adjustments to combat inflation.
Some also offer features similar to long-term care insurance, increasing payments if the policyholder requires long-term care. There are hybrid life insurance policies that incorporate long-term care benefits as well.
In the end it is i.e. about investing according to the personal risk profile with in time risk reduction near retirement age and while paying attention to getting the lowest tax exposure in the pay-out phase.
D] International Tax Context
Please be aware that if you are having an international annuity pay-out, that the stipulations in a bilateral double tax treaty between the residential and at source country might differ from those regarding classical pensions.*
* For more tax related information, feel free to visit our dedicated webpages:
https://expatpensionholland.nl/global-tax