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Financial Planning for Scientists, Part 13: Retirement Plans

Over the last year, I've explored many different facets of planning a financial future. I've discussed how important it is to start thinking about retirement early in your career, I've looked at ways you can save your money, and I've explored some of the more popular investment choices, all with the plan of making your retirement (and mine!) a little more comfortable.

But I've yet to address one of the largest sources of cash at retirement: government and employee pension plans. There are two reasons for this. First, I've been concentrating on the proactive things a scientist can do to improve their financial future, whereas in many cases a pension plan is "set in stone" and not really something that takes much thought or planning--in fact, the whole point of a pension plan is that your pension is taken care of for you.

The second reason is that pension plans won't really be a factor until you get a real job--the vast majority of graduate students and postdocs in academia don't have an employee plan. And because the reason for this series is to show you the importance of saving while you're a student or postdoc, it didn't make sense to discuss retirement plans initially.

But pension plans still require some thought, because they are likely to be your largest single source of income at retirement. So understanding what to expect from your pension plan will allow you to plan your proactive investments more appropriately.

So what, exactly, are pension plans?

Pension plans are a type of forced savings "inflicted" on an employee by an employer or a government. In the case of the Canadian government, you pay into the government pension plan while you are employed, and in return the government gives you a check every month upon retirement at age 65. An employee pension plan is either deducted from your paycheck or paid for by your employer; it entitles you to a pension check, also usually starting at 65.

The first step in figuring out your pension plan is determining whether you actually have one or not.

With the government plan (at least in Canada), everyone who works and pays taxes also pays into the Canada Pension Plan. When you retire at 65, you get monthly checks out of the plan. It seems like a great system, offering in many cases about CAN$6000 a year in income. However, most experts tend to agree that although this pension plan is working fine right now, it may not be able to cope with the strain imposed by the retirement of the baby boomers. That's because the pool of money we, as young Canadians, will be able to dip into in 35 years or so will likely be much smaller, if it exists at all. (The U.S. faces similar issues.) So, although we pay into this fund with every paycheck, relying on getting any money back out when we turn 65 is optimistic. So here's a quick answer to the question of whether or not you can expect a government pension: If you're retiring in the next 10 years, you probably can; if you're going to be working for longer than that, you could ... but then again, you might not.

There are three different places to look to determine if you are a part of an employer-based plan. First, members of an employer-based pension plan will often get an annual statement of assessment, which gives information about the plan, what the expected annual pay out will be, etc. Often, you'll know you're part of a plan because deductions to pay for the plan will show up on your paycheck. If you're still not sure whether or not you have a pension plan, ask your human resources manager, union representative, or boss.

Most universities have pension plans for their professors, assistant professors, and the like. Most large pharmaceutical firms have plans for all of their employees. However, most postdoctoral positions in academia and jobs in many smaller biotech start-ups may not come with pension plans. By one estimate, 40% of employees in the U.S. do not have an employer-based pension plan.

Once you've determined that you have a plan, the next step is to try to estimate how much a plan will contribute to your retirement budget. A typical plan will set out expected pay outs using a calculation based on number of years that you have worked with that employer, your age at retirement, and your salary the last year you worked there. The longer you've been with the employer, the more money you will be entitled to.

These plans work as a type of "golden handcuff," enticing you to stay at the same job. The reason for this is that, in many cases, the relationship between the number of years you work at an employer and the value of the pension is not linear. Increasing your pension every year you stay at the company is a way of trying to keep employees from moving around from job to job. Most pension plans aren't really worth anything until you've been at the same company or university for more than 10 years. Recently, some of these plans have become portable to a certain extent: Reciprocity agreements between some Canadian universities, for example, allow their professors to take their pensions with them, so long as they're moving to an approved school.

If you're not part of a traditional pension plan, you might have a "defined contribution" plan. These plans (the most common of which is called a 401k in the U.S.) allow employees to make pretax deductions from their paychecks and to place those funds in an investment plan of some kind. Employers will often match some portion of the contribution you put into the plan: For example, an employer may match 50% of what you put into your plan, up to a total of 6% of your annual salary. So if you're earning $50,000 a year, and you deduct $200 a month from your salary to put into your plan, your employer will deduct that $200 from your income and add $100 more, leaving you with a monthly contribution of $300.

Unlike a traditional plan, where the pay out is based on the number of years worked, the age of retirement, and your final salary just before you took retirement, a defined contribution plan gives a pay out upon retirement that is based on the amount of money that you put into the plan over time, and on the amount of time you've been paying in--much like a self-directed investment would be. You also typically have a choice as to where the money gets invested--in a mutual fund, a guaranteed investment certificate, or in company stock.

The amount of money you invest into your 401k plan (or the similar RRSP plan in Canada) is up to you, with the exception of an upper limit based on your salary. Obviously, the more you put into your plan, the more you defer your taxes (a good thing) and the more you'll have when you retire. And if you're employer is "topping up" by adding to your savings, you'll probably want to take full advantage of that (to the maximum that the employer will top up). But there is a caveat: Don't put in more than you can afford. You need to make sure that any money you put into the plan can stay there until you retire, because very heavy tax penalties accrue if you dip into the plan before you retire (with the exception of pulling out up to $20,000 to purchase your first home, in the case of a Canadian RRSP).

Taking a good look at your retirement plans early in your career is imperative. It'll give you an idea of how much you're covered for, how much you need to save in addition to your plan, and what the true costs are of switching jobs.

Next month, we'll take a look at employee stock options: how they work and how to figure out how much they're worth.