The pensions offered to state employees in the United States are a little different from federal pensions. Most states offer state workers a defined benefit paid by a state fund.
The defined benefit is a specific amount of money that is paid out to a retired employee each month. In most cases, the benefit is a percentage of the employees’ monthly salary. To qualify for the benefit the person usually has to work for the state for a set period of time usually 20 years.
How State Pensions are Funded
Unlike an IRA such a defined benefit plan is funded directly by the employer, usually by the state. In most cases state pensions are funded by a state pension fund that is partially funded by the state legislature and partially funded by contributions from employers. The drawback to this arrangement is that many states have pension obligations promised payouts to former and current employees that exceed the amounts in the fund.
Something that many people may not be aware of is that state pension plans are generally not insured. Unlike annuities which are guaranteed by insurance companies and state governments and private pensions which are partially insured by the federal Pension Benefit Guarantee Corporations. State pension plans are generally not insured, if the funds in one run out the state legislature will have to appropriate more money.
The problem with this is that legislature will have to use tax money to make up any shortfall. Obviously politicians hate the idea of cutting services or raising taxes in order to fund pensions so they usually refuse to deal with the situation. That means many state pension funds are facing shortfalls. No state has stopped paying pensions yet but it could happen.
Double Dipper Rule
Something that everybody who relies on a state pension needs to worry about is the Double Dipper Rule” or Windfall Elimination Formula. This formula reduces your Social Security payment if Social Security taxes are not charged at your job. If you are part of a state pension program and Social Security is not being taken out you could be affected by this.
There are some exemptions to this provision but persons not paying full Social Security should definitely be aware of it. If your pension amount is low say you worked for the state for a few years the Double Dipper Rule should not affect you. If a substantial amount of your retirement comes from a state or local government pension you could be hit by it.
Compensating for Pension Shortfalls
There are ways of compensating for this and for the other risks in state pensions. An excellent method of compensating is by using an annuity to lock in additional retirement income. An annuity is a contract between you and an insurance company it obligates the insurer to make monthly payments to you for a specific period of time. Some annuities can be set up to provide payments until you die.
Anybody can purchase an annuity and they are tax deferred. Unlike an Individual Retirement Account there’s no limit on the amount of money you can keep in annuities. This makes them a perfect means of ensuring additional retirement income.
It is also a good idea for persons that are heavily reliant on a state or local government pension to talk to a certified retirement planner. Such a professional can help you ensure retirement income without incurring tax penalties.