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Analyzing Defined Benefit Pensions: How Do Various Distribution Methods Affect an Individual’s Financial Independence?
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Nearly one third of the U.S. population is between ages 50 and 79 meaning that they are nearing or currently in the early years of retirement. Individuals tend to seek financial planning advice as they plan for retirement. The baby boomer generation that is currently retiring worked when defined benefit pension plans were the most commonly offered company-sponsored retirement plan. 78 percent of state and local government workers were participating in a defined benefit pension plan and 49 percent of private companies with 500 or more workers offered defined benefit pensions (Rafter, 2013). A defined benefit pension plan is a type of retirement account where an employer agrees to a pre-specified payment amount to an employee at retirement. The payment of the defined benefit pension plan can be distributed in various ways. The retiree may take a lump sum, a partial lump sum and 50% joint survivor annuity, a single life annuity, or a 50% joint and survivor annuity. Defined benefit pensions will distribute as a 50% joint and survivor annuity by default. Existing research discusses trends in retirement and various investment techniques retirees should consider but there is no analysis on how defined benefit pension distribution methods may affect an individual’s financial independence. Financial independence is achieved when an individual has enough liquid assets to support his or her standard of living and cash needs through the end of his or her life. This thesis conducts a case study on a hypothetical married couple, John and Jane Doe, and uses financial plan scenarios to understand the effects defined benefit pension distribution methods have on an individual’s financial independence.