Hidden Treasure
There is one overlooked source of wealth for many people. This is a big financial regret for those who do not do it, and a costly financial mistake. It is utilizing their defined contribution (DC) pension. Pensions are an iceberg asset, a hidden treasure. This is because it does not show overtly in a person’s wealth and grows over the longer term. I have even seen them overlooked during divorces!
Defined contribution (DC) pensions have replaced the more traditional defined benefit plans (DB) for the majority of employers. The difference is with DB (money-out plans), the retirement income is defined and secure for the retiree. For a DC pension, it is the investment (money in) that is known or ‘defined’; the pay-out is uncertain.
With the DC plan, you have relative control over your pension pot, but you have the responsibility of making investment choices and determining a sustainable pay-out (meaning you determine the investments and pay-out amount so you do not outlive your money), and you accept the related investment risk. DC pensions offer region-related tax advantages, but as the contributions are defined and not the benefits, they are more uncertain for the pension holder.
I have never truly understood why pensions are overlooked wealth, but here are three possible reasons:
1. It is not ‘sold,’ it is usually embedded in your benefits package
2. It is considered boring and complicated
3. It is considered for really old people
Ideally, you will be contributing from an early age into your DC pension and then transferring them to a good management provider when you leave your employer. During that time, your employer puts in a matching contribution usually capped at a certain percentage. The higher percentage of contributions of your salary, the better outcomes you will have. It depends on your situation, but a minimum of 5% contribution is recommended, and you can slowly increase that to 10% or even 15% as your cash flow allows.
Unfortunately, the value of pensions are realized to late by some. I have seen many people never participate in a pension and then decide to start saving for retirement when they are in their early sixties. This is a much harder timeline and the mistake cannot be easily reversed, so I strongly encourage you to maximize the potential of your Pension contributions as early as you can.
Your DC pension asset will grow with time, until it is time to utilize it, usually at 55 years old or later depending on your country. If done right, your pension could be the largest asset you own, far more than your home. That is a very high level snapshot, let me know if you want me to write other blogs on pensions, or you can refer to my book Compass Star, the Retirement chapter. If you have an employer and are not fully utilizing your DC plan, I strongly recommend you contact your HR or benefits team.
And if you happen to be in the growing minority who has a DB plan, congratulate yourself, as you have the equivalent of Willie Wonka’s Golden Ticket in your hidden treasure as well.
What percentage income do you recommend putting into your hidden treasure?
Disclaimer: This article if for educational purposes only and is not personal financial advice.