Pensions and Your Retirement

We’re going to go over how to save for retirement if you have a pension.  Just a little disclaimer: This strategy is no doubt from a more conservative saver’s point of view.  I tend to be a little less trusting of defined benefit plans–like an employer pension or social security–than others.  This is the safe way to do things and is a pretty sure-fire way to make sure you don’t end up working the door at Walmart if something goes wrong with your pension.

When people talk about pensions, they are thinking of what is called a defined benefit plan. In other words, the plan has a promised payout upon retirement.  It could be something like 50% of the average of your last five years’ salary, every year, for the rest of your life. In this post, when I refer to pension or defined benefit plan, I am talking about the same thing.

Another, similar-sounding term is defined contribution.  Defined contribution plans are plans where the employee (versus the employer) pays into their own retirement plan.  A 401k or 403b are examples of defined contribution plans.  More information about the differences can be found here.

Pensions through private employers are getting pretty rare these days. In 1979, nearly 62% of private-sector employees that participated in a retirement plan (like a pension or 401k) had a defined benefit plan. Compare that to only 7% in 2011. 401k and similar plans follow almost an inverse trend: 16% of private-sector employees participating in retirement plans had defined contribution plans in 1979 compared to 69% in 2011. It’s easy to see that defined benefit plans are on their way out. Why? Because they’re really expensive for employers.

How to Save for Retirement if You Have a Pension

This chart shows the breakdown of how employer retirement plans have changed over the years. This data is shows the breakdown for only those with a plan.  It excludes employers that do not provide any sort of retirement plan (defined contribution or defined benefit).  Source: EBRI

How does a pension affect your retirement saving?

In an ideal world, it would make saving for retirement super easy. You would have to save much less for retirement since your defined benefit plan is paying you a set amount every month for life.

But as you know, this world is far from ideal. Pension plans can have their benefits changed. Don’t believe me? Here are three cases of plans that were not able to pay out the originally promised amount:

  1. Central State Pension Fund Benefits Cut 50%
  2. United Airlines Wins Right to Default on Its Employee Pension Plan
  3. Detroit Cuts Pensions By 6.7%

Some plans are insured by the Pension Benefit Guaranty Corporation, which is run by the U.S. government.  This is a great benefit because if reduces the chances of you missing out on your pension if the plan fails.  The bad news?  The 2014 Projections Report does not paint a rosy picture for the PBGC: the financial status of the single-employer program is likely to remain at a net deficit for a long time.  Long story short, I’m not counting on the PBGC.  I doubt that it will completely be phased out, but I don’t think some form of reduction in coverage is out of the question over the next 20 years.

The bottom line is this: don’t count solely on your pension to get you through retirement. I like to treat employer pensions the same as I treat social security–they’re nice to have, but don’t bet your entire retirement on them.  Don’t let all this talk about pension failure freak you out too much. Uncertainty is a fact of life–accept it, plan for it, and move on.

In order to hedge against the threat of a failed pension plan, continue to max out your Roth IRA and contribute enough to your 401k to get the full match.  This should be a minimum. If something goes wrong with your pension and it ends up paying a much smaller benefit, you’ll have your other retirement savings to fall back on. If you are fortunate and your pension pays out as promised, then all that means is that you’ve got a bigger pile of money to play with in retirement.

What is this “vesting” thing

Being vested in your defined benefit plan means that you’ve earned the right to claim a benefit.  Vesting usually occurs after participating in the plan for a number of years.  Once you are vested, you will earn a pension even if you change jobs.  The benefit will definitely be smaller since your years of service is smaller; almost all defined benefit plans use years of service as one of the variables to determine the benefit amount.  The more years of service, the higher your benefit.

Final thoughts

I am very fortunate to be one of the few private-sector retirement plan participants that has both a defined benefit plan and a 401k. So how do I save? Like I don’t even have a pension.  Saving for retirement like I don’t have a pension gives me a tremendous amount of freedom:

  • I don’t need to stress too much about the health of my pension fund.
  • I’m not handcuffed to my employer because I’m not relying on the pension to retire. If I want to go a different direction with my career when I’m 45, I don’t need to worry about the reduction in pension benefits delaying my retirement. Believe me when I say that I enjoy where I work, but I think most people would prefer freedom of choice.
  • It dramatically improves my retirement finances. I really don’t think any retiree complained about having too many sources of income.

I’d like to reiterate that this is a pretty conservative approach to retirement savings.  You can tweak your own plan however you’d like depending on your comfort level.  In fact, a good tool to use is your plan’s Annual Report.  Every year, your plan administrator will mail you a little report that will show how well the plan is funded.  If your plan is close to 100% funded, then your pension’s existence in your retirement is a much stronger bet than if it’s something like 70%.

Action items
  1. Get a copy of your plan’s annual report (Form 5500).  Use this to determine how “safe” of a bet it is that you’ll have your pension.
    • The Department of Labor will let you search for this online here.
    • Look under Schedule SB (for Single Employers) or MB (Multiple Employers).  Each of these schedules will give you a % Funded number.  These schedules will be in the pdf you pull up when searching on the DOL website.
      • Schedule SB – Check Line 14
      • Schedule MB – Check Line 2c
    • Optimally, your plan will be 100% funded.  The lower percentage it is funded, the more endangered the fund is.
  2. Based on your pension’s health, adjust your 401k/Roth contributions.  Maxing out your Roth and contributing enough to get your employer’s match for your 401k should be a minimum.
    • If your pension’s health is not in tip-top shape, consider saving for retirement like your pension doesn’t exist.  If your pension is 100% funded, then you can settle for your employer’s match on your 401k and max out your Roth.  Remember though: your pension’s funding status can change wildly over a 20-year period.

 

 

 

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