Don't Count on Your Pension to Carry You

Having a Pension ≠ Worry Free Retirement

In the not too distant past, the main source of retirement income was from pensions and they were prevalent. They worked well in theory: You and your employer put money into a pension fund that was then invested by either the company or an outside money manager if they hired one. During retirement, you were guaranteed a certain level of income or “benefit” each month and in the event there was not enough money, your former employer had to pick up the bill. However, as the years went by, pensions got slowly phased out, specially once 401(k) plans and IRAs came into existence in 1980. At which point employers discovered that sponsoring a 401(k) plan (or more broadly called a “defined contribution” plan) was much cheaper than maintaining an old school “defined benefit” pension plan. But it’s not only the rise of the defined contribution plan that has sent defined benefit plans or pensions into disarray, with article after article on how Americans are not ready for retirement and how pensions are underfunded, let’s take a look at some of the top contributing items plaguing DB pensions today and what it might mean for someone with one of those pensions.

Expected Returned or “assumed rate of return” was set too high and was not adjusted.

The way companies calculate how much needs to be contributed into a pension fund is done with the help of an actuary…and many “assumptions”…or guesses. As a result, entities did not contribute enough money to these plans to make sure they were on sound financial footing and could afford to pay the pensioners,. According to the Milliman 2020 Corporate Pension Study, the average rate of expected return was 6.5%.

One example is the Illinois state pension fund is currently set to run out of money in 2039 if they were to experience a 20% drop in the value of investments. This is largely due to the State of Illinois not contributing enough to the fund each year. As a result, Illinois is looking at pension reform.

Poor Investment Choices

Some pension plans made very poor investment decisions, ask the New Orleans Fire Department about their pension blunders and even a court battle to have the City of New Orleans prop up the fund.

In many cases, pensions either had to be shored up by the sponsoring entities by putting in large sums quickly to make up the difference and get the pension back on track or the pension plan would become “underfunded”. Underfunded means the plan is not on schedule to have enough money to pay its obligations as they become due. From a practical standpoint, a pensioner who is drawing on a pension that is underfunded could see income stagnated and not see any cost of living adjustments. In extreme cases, there could be benefit (retirement income) cuts. While there are entities such as the Pension Benefit Guarantee Corporation, there are limitations as to how much is protected.

A large portion of American workers are retiring at the same time, and the next generation is much smaller in population.

For those at entities with defined benefit plans still in full swing, there

It can be costly to run a pension plan

Costs of a defined benefit plan often fo beyond the cost of a traditional 401(k) plan. There are actuaries, an investment committee, PBGC premiums (protection costs money), surety bonds, and the cost of the investments themselves. Some pensions can use their dollars to negotiate significant discounts on items such as advisory fees, but other items are costly no matter how big the plan is.

The Bottom Line

The point of this article is not to scare anyone with a pension, but rather to remind them that the “guaranteed” money is only as good as the entity’s ability to come up with the cash and saving outside of your pension plan might be wise. If you have a pension plan, I encourage you to ask questions concerning your pension plan if there is something you do not understand. When run well and properly funded and managed, pensions can be a wonderful tool to make sure retirees can have some sort of “guaranteed” income but like any other asset, need to be monitored and evaluated.