This section should be titled “Has Anyone Seen a Pension Lately” but we won’t go there. Pensions have a decades-old history in the US as the primary way to provide workers with a comfortable retirement.
When the US had more large companies, with large workforces performing hard work, there was an idea that by providing a retirement benefit, in the form of a stable monthly check based partly on years of service, a company could create a loyal employee for life and control hiring costs by reducing turnover. It was also thought that prudently and patiently managing money would be beyond the scope of the average worker so having a pension that was professionally managed prevented the worker from hurting himself financially.
Pensions use a formula typically, factoring in age, years of service, and last salary or average of the last few years of salary, to determine a worker’s retirement benefits. How these are funded goes something like this: a company’s pension actuaries estimate at regular intervals, the money that will be needed each year going forward so many years (depends on actuary & company), and they determine how much money they need in the current year to fund those benefits. Investment earnings on the pension portfolio determine if the company will need to make a contribution to the pension to get it to proper funding levels or if investment returns are keeping the pension funded.
This worked fine until demographic changes and people living longer changed the paradigm.
Today pensions are going away. Larger pools of retirees funded by a smaller pool of workers, along with unrealistic investment growth expectations have caused many pensions to bust. Takeovers by the PBGC (Pension Benefit Guaranty Corp) have skyrocketed (draining funds available) and many pensions, including those at the state and city level, which may be some of the most endangered pensions, are severely underfunded.
GM is a case of where the number of retirees well-exceeds the number of current workers. The company is also much smaller with years of losses. They got by in the 1990’s with the market returns but when the investment markets began their decade of ups and downs in 2000, the GM pension situation became more precarious.
Some people are offered the opportunity to cash out their pension or to “pensionize” and take the monthly benefit guaranteed by the employer. Cashing out means you get the lump sum but are responsible for the investment management. Pensionize means you give up the ability to cash out but take the more standard monthly check guaranteed by the employer.
If you are given this option what should you do? For one example, the size of your pension would be part of determining this decision. In 2010, according to the PBGC website, they will guarantee up to $4,500/month of a life annuity pension option. If your pension is at this level or below, you may want to consider what it would mean to give up this guarantee. If your pension is much larger, you may want to check out other options because if your benefit is $12,000/month, and your company is shaky, and there is any chance your company will give the pension over to PBGC, your benefit may be reduced to the $4,500 max level (ask some airline pilots about this).
Bottom line, a pension, with a safe payor is a wonderful thing. Having a guaranteed stream of income, especially in these times, makes a tremendous difference. Interestingly, most people don’t realize the true value of a pension. If your pension pays you $4,000/month or $48,000/year, you would need $1 million at 4.8% interest to get the same check! A pension of $48,000/year effectively makes you a “balance sheet millionaire” if you use present values of cash flows on your personal balance sheet.
If you are trying to decide whether or not to cash out a pension or how it affects your overall comprehensive financial plan, feel free to call our office at 781.393.0021 or drop us a note for a Quick Consult HERE.
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