Retirement pension – how to get one if you don’t have one
In the good old days, people went to work for a large company, and when they retired, they received a retirement pension for life. Enjoyment of lifetime pensions was before the days or IRAs, 401ks and profit sharing plans. The technical name for these old-style company retirement plans is defined benefit plan.
In these plans, the focus is to ensure the worker’s benefit at retirement. As an example, the worker receives 70% of their average pay of the last five years. Because the company is on the hook to pay this benefit at the worker’s retirement, these plans have become less common as they are unattractive to employers. Employers no longer want that obligation, and over time, most large companies have phased out their retirement pension plans.
In a typical retirement pension plan, the worker gets a benefit at retirement that is a function of their average pay over a predetermined number of years and their length of employment with the company. A person starting their employment at age 25 and retiring at age 65 would have 40 years of employment and thus likely qualify for the large benefit.
Some of the largest retirement pension plans in existence are those for public sector employees such as teachers, police, fireman and state employees. While private sector companies have been free to shut down their retirement pension plans, these public-sector plans are mandated by local or state laws. Of course, these laws can always be changed by legislators.
The employer is responsible for depositing money into the pension plan every year so that an adequate balance will be available to make your monthly pension payment when you retire. Unfortunately, there is no law requiring companies to make that deposit. As a result, most company pension plans still in existence are underfunded. Simply, they have insufficient money to make the estimated lifetime payments required.
In such cases, the company can deposit the necessary amounts and are then permitted to close down the plan so that they have no additional obligations. The alternative is for the company to show it cannot make the necessary deposit and the federal government attempts to make up the shortfall.
Instead of being obligated to pay you for life at retirement, employers have installed 401(k) plans that have no such obligation.
In a 401(k) plan, the company typically makes some contribution, and after that, their obligation ends. It’s your job to manage those funds and get whatever you can of retirement.
With a 401(k), you have the opportunity retirement to take the entire balance. Some companies offer the option to buy a retirement life annuity for you. Rather than you taking the balance in your plan, they take the balance and buy you a lifetime annuity from a large insurance company.
You then get payments for life. You can also take your 401(k) balance and by your own annuity and possibly get a better rate than the company finds for you.
What happens to my money if I leave the company before retirement?
You must be "vested" in your current employer's retirement pension plan to be owed any benefit. A typical plan may require that you have worked for the company at least five years or so many hours. Assuming you are vested but leave for another job before retirement age as defined in the plan documents, your pension benefits "freeze," and the company makes no additional contributions on your behalf. Once you reach retirement age, you will begin getting monthly pension benefits from the company. Of course, those benefits will be smaller than if you had stayed with the company until retirement age.
If the amount owed to you is small, come companies allow you to take a small lump sum rather than wait years fort your benefits to begin.
There is a kind of retirement pension plan called a "cash balance plan." With this type of plan, the employer deposits a specific amount of money each year into your account, typically with a guaranteed rate of return earned. An example might be an annual contribution of 3% of your pay, guaranteed to earn 4% annually. Some employers with these kinds of plans will allow former employees to roll over the balance into an IRA. These plans focus on the balance in your account rather than a future guaranteed payout in retirement.
What if the pension plan runs out of money – an overview of the public-sector pension calamity
The Centre for Retirement Research (CRR) at Boston College calculates that states’ pensions are 27% underfunded. That is a shortfall of $1 trillion. And each year, the states only contribute 80% of the calculated amount needed to pay retiree benefits. When one uses a reasonable 5% discount rate for these future obligations, the cash shortfall may be $2.7 trillion. Everyone knows that the emperor wears no clothes yet no one does anything about it. Why?
These plans are all about politics. No politician wants to speak the bad news. The bad news is that the retirees will get less than promised or the state’s taxpayers will be assessed a tax to make the promised payments. And politics created this mess. When a politician wants votes, he gets cozy with the state unions and makes promises that can never be kept, in exchange for votes.
Additionally, retirement pension plans have the same problems which burden Social Security. Primarily, the problem that people are living far longer than originally anticipated. Rather than planning for this as it occurred, those responsible ignored the issue. Years ago, actuarial services may have assumed people would retire at age 65 and live another 15 years. Current life expectancy at age 65 is closer to another 20 years, and the pension plan sponsors (i.e. the employers or trustees) have not made these additional required payments.
Another inescapable issue is underperformance of investments. If the trustees of the plan assume the investments in the retirement pension will earn 8% over the next decade, yet the investments earn only 6%, the plan becomes underfunded. The employer is then supposed to increase their contributions to the plan, but this rarely occurs.
Consider that New York State & Local Retirement System (NYSLR) now has more retired policemen than working ones, and contributes more to the police pension than it pays out in police wages. You quickly see the problem that retirement pension sponsors have an obligation they cannot meet to those already retired, to say nothing of the underfunded obligation to current workers.
How can these plans be underfunded? Because there is no official funding requirement or regulatory authority that monitors funding. If you look at the NYSLR website, there is not an inkling of any problem. It’s a nicely designed site with all good news and a patina of solidity with plan explanations and calculator for members to estimate benefits.
Organization executives’, politicians’ and union leaders’ incompetence created this huge liability to those already retired. Additionally, these plans have no way to meet that same obligation current workers, i.e., tomorrow’s retirees. The folks we can credit for the problem will be long gone or dead by the day of reckoning.
What Happens When a Public Sector Retirement pension Becomes Insolvent
The City of Detroit declared bankruptcy, largely because it could not adequately fund its pension plans. What steps have been taken and who paid?
- The city’s two pension systems — one that covers the service of general workers and another for police and fire workers — stopped accepting new employees into pension plans that existed before the bankruptcy.
- The city moved newer workers into a so-called hybrid plan with features similar to a 401(k).
- General pensioners accepted 4.5% cuts and other reductions and police and fire pensioners accepted decreased cost-of-living increases.
Unbelievably, because of politics, the failure of the city, the inability to sustain its pension has not been resolved. The mayor says, “the city’s bankruptcy plan in 2014 underestimated how much the city will owe when it resumes making payments to its two pension systems in 2024.” In other words, those responsible have kicked the can down the road, just like most difficult financial issues to be solved by politicians. It is clear to this author and anyone who can do basic math that the insolvency of the pans will again recur.
Pension payments could start at $167 million in 2024 and increase by 2% each year for the next 20 years, according to data available in December. The city’s bankruptcy exit plan estimated the 2024 payment to be $114 million. Duggan said the city manager made this insufficient estimate.
We see that the politicized climate which dictates management of these underfunded public-sector pensions ends in long-term insolvency. The remedies are:
- Existing retirees giving up some of their benefits through reduced monthly payments
- Existing workers haveing the defined benefit plan canceled and converted into a defined contribution plan (e.g. 401k)
- Residents of the state or municipality receiving fewer public sector benefits as more tax dollars get allocated to pension payments
AARP notes a fourth possibility. In an extreme case, a union’s miscalculations resulted in a clawback of already paid pensions.
One other note about shortfalls for retirees. In addition to promised pension benefits, in many public-sector instances, the retirees have also been promised additional benefits such as health insurance, life insurance or other benefits that the pensioner may have received while employed. The cost of these benefits can prove complicated for actuaries to calculate because of the changes in fields like medicine. The difficulty in forecasting future costs, coupled with the normal challenges in calculating and meeting pension requirements, can result in funding shortages for pension plans.
Unfunded liabilities totaled nearly $500 billion throughout the country for OPEBs. Texas alone was reported to have about $52.3 billion in unfunded liabilities for OPEBs, equal to about 10.51 percent of the country's total unfunded liabilities for these other services.
The Federal Gov Picks up the Check for Private Sector Plans
Because companies that run into financial trouble may fail to meet their pension obligations, the federal government set up an independent agency called the Pension Benefit guarantee Corporation (PBGC). The PBGC gets its money by assessing all of the defined benefit plans an annual fee. That income is supposed to be sufficient to cover the deficiencies in the plans that fail.
Since the PBGC’s establishment in 1974, roughly 4,700 private pension plans have failed, leaving the PBGC responsible for paying insured benefits to more than 1.5 million individuals today. Note that the PBGC insures defined benefit plans offered by private-sector employers. There is no such safety net for the trillions of underfunded dollars of state sponsored and public sector plans.
The idea is that federal taxpayers should not have to pick up the bill for these fantail plans. Unfortunately, the PBGC ran out of money long ago from the assessments it collects. According to the PBGC’s November 2014 annual report, the PBGC has a combined deficit or unfunded liability of $61.8 billion. This deficit will eventually come from
- Increased assessments on the healthy retirement pension plans
- The revenues of the US Government (your tax dollars)
Single Employer vs Multi-employer plans
PBGC’s big problem is with multi-employer plans. These are large (cover workers at many companies and are more greatly underfunded. The job that PBGC has is to provide loans to multi-employer plans that cannot fund their promised benefits. Only one problem- since the PBGC makes the loan to the insolvent plan, there is no expectation of repayment. Only one of 53 insolvent multiemployer plans has ever repaid its loans.
The PBGC does not have the financial resources to cover these large plans. In fact, just 2 of these retirement pension plans can ruin the PBGC. The insolvency of two large, highly underfunded plans: the Central State Teamsters and the United Mineworkers would make PBGC insolvent within two to three years. Unfortunately, the trustees of these plans do not have any focus or allegiance to one company. In fact, half of the trustees are union members (always pushing for a richer retirement benefit) and management of member companies who oversee dying businesses (e.g. manufacturing in the US).
You can find a great summary of the unworkable situation of the PBGC at https://www.pbgc.gov.
Unlike other public sector programs which need adequately set aside funds for future liabilities, military pensions are paid by you, the taxpayer. They are part of the annual Defense Budget. The US military offers very generous pension benefits—after 20 years of service, members can retire with 50% of their final salary for the rest of their lives. Since that allows most to retire around age 40, the payouts may last for a very long time (and they are also adjusted for inflation).
In 2015, the US military paid out $57 billion in pension benefits (pdf) to more than 2 million veterans or nearly 10% of its annual budget. So if you ever thanked a vet for their service, you have been thanking them, and will continue to thank them, your entire life by paying their pension.
Because payments for the various divisions of the military do not come from an “employer’s” pocket or the employee’s paycheck, it makes sense they are generous. Congress is quite liberal when it comes to spending other people’s money (OPM for short at the Capitol).
Federal Government Pensions
Federal retirees get a handsome payday in retirement. They enjoy a three-part retirement program:
- A thrift savings plan (similar to a 401k)
- Federal Employees' Retirement System (an annuity)
- Social Security