The Best Pension Option To Maximize Results In Your Retirement

Foreign hello everybody, I'm Brian Scribonia, host of the Common Sense Financial Podcast, and today I want to share some insight into pension elections and a few things you will want to think about as you approach retirement. Now, if you're already drawing a pension payment, you may still want to tune in to what I have to say because even though you have already made your election, some of what I will share with you in this podcast may still impact your future benefits. Now the reality is that pensions are becoming more and more of a dinosaur as companies are moving away from them and are replacing them with 401k type plans. There are a multitude of reasons why this shift is occurring, but the primary reason is due to the simple fact that pensions are just unsustainable. This was highlighted back in 2008 when GM was going through the economic crisis. We heard a lot about their drop in sales, government assistance, and the problems plaguing the company, which ultimately drove them into bankruptcy. This raised a lot of questions about the company's financial state and uncovered the fact that not only were they employing around 170,000 people at the time, but they were also paying pension benefits to over 118,000 families. That was 41% of their payroll going to people who were not contributing to the profits of the company. In other words, 59% of the payroll is working to generate the profits, while the other 41% simply drew a check. Now this isn't a conversation about whether these folks are owed something for their time spent at a company or any of the arguments floating around in your head right now. This is strictly about the economics of what happening with pensions and the viability of the plans. Pensions had their heyday in the 1960s but began to fail, which opened the door for the government to enter the picture. And the government did what they do best by adding promises and regulations to the programs. And the truth is, pensions have been struggling to keep their head above water ever since. The point is, is that one time pensions were as common as 401ks are today. Many of our parents and grandparents worked for 40 years at the same job and then they retired with a payment from the company for the rest of their life. You see, at that time, people commonly worked until they could no longer physically work and life expectancy was shorter than it is today. So not only was a pension payment a way to entice older employees to rotate out of the company to make room for younger workers, life expectancy was shorter, which meant the timeframe for paying the pension was shorter than it is today. Contrast that with the image we have of retirement today, where it's not always a matter of not being able to work, but rather a mindset of not wanting to work. This means there are healthy and capable people choosing to retire early and drawing their pensions while living another 30 plus years. So when you take an antiquated model of a pension and attempt to plug it into the current paradigm of retirement, you have a system that is riddled with problems. Actuarially, pensions are not calculated to support someone living 30 years, which jeopardizes their ability to make payments. So you get the big picture here. But there are a few more facts to be aware of to make sure you understand what's happening. Pensions actuarially use aid as part of their projection, but they also have to assume rate of return on the money set aside to meet their pension obligations. They have historically used 4.5 up to 7.5% to project earnings. Now, when you consider the reality of where interest rates are and the fact that they're way below these percentages now for more than a decade, you can begin to see why. These higher interest rate assumptions go a long way to improving the plan's stated financial position. But they do nothing to change their actual solvency. Here's another fact. Actuarially, pensions look at a 10 year period for projecting the viability of their benefits comparison. Social Security projects the viability of benefits by looking at 75 years. Now, a point to make here is that since most pensions are still popular with taxpayer funded government jobs, people are drawing benefits in their early 50s. Many of these people will draw benefits in retirement maybe as long as they were working, or possibly even longer. Now, what happens if a pension becomes insolvent and is unable to pay its promised benefits? According to heritage.org the Pension Benefit Guarantee Corporation, the PBGC, which is similar to the FDIC, did a study and found that for someone that is promised $24,000 a year in a pension benefit, they are insured up to $12,870, which is roughly half. The problem with these insurance plans for pensions is the same problem we have with the FDIC. For instance, the FDIC is around $25 billion in reserves. Seems like a lot of money, but there's 9.3 trillion sitting in banks. The insurance cannot cover all the liabilities that exist. The same thing is true with the pbgc. The promise of insurance benefits is not mathematically supported. If PBGC goes insolvent, that $12,870 that we discussed being promised on a $24,000 benefit is really only able to cover $1,500 of that insurance benefit. The concern here is that when you retire and you're counting on a pension as part of your income and that system were to default, what do you do? Studies show that back in 2008 the projected deficit for pensions was $5 million, and in 2014 it was 42 billion. So from 2008 to 2014 it went from $500 million deficit projection to a $42 billion deficit. All of this makes a strong case for accepting lump sum options when they're offered to move the control of your future benefits into your hands. A side note here, when I speak of solvency issues, I'm not suggesting that the pension you have will become insolvent as I explained earlier. I'm simply stating that there are serious problems with the viability of pensions that a cause for concern and that you need to be aware of now. Not all pensions plans have lump sum options. Some only offer a monthly payment, which leaves you with fewer options for your retirement planning. And if that's you, here are a few things to consider when making your annuity decision. When looking at your options, it can be viewed as a race to get the most out of the pension before any potential solvency problems occur. This is certainly not the only factor for you to consider if you're married and considering survivor benefits, but this reality should highlight a need to find ways to move things into your control. A single life annuity option is often your highest monthly benefit that pays a benefit to one person for their lifetime. Electing this option will be the fastest way to get the most from the pension in the shortest period of time. However, a single life option can leave a spouse exposed to an income shortage if the pension recipient dies, since the pension stops after their death. This is why if you're married and choose to take this single life election, your spouse must sign off on that decision. Oftentimes, when a single life option is elected, this decision includes the purchase of a life insurance policy. This allows for the maximum benefit to be received from the pension, while the proceeds from the policy create a new stream of income to replace the pension when a death occurs. This approach easily remedies the gap in pension benefits and moves more of your future into your control. Of course, you can elect to take a reduced pension benefit to cover your spouse and is likely your best option if you're uninsurable and cannot qualify for life insurance. So if you choose to take a reduced benefit There are some things you should be aware of. First of all, you will receive a lower monthly annuity payment. The amount of the reduction will vary from plan to plan, but suffice it to say that it will be less than if you accepted a single life payment. Another consideration is that if your plan has a cost of living adjustment built in, which is designed to increase your benefits each year to keep up with inflation, this increase will be less on a reduced benefit. So you want to know and understand the effects of this over time. So here's an example. If your maximum benefit amount is, say, $5000 a month and a reduced spousal benefit is $4000 a month, you are essentially giving up $1000 a month to protect your spouse. So essentially, that $1000 is going to purchase some type of insurance for the spouse so they can continue to receive the 4,000amonth. So if you consider the cost of living adjustment calculation and assume a 3% as the INFL figure, you have a $30 a month difference in your year two payment. And that number increases over time. So instead of $1,000 a month difference, which I referenced before, it's now $1,030 a month difference. If you project the difference out 20 years, that monthly difference grows to $1,800 per month. So it's important to understand the escalating cost of opting for this benefit and the fact that the benefit you are paying for is decreasing over time since both you and your spouse are both growing older. In other words, each year that passes is one year less that the surviving benefit could be received. So when you think about this carefully, what you'll figure out is that when electing a spousal benefit, you are accepting an arrangement where you are paying an increasing monthly premium for a decreasing benefit. Another issue here is that this benefit only extends to a spouse. So no benefit is left for kids or grandchildren unless you choose a child as the beneficiary and leave your spouse out. So a quick review. We did cover a lot here. So the cost of the policy goes up each year since the COLA received on the maximum benefit is greater than what is received on the reduced benefit. When taking a reduced spousal benefit, the benefit continues to go down each year you and your spouse are alive, making the number of years the benefit may be received less. Each year that passes, you disinherit your family since the benefits are not transferable to your heirs. Now, in my experience, many retirees think the reduced benefit is the preferred choice to protect their spouse until they learn the cost that goes along with making that election. What I have found is that once this is explained and it's understood that you can take a maximum benefit and purchase a life insurance policy outside of the pension system to protect both their spouse and their heirs, they often elect to take the maximum benefit. Keep in mind that this takes careful planning and the use of carefully crafted life insurance policies. But the point with all this information is to help you understand your options. It is all too common to find people making decisions about their pension without fully understanding the bigger economic picture of what's actually happening. In addition, there really is a new reality that exists today that is influencing and forming a new retirement. And if you're not paying attention, you may find yourself taking on more risks than you realize. There are approximately 10,000 baby boomers retiring every day over the next 15 years, and on the surface, you may think that has nothing to do with you and your situation. But the reality is, is that as these baby boomers ret, they're increasing pressure on Social Security, they're increasing pressure on the pension and the stock market. This is important to understand because there are more and more retirees drawing from the same sources of assets that you're relying on for your retirement. So the question I'll leave you with to consider is how do you think this will impact the viability of these programs and your future? With all that said, my team and I are here to help you feel more confident about your financial future. That's why we created a community of people just like you who want to think differently about money, their retirement mindset, and reach their goals. If you're not already following me on Facebook, YouTube, Instagram, and LinkedIn, and if you're not already plugged in and subscribed to our Forbes Top 10 rated podcast, the Common Sense Financial Podcast, take time to do that right now. And if you have specific questions or are looking for an advisor to help you through the maze of investing and financial planning strategies, reach out to us through our website. That concludes today's podcast. I'm Brian Scribonia and thank you for listening to today's Common Sense Financial Podcast.