You need more than a pension to fund your retirement
- A pension can provide a steady source of income during retirement.
- Pension benefits aren’t guaranteed, so they should represent only part of your overall retirement strategy.
- It’s a good idea to contribute to a variety of retirement investments, including employer-sponsored plans (such as 401(k)s), and IRAs.
If you have a traditional, defined-benefit pension plan at work, you have nothing to worry about, right? Maybe not. The world is changing and, like a lot of other things, pensions aren’t the same as they used to be.
Now is a good time to start thinking about where your pension fits into your overall plan for retirement. It’s dangerous to rely on any pension—even a generous one—to cover all your retirement needs.
Traditional Pension Plans: A Blast from the Past
Pensions are terrific if you’re lucky enough to still have one. Until the 1970s, most workers had defined-benefit pensions. With this type of pension, the benefits are based on metrics, such as salary history and years of service. And the employer completely funds the pension.
Fast Fact: Only 16% of Fortune 500 companies offered a defined-benefit plan to new hires in 2017. In 1998, 59% of those companies did.
Defined-benefit pensions were originally designed to encourage employees to stay with one company for the long haul. The employee was rewarded for loyalty and the company benefited from having a stable, experienced workforce and low recruitment costs.
During the 1970s, the government created several defined-contribution plans, including 401(k)s and IRAs. These get their name because they are funded by employee contributions. The amount you receive at retirement depends largely on how much you contribute to the plan—and how well your investments perform.
While defined-contribution plans were welcome creations for the self-employed, few realized at the time that they would eventually replace the cherished traditional pensions that employees had grown accustomed to.
Defined-contribution plans are cheaper for employers to maintain and fund, and they put the burden of retirement planning on the employee. As a result, traditional pensions are no longer part of the retirement equation for most workers.
Government Employees: The Exception—For Now
Traditional defined-benefit plans are still available to most government employees, whether they work at the federal, state, or municipal level. While it may be comforting to assume your retirement needs will be fully met by a government pension, recent events are calling even these into question. Many state and municipal employee pension plans are facing substantial shortfalls to cover future obligations.
This provides more than a hint that such pension plans will be less generous going forward. Even government employees should be making additional plans to save for retirement.
If You Have a Traditional Pension
If you do have a traditional pension plan through your employer, the first order of business is to contact your human resources department to determine what benefit payment you can expect at retirement. This is usually based on a percentage of your income that increases with the number of years you work for your employer.
It also depends on whether you have worked long enough at your company to be “vested” in your pension. Leave before that magic date and your pension rights disappear. Even after you’re vested, tenure is important for future income. Most employees today don’t (or can’t) stay with their employers for the 20, 30, or 40 years it takes to earn a generous monthly pension benefit.
Start by determining whether you are vested and getting that projected monthly income number. Add the number to your expected monthly Social Security benefit to determine if the resulting figure will be sufficient to afford the type of retirement you’re expecting. If not, you’ll have to look at defined-contribution alternatives, such as a 401(k), traditional IRA and Roth IRA, to make up the difference.
You Don’t Control Your Employer’s Pension Plan
A pension that looks good now can change—especially if it’s not part of a union contract or other mandate. Your employer has absolute control over a defined-benefit plan (subject, of course, to federal law and any contracts). That means your company can generally change benefit calculations, reduce benefits, or even terminate the plan.
That last point is critical. Since the 1970s, thousands of employers have terminated their traditional pension plans in favor of defined-contribution plans. Sometimes they’ll arrange a payout to employees for their portions of the plan to date. In other cases, they leave the funds in a poorly managed account that pays meager benefits until the last pensioned employee dies. Either way, you won’t get your expected monthly benefit if this happens.
There’s also the chance that your company’s pension plan could fail. There are some protections in place to help preserve a portion of your pension plan, but not all of it.
Whenever possible, make sure your pension represents only a portion of your expected retirement income—not all of it.
Watch Out for Inflation
Inflation is the “X-Factor” in retirement planning. Most private employer pension plans establish a fixed monthly benefit at the beginning of retirement and pay out that amount for the rest of your life. While that might be very generous in the early years of retirement, you’ll begin to feel the pinch in ten years or so when your monthly benefit doesn’t buy as much as it once did.
Government pensions typically have some type of cost-of-living adjustment (COLA) that partially addresses this concern.
The definition of inflation that triggers a COLA can work against seniors, however. COLAs are generally based on the Consumer Price Index (CPI), a general-purpose index that doesn’t address specific demographic needs. For retirees, for example, healthcare is a major component of a household budget. Price levels in that sector are rising much faster than in the general economy. If the CPI is 2%, but your personal rate of inflation is 5%, you’ll fall behind even with a COLA provision.
Again, you’ll need some type of supplemental provision, even if you’re expecting a government-sponsored, COLA-adjusted pension plan.
Think of a Pension as a Bonus
Perhaps the best course of action in regard to pension plans is to consider them a bonus.
In addition to your pension, it’s a good idea to fund a defined-contribution retirement plan—such as a 401(k) or 403(b)—if your employer offers one. Traditional and Roth IRAs are other good choices. And you can max out your contributions to both a defined-contribution plan and an IRA during the same year.
Other ways to prepare for retirement include building up non-retirement investments (stocks, mutual funds, investment real estate), working to get out of debt, and even investigating post-retirement career opportunities.
A traditional pension is great if you have one, but never assume that your employer has your retirement fully covered. Ultimately, the quality of your retirement is your responsibility.