Pension Benefits 8/9/15

Many people are familiar with what has been called the three legged school for retirement income - social security, personal savings and an employee pension. Historically the employee pension was what is called defined benefit pension plan. A defined benefit pension plan gave the retirees a fixed monthly payment for the rest of their lives. There was no stock market risk. And the pension is also backed up by your employer. Even more importantly, your pension is backed by the Pension Benefit Guaranty Corporation, a government corporation which insures a pension up to approximately $60,000 per year.

Over the last several decades pension plans have become rarer, replaced with 401k plans. Since 1997 the number of defined benefit plans has dropped in half. However, until recently many people who were lucky enough to have defined benefit plans were making the decision to walk away from the protection of guaranteed money. Many companies that still have defined benefit plans were offering current retirees an option to give up the monthly payment for a lump sum amount. They would calculate your lump sum payment based upon your life expectancy and an assumed rate of return.

Why did companies do this? They wanted to switch the financial risk of bad investments and longer lives to the retirees. Well if they reduce their risk, then someone else's risk has to increase. That is you!

What happens if your investments don't receive the rate of return that you expected? What if you live longer than expected? With a defined benefit pension plan you could never outlive your money, with a lump sum benefit paid into your IRA you could.

So the IRS issued a notice effective July 2015 that prohibits employers from allowing retirees who are receiving pensions from switching from an annuity payment to a lump sum amount. Also as we have reported on the show, the government is now allowing IRAs to invest in what are called longevity annuities. These are annuities that do not begin payment until later such as age 85. The idea of the longevity annuity for IRAs is to reduce mandatory distributions and stretch the ira payments out longer so that more money is available later in life.

The important point is whether you have a pension benefit, 401K or IRA, you should meet with a qualified financial advisor to make sure you use your retirement money wisely so that you don't end up with one leg of the three legged stool missing.