Managing Your Pension In A 401k World

July 15, 2015

Lately there’s been a lot of criticism of 401k plans in the news and some of it is very valid. A 401k that is poorly designed and/or poorly managed can leave people in a bad place when they want to retire, but traditional pensions aren’t a perfect solution either. Don’t get me wrong. If you have a pension that is a GREAT benefit to have. You just can’t assume that everything will work out as planned.

The 3 problems that I’ve seen with pensions are the “golden handcuffs,” the “what just happened” and the “what do I do now” scenarios. The “golden handcuffs” is how I describe a situation when someone no longer likes their job or is not engaged in their work but they feel like the pension is just too good to walk away from. Life is short and no one wants to be miserable at work.

“What just happened” is my description for sudden changes that you weren’t expecting such as the pension being frozen. The good news is that you still have some benefit if you’re vested but if you’ve been planning on a $1,000/month pension at 65 and now it’s going to be $200/ month, that’s a big gap to make up. Often people in this situation weren’t saving much because they were counting on that full pension.

“What do I do now” is for those terrible situations where you lose your job or the majority of your pension. Due to the way pensions are funded, the bulk of the money is contributed in your later years of work so someone in their 50’s could start to get very expensive and might be more likely to be laid off. Another potential issue is companies that go bankrupt with a pension that wasn’t fully funded. If it was guaranteed by the Pension Benefit Guarantee Corporation (PBGC) then the benefits, up to their limits, will likely be paid but above that, you could be out of luck.

So given these potential issues, how can you avoid these situations?

Don’t assume that you will work at your current job until the day that you retire. If you aren’t vested in the pension plan yet, run a retirement estimate assuming that you won’t get anything from the pension. This way you will know how much you need to contribute to your 401k, IRA and other savings to meet your retirement goals and if you get a pension then you can really enjoy retirement or retire early.
If you are vested in your pension, run your pension estimate as if you were going to leave the company this year and take the pension at your expected retirement age. This way, you get the worst case scenario in case the pension gets frozen in the next year or two. Again, use this info to run your retirement estimate so you are adequately funding your 401k.
Have an emergency fund of 3–6 months of your expenses. If you get laid off, you’ll have plenty of time to find the right job, which will hopefully be able to fund your financial goals. If you are worried about the financial stability of your company or layoffs in your division, you may want to increase your emergency fund to a full year of expenses. This is especially true if you are in the age 50–62 range.
Even if you have a great pension from a financially stable company and you get the full pension, be prepared to decide whether to take the monthly payment or a lump sum. If you are a conservative investor or you have a family history of living into the 90’s, you may want to take the monthly payment to reduce your risk of outliving your money. If you have health or family history that makes you think your life expectancy will be below average, you are an aggressive investor or your primary concern is having control of the money and a chance of leaving some of it to your heirs then you may want to take the lump sum option.

So if you have a pension plan, remember that the good news is that it doesn’t cost you anything and the investment risk is on the company. However, you still need to do your part to make sure that you get the benefits you are counting on. The ultimate responsibility for your retirement is on you.