The Pension Pitfall

Dealing with the Long-term Decline of Traditional Pensions

There used to be a time when you knew that if you stayed with the same company your entire working career, there was an excellent chance that your loyalty would be rewarded with a generous pension.  Those days are long gone.  Over the past 30 years, the number of companies that offer pensions has declined dramatically as reflected in the chart below.  Even worse, a lot of the companies that still offer a pension have frozen benefits thus preventing employees from increasing the value with higher earnings later in life.

Pension DeclineOne of the few exceptions where pensions have been a mainstay is in the public sector (federal, state and local government employees).  Since these benefits rely on dependable revenue streams (i.e. taxes), they looked very safe.  Not anymore, at least for state and local government employees who don’t have the luxury of federal income taxes to pay their future benefits.  Over the past several years, we’ve seen a lot of high profile city bankruptcies, none bigger than the city of Detroit.  In fact, things are so bad in Detroit, the city is saying there’s no way they can pay the promised benefits the cities employees have earned.  For anyone who’s close to retiring and felt their financial security was solid, this news feels like a punch in the gut at a time where they don’t have enough years to make up for the shortfall.

This is a real problem that’s only going to get worse.  Over the past decade, we’ve seen cities and states negotiate with their public employees to transition future contributions away from a traditional pension in favor of a defined contribution style program (i.e., 403(b) or 457(b) plan).  These retirement plans, which are equivalent to 401(k) plans that are available to most private sector employees, would provide state and local governments a better way to budget their retirement expenses and have some certainty regarding their future financial obligations.  Compare this to a pension, where they have the almost impossible task of forecasting investment returns and life expectancies, and you can see the appeal to the benefit providers.  Although most people agree this approach makes sense, public sector employees are outraged and are fighting to ensure their level of promised benefits are guaranteed for themselves and future employees as well.

I truly believe this is a negotiation that public sector employees just can’t win.  In order for state and local governments to ensure these benefits, they will need to make drastic changes to their budgets.  And although there’s probably enough waste to protect a good portion of these benefits, they only way they can guarantee future pension liabilities is with additional tax revenues.  With most people feeling the pinch of a tight economy, trying to get people to agree to additional taxes to protect benefits that most employees don’t have is a losing battle.  Another approach, which has become popular recently, is to have public sector employees contribute a bigger percentage of their pay to help fund their pension.  Although this is a good idea, the contributions would probably need to triple in order to minimize the large unknown of future pension liabilities.

When it comes to pensions, another surprise for most recipients is the level of guarantee is not as iron-clad as you may think.  Private sector employees have their pensions backed by the Pension Benefit Guaranty Corp (PBGC), but this guarantee is only up to a certain dollar amount ($60,136 in 2016) for a 65-year-old retiree.  As for public sector employees, there’s no PBGC to guarantee pension payments.  In 2014, an analysis of 150 state and local pension plans by the Center for Retirements at Boston College found that pension plans had 74% of the funds needed to cover promised benefits.  This translates into a $1.1 trillion shortfall.  What’s worse is that over 30% of public sector employees aren’t covered by social security which means their pension is the only regular income source they may have in retirement.  Not real comforting is it?

If you’re one of the few people left with a pension, the best thing you can do for yourself is to not count on the full amount of promised benefits.  To be safe, you should assume that your pension could be reduced by as much as 25% to 33%.  I say this not to scare you but to prepare you now while you’re still working and have the opportunity to make up the potential shortfall with additional savings.  If you’re a public sector employee and have the option to contribute to a 403(b) or 457(b), take advantage of it by setting aside pretax dollars for your retirement up to the 2016 maximum of $18,000 plus an additional $6,000 if you’re 50 or older.  As for private sector employees, don’t rely on your pension as your key source of retirement income.  If you have access to a 401(k), which has the same contribution levels as a 403(b) and 457(b), use this retirement vehicle to set aside pretax dollars for your retirement as well.

I know planning for a reduction in your pension may sound excessive, but the last thing you need is to get within a couple of years of retirement and be told that what you were promised won’t get paid-in-full.  It’s imperative that you take a proactive approach immediately.  And if for some reason your fortunate enough to receive 100% of your promised pension, think of all the extra money you’ll have in retirement that can be spent on more appealing things.  Bottom line, if you expect the unexpected, you’ll never be unprepared if something happens down the road.

Ron Hawks

Ron is a personal finance author, advisor and speaker. For more information about Ron and his highly acclaimed current book Climbing The Financial Mountain:  Wealth Building Strategies for Every Stage in Life go to where you’ll also find access to free financial tools and resources. 

18 thoughts on “The Pension Pitfall

  1. W. Dufek

    Hello, just wanted to say that this article is amazing. It’s very well written as it comes with all the vital information necessary to make an informed decision.

  2. M. Henderson

    You can certainly see your enthusiasm within the work you write. The sector hopes for more passionate writers such as you who are not aftaid to say how they believe.

  3. M. Salerk

    I just got my pension frozen with 5 years left to retire. Just like you said in your blog, I’m now at a point that I won’t get what I was promised and will have to work a few more years to make up the difference.

  4. C. Obershaw

    Pensions will be like dinosaurs within the next 20 to 30 years if not sooner. Better get used to saving for your retirement on your own.

  5. K. Nitz

    Even if you have a pension, I agree with the author that you need to set money aside yourself for retirement just in case the amount you’re expecting isn’t realized.

  6. B. Littleton

    I’d much rather have a 401k than a pension. At least that way, I control my retirement and don’t have to stay with the same company for most of my life in order to get a decent pension benefit.

  7. T. Relbin

    But as with pensions, insurers reluctantly paid out billions of dollars in compensation as complaints mounted and it was impossible to ignore the scale of the problem. Sadly, as with the pensions scandal, the compensation has all too often not put matters right.

  8. S. Velmen

    I agree with the other people’s comments that we need to start moving everyone to a 401k style retirement plan. It’s what most people have and it’s only fair that we taxpayers don’t pay for benefits for other people that we don’t get in the private sector.

  9. H. Pellken

    Great article. Even though I have a pension, I’ve been concerned that what I’m promised might get reduced due the company’s finances. Based on your blog, I’m going to start preparing for a reduction in my pension benefits now while I still have some time.

  10. H. Libular

    Whether people like it or not, pensions are going away. It’s time everyone gets used to a 401k style plan as the only employer sponsored retirement plan.

  11. K. Veitch

    I’d love a pension as well but my company decided to transition to a 401k ten years ago. I guess if it’s good enough for corporate employees, there’s no reason why it’s not good enough for government employees.

  12. Allison Geltern

    Great post. I really didn’t understand how public pensions worked for government employees until I read your blog. Changes need to be made so it’s fair for employees and the taxpayers.

  13. Bethany Suntel

    I have a problem with paying more in taxes just to preserve generous benefits that private sector employees, like myself, have never received. If we are all in this together, a class of workers shouldn’t get special treatment.

  14. Mary Kilns

    Detroit is just the beginning. If we don’t find a way to get our local budgets under control, taxes will go through the roof. There are plenty of places that should be cut, but changing from a pension to a 403(b) or 457(b) must be implemented in order to stop the future bleeding of money.

  15. Mark McCurdy

    So I like your advise to your readers, that if they want to be in any control of their futures, they should discount expected cash flows on these types of evolving unknowns ( including returns on their investments, and maybe even social security payouts, etc…). Those people who have a choice, but chose to retire speculating on nothing but good things are in store for future, are naive if not stupid.

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