Pension Question

[KTP]

Well I think we have settled on the matter that pensions > 401K. This is also kind of obvious as the private sector has largely abandoned pensions.

The only question remains is where will the various underfunded pension plans get the resources to pay out the promises. I fear it will be through reduced services and/or increased fees and taxes. You can already see this happening in our state. The more taxes and fees, the less money available to shore up the 401K and IRA which have not been getting the returns expected.

What is the fair solution? I have no clue. Work the system however you can is my guess. Try to find every loophole you can such that you can fund your 401K, IRA, etc. enough to be able to buy a comfortable annuity with at least part of the balance. With bonds paying close to zero real rates, good luck.

[jpg7n16]

She got 2% per year of service, worked 33 years + 2 years of accrued sick leave. She got 21 days of sick leave and 21 vacation days a year. She was allowed to accrue unlimited sick leave and 90 days of vacation paid out. My mom cashed out 90 days of vacation when she left. Crazy. Now she also got at age 55 free medical premiums from the state for her and my dad for LIFE. $1k/month. Ridiculous benefits.

I've already said that I believe she had a great pension. Good for her. I seriously mean that.

But don't assume all pensions are that way. Not all pensions have cost of living adjustments. Not all pensions entitle you to free medical premiums. Not all pensions give 2% credit per year of service.

Pension benefits vary by plan. Some are great, some would have been better with a 401k.


But just because she has a great pension, does not mean that the world would be better off without any 401k plans. I've tried to show that you can still get great benefits with a 401k if you plan properly and save like we recommend here on SA.

[KTP]

Why are you only using a 45% replacement rate? Is that standard for 25 years of service (plus accrued vacation and sick leave...I don't get to accrue sick leave in my private job).

To get a return of 9.4% you would have to be 100% equities. There are plenty of 25 year periods where this would totally wreck you. If you go a mix of 60% stock 40% bonds, you end up with something less, but even if we call it 8%, that is still only a 5% real return if inflation is 3%.

Since I needed to backdate the calculator 25 years ago, and since I needed the present value to represent the amount available today to buy an annuity, I used 5% REAL return, which would be about 8% nominal. Totally legit.

Try again.

[jpg7n16]

Why are you only using a 45% replacement rate? Is that standard for 25 years of service (plus accrued vacation and sick leave...I don't get to accrue sick leave in my private job).

Uhh.....Because the pension payout for the example I gave was 1.8% of final salary credited per year of service with the firm. I posted the link to the pension benefit earlier. Did you not read that earlier? I posted it right in the middle of the post...

25 yos * 1.8% credit per yos = 45% replacement rate

To get a return of 9.4% you would have to be 100% equities. There are plenty of 25 year periods where this would totally wreck you.

Really? Please name a 25 year period that stocks lost money.

If you go a mix of 60% stock 40% bonds, you end up with something less, but even if we call it 8%, that is still only a 5% real return if inflation is 3%.

And are you adjusting the pension payout for inflation too?

Since I needed to backdate the calculator 25 years ago, and since I needed the present value to represent the amount available today to buy an annuity, I used 5% REAL return, which would be about 8% nominal. Totally legit.

Try again.

Oh I get it now -- You reduced the returns on the 401k to account for inflation, but gave the pension worker a 4% salary increase each year and didn't reduce the pension benefit for inflation. Got it. Comparing one reduced for inflation, vs one not reduced for inflation and stating why that one is so much superior. Totally legit, just like you said.

I on the other hand, just calculated what the balances/benefits would be using actual numbers and compared the two. What the heck was I thinking??


You were the one who brought up an example comparing a $25k salary + pension, vs a $35k salary and reducing for 401k contribution.

Adjusting for inflation by removing the cost of living salary increase, and using even a 2% credit per year of service gets you

$25k salary * 2% salary credit per year of service * 25 years = $12,500/year -- def not $60k.

Try again.

[KTP]

Uhh.....Because the pension payout for the example I gave was 1.8% of final salary credited per year of service with the firm. I posted the link to the pension benefit earlier. Did you not read that earlier? I posted it right in the middle of the post...




Really? Please name a 25 year period that stocks lost money.


And are you adjusting the pension payout for inflation too?



Oh I get it now -- You reduced the returns on the 401k to account for inflation, but gave the pension worker a 4% salary increase each year and didn't reduce the pension benefit for inflation. Got it. Comparing one reduced for inflation, vs one not reduced for inflation and stating why that one is so much superior. Totally legit, just like you said.

I on the other hand, just calculated what the balances/benefits would be using actual numbers and compared the two. What the heck was I thinking??


You were the one who brought up an example comparing a $25k salary + pension, vs a $35k salary and reducing for 401k contribution.

Adjusting for inflation by removing the cost of living salary increase, and using even a 2% credit per year of service gets you

$25k salary * 2% salary credit per year of service * 25 years = $12,500/year -- def not $60k.

Try again.

Ok, I may have messed up trying to use real returns. But the biggest issue is that the pension is a GUARANTEED payout, while the 401K is just a hope and pray. Sure, there may not be any 25 year periods where you end up with less money in stocks than you started, not counting inflation losses, but there are certainly time periods where you get nowhere close to 9%, or even 5%. The pension ALWAYS gets paid, because it is backed by the ability of the employeer to print money and raise taxes.

In the case where you want to model your 401K to closely match what a pension can give you, you must invest the 401K in mostly fixed income returns, like Tbills or TIPS. These are currently paying about a 5% return for a 30 year Tbill. This will guarantee that you have the money to buy the annuity in 30 years, just like the pension is guaranteed. Thus I think using the 5% in the calculator is totally legit.

Yikes..I just realized the 30 year treasury is only 2.69%. I was being way generous by using 5% in the calculator.

[Like2Plan]

You are entirely ignoring the employer contribution made to the plan, instead of paid to the worker as salary.

The exact point I am trying to make. 401ks don't seem to enjoan inch if any kind of match as compared to pensions. My point is with a better match, 401Ks might be more favorable...

[maat55]

IMO, pension plans are nearly as risky as SS. Both are ponzi-schemes that have the potential to fail.

[bennkar]

The one thing people constantly seem to forget with these arguments is that you can take 401/403/457 money with you but pensions you can forfeit if you don't stay in your job long enough to vest for the pension. If you feel like you are going to stay in a job forever and the employer can be guaranteed to be solvent and not break the pension, then the pension will usually come out much better. Unfortunately too many people have to switch jobs, and once you do if you're not vested - there goes any benefit you had.

I say this as I ended up rolling in about $60,000 in retirement funds into my current retirement account, and probably 1/3 of that was from employer matches. If I had a pension in those jobs instead I would have lost that matching amount (as well as the tax breaks from my contributions). I hope for that money to double by the time I retire, and I'll be very happy to have gotten it.

Each side in this argument has good points, you just need to figure out what works best in your situation.

[skruggie]

I have a pension. Do not have to contribute funds, it's an automatic benefit. In addition I also get a 401k match.

However, if I don't stay with my employer for the next 25 years (which I do plan to do) it will by no means fund my retirement. However I'm fully vested so no matter what happens I will be getting a monthly check for life.

Interestingly, pensions have been frozen to new hires as of January 2012, but everyone who started prior to then will continue to accrue. At least, until they change the rules again.

I work for a very well known company in the public sector that had been in business's since the 1920's.

[KTP]

I have a pension. Do not have to contribute funds, it's an automatic benefit. In addition I also get a 401k match.
***
Interestingly, pensions have been frozen to new hires as of January 2012, but everyone who started prior to then will continue to accrue. At least, until they change the rules again.

This is a great example of why pensions are better than 401K plans (or only having access to a 401K). If pensions were not a great deal for the employee and bad deal for the employer, they would not be freezing them out to new hires. Or do you know if they are paying new hires $10,000 more each year than they are paying you such that they may contribute more to a fund to eventually buy their own annuity pension? I seriously doubt it.

[Like2Plan]

I have a pension. Do not have to contribute funds, it's an automatic benefit. In addition I also get a 401k match.

However, if I don't stay with my employer for the next 25 years (which I do plan to do) it will by no means fund my retirement. However I'm fully vested so no matter what happens I will be getting a monthly check for life.

Interestingly, pensions have been frozen to new hires as of January 2012, but everyone who started prior to then will continue to accrue. At least, until they change the rules again.

I work for a very well known company in the public sector that had been in business's since the 1920's.

You have a very nice benefits package. The pension does add an additional incentive to stay with the same company over a career.

[Like2Plan]

The one thing people constantly seem to forget with these arguments is that you can take 401/403/457 money with you but pensions you can forfeit if you don't stay in your job long enough to vest for the pension. If you feel like you are going to stay in a job forever and the employer can be guaranteed to be solvent and not break the pension, then the pension will usually come out much better. Unfortunately too many people have to switch jobs, and once you do if you're not vested - there goes any benefit you had.

I say this as I ended up rolling in about $60,000 in retirement funds into my current retirement account, and probably 1/3 of that was from employer matches. If I had a pension in those jobs instead I would have lost that matching amount (as well as the tax breaks from my contributions). I hope for that money to double by the time I retire, and I'll be very happy to have gotten it.

Each side in this argument has good points, you just need to figure out what works best

I think this is more an academic discussion more than anything since few people have a choice of one plan or the other since it is employer driven. Though, I guess you could elect to go to work for one company over another based on the different types of compensation they offered.

[jIM_Ohio]

401k contributions are PRETAX money, but subject to SS and Medicare tax. Unless you are claiming that SS and Medicare are charging 40% these days.

The actual SS and Medicare tax rates are 4.2% + 1.45% = 5.65%

Meaning Person B can actually fund his acct with $12,435, or 17.76% of income - and have the same after-tax lifestyle of Person A.

Try re-running your calculator with 17.76% and you'll see that things will be a little different after 25-30 years, than just 5%. And you'd be able to find a great lifetime income solution - plus have full access to your account balance if needed for legacy goals and inflation protection.

MyCalculators.com |- 401(k) Calculator

Good post, remember a pension is a cost/liability to employer, a 401k contribtion is compensation to employee, one is a cost item, not subject to 7.45% tax on FICA, and the other is compensation, which is subject to that tax.

[jIM_Ohio]

IMO, pension plans are nearly as risky as SS. Both are ponzi-schemes that have the potential to fail.

AGREE

Pensions are a transfer of risk, not removal of a risk.

The risks with IRAs and Pensions are different. If you only compare the numbers without comparing the risks, the whole discussion is irrelevant maybe and definitely incomplete.

[skruggie]

You have a very nice benefits package. The pension does add an additional incentive to stay with the same company over a career.

Yes, I realize I am extremely lucky. Barring layoffs i will be with this company for life. In addition to pension, medical benefits and the various perks we get for working at this company carry over into retirement as well.

And to answer the question about newer hires - I highly, highly doubt that they are being compensated financially by the loss of being able to take advantage of the pension. Im very fortunate to have been hired when I was and not miss that window.

It's amazing how many of my co-workers not only don't care about this benefit but barely, if at all, contribute to the 401 and take advantage of the match.