Traditional defined benefit (DB) pensions are becoming rare as a company benefit. DB plans provide workers with guaranteed lifetime annuities that begin at retirement age, which varies among employers. Some plans allow workers to collect reduced benefits at specified early retirement ages.
So how rare are these pension plans? The chart below shows that in a 20-year timeframe (1998-2017), 96.7% of the Fortune 500 had an open plan. Unfortunately, with two significant recessions and historically low interest rates, only 27% had open plans by 2017. These events accelerated the increase in pension plans becoming frozen or closed.
The Willis Towers Watson Study
A couple of years ago, my company closed the DB pension plan to new employees. Though current employees weren’t impacted, my instinct told me that this was a significant event and that eventually more news was likely to follow.
Why did I think the other shoe was about to be dropped? Because retirement plans (pensions, 401k, etc…) aren’t allowed by the IRS to be top heavy, meaning higher paid employees are not allowed to be the main benefactor of the plans.
It could take years to become top heavy but it will likely occur at some point. So I went looking for answers to see how long it might take for my company to completely freeze our pension plan.
This lead me to find an important study (download here) on pensions by Willis Towers Watson. It studied retirement benefits in the Fortune 500 from 1998-2015 and there was some tremendous insight as it pertains to my company pension. Though I encourage you to download the study and do your own reading, I’ll provide you with some insight the study gave to my plan.
First, many factors that are specific and unique to each company influence how a company might behave in handling their pension plan. For example, the outlook (forecast) of the company or industry, company culture (employee friendly?), health of the plan, whether a union environment was present, and forecasted direction of interest rates all play into decisions of the companies.
In the study, the recent uptick in freezes had been among plans that were already closed to new hires. Of the plans frozen since 2010, 50% had closed the plan at an earlier date.
The pattern of first closing, then later freezing, has become more common since 2013: 65% of these plans were already closed prior to the freeze.
And very important to me since my company just closed the plan to new employees, the average pension was frozen approximately 4.5 years after closing the plan to new hires brought into the company.
In the study, here are the years from closing the DB pension plan for new hires to freezing the entire plan:
- 90th percentile = 9 years from closing to new hires to freezing plan
- 75th percentile = 6 years
- AVERAGE = 4.5 years
- 50th Percentile = 4 years (median)
- 25th percentile = 2 years
- 10th percentile = 1.3 years
This is an important question in the analysis of your pension plan – Where do you think your company lands on the scale? Above average? Below average? Personally, I think my company will be on the higher percentile range but I’m keeping a very close eye on the influencing factors.
Let’s Talk About My Pension Plan
Let’s start with a fact … I am blessed (or lucky, fortuitous, and even handcuffed) to have a company funded pension plan at work. I know it, you now know it, and everyone at my work knows it. And it’s overfunded to the tune of approximately 115%, which means it’s healthy and in really good shape.
Like most defined benefit pension plans, the main components of our plan is compensation (highest income the last 5 of 6 years) and time on the job. When I was first hired many years ago, they started me at $51,000 but I’ve been making over $200,000+ the last several years. Add to that the 21 years of service and I’m sitting in a pretty good position for the pension calculation.
When I retire at 62, I’ll have 27 service years combined to an income that will likely average ~$250,000 per year.
How Much Can I Expect?
First things first. Since I’m married and in a one-income household, I won’t be taking the single life annuity. According to my company website, a single life pension for my income and years of service is estimated to pay me ~$103,000 yearly when I turn 65.
Remember, if I choose the single life annuity and I die then my wife will receive no further payments from my pension. That needs to be factored when we create our retirement plan.
My other payment options are 50%, 75%, or 100% joint life annuity. Even though my payment will be much lower than a single life annuity, I’m likely going to choose the 100% joint life payout so that my wife won’t have any reduction (or elimination, if we chose the single life payout) in her income stream if I were to die before her.
Though I’ll have to contact our pension department as I get closer to retirement, I’ve assumed (using joint life annuity payouts at insurance company websites) that we’ll probably receive a yearly pension amount of ~$80,000 when I turn 65 years-old. Of course, I could take the payment sooner but the payment would be lower because the annuity would be paying out for a longer period of time.
Using the 4% rule, this $80,000 yearly pension is like me having an additional $2,000,000 in retirement assets. Now you know why I love my pension!
Why Has My Pension Handcuffed Me?
Two years ago, I was being courted for a position at another company that would be similar in base and bonus compensation but there were significant stock options provided each year. Total stock options would have been about $200,000+ yearly but they matured in three years with no vesting. This was a significant issue when comparing my current role with the new one.
The issue would have been when I turned 60 years-old and received another $200,000 in stock options. If I planned to retire at 62 then I would never receive any proceeds from those stock options because they didn’t vest.
So at 60 and 61 years-old, I would have received no valuable stock options and that significantly changed the equation. I had to compare my current pay and benefits, including pension, to the new role and the current role outweighed new role.
So was I handcuffed in this situation? Maybe not but the pension was the game changer in keeping me in my current company. If I was younger – say 45 instead of 55 – then I would have very likely considered the position.
Honestly, the company I’m at now provides me with 2 months of paid time off, pension, retiree healthcare, 401(k), and a very nice base + bonus compensation structure AND the culture at my current company is much better than most.
Remember, the grass isn’t always greener on the other side and sometimes you have to just stick it out in your current situation.
Conclusion
There is so much to write on this topic but we each have to come to our own conclusions on the direction and potential outcome of our unique DB pension plans.
Here’s my recommendation:
- Read the Willis Towers Watson study (perhaps 2-3 times).
- Determine the health of your current DB plan. If the plan is under 90% funded then that is a risk that needs to be considered.
- Create a checklist of influencing factors (company culture, industry outlook, direction of interest rates, unionized environment, etc…) and rate your company on each factor to determine the likelihood of them freezing their pension plan.
- If you feel your plan is at significant risk of being frozen then consider increasing your savings (always a good idea).
- Determine how your company pays their pension benefits – single life, 50%/75%/100% joint life, etc… – and how much you are likely to receive at retirement.
- Determine your retirement funding gap. For example:
- $75,000 yearly expenses – $50,000 yearly pension = $25,000 retirement income gap
- $25,000 retirement income gap divided by (/) 4% = $625,000 in additional assets needed to produce another $25,000 in yearly income.
- Increase your savings to make up for any funding gaps ($625,000 in the above example)
- NOTE: Don’t forget about social security income or inflation.
Thanks for reading and enjoy your DB pension plan!
Mr. TLR