Problems with Pensions – Episode 179

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[00:01] Welcome to the Prosperity Podcast, fresh alternative personal finance talk for independent thinkers who prosper outside of Wall Street. Here’s your host, bestselling author, Kim D.H. Butler, and No BS Money Guy, Todd Strobel. Hey everybody, welcome back to the Prosperity Podcast. This is No BS Money Guy, Todd Strobel. Once again, we have our co-host and bestselling financial author, Kim Butler, with us today. And we’re going to be talking about pensions. And the reason I really wanted to get into this subject is so many times we interchange terms. We say pensions, 401k, retirement plans, all thinking that we’re talking about the same thing when they’re actually very different. Now, probably most of you who I would say at least 30 or younger may never deal with a

[00:59] pension, but for those people who are for sure 40s, 50s, maybe even a little older than that, a pension was a standard thing. So first of all, I want to welcome Kim. And second of all, Kim, maybe you could just kind of go through and define what each one is. Absolutely. And you’re so right. These terms get all thrown together. And I would add in the 403b arena, which is very common for teachers and people in the nonprofit sector. And then, of course, you have Kios and IRAs and annuities that act like IRAs, and even the Roth IRA and SEP IRAs and Simples and et cetera, et cetera, et cetera. But other than what is technically known a defined benefit pension plan, literally all of those other things, profit sharing plans, often 401ks, 403bs,

[01:58] IRAs, TSA accounts, Kios, SEPs, Simples, all of those types of quote retirement plans are known as defined contribution plans. And this is one case where the title actually makes sense. The title actually tells us what it is. And that is that in a 401k, you define, you decide what you’re going to put in your contribution. Same with a 403b and the myriad of other strategies like that. You’re defining the contribution. You’re defining what you’re putting in a true pension, the old style pension. Now, I’ll admit, I do have a tiny one from a company long ago, but a true pension is a defined benefit. In other words, they may say they, the company, your former employer, or sometimes insurance companies buy these pensions out.

[02:59] So they may say, oh, you have a defined benefit of a thousand a month. Actually, when we take a look at it, technically social security is a defined benefit plan. At a certain age, you get a certain amount of money per month. And there’s no real, quote, account value like an asset that backs that up. There may be, but it probably doesn’t exist on your balance sheet. And it may or may not exist on the company’s balance sheet, which is scary in and of itself. We clearly know that in the government’s case, social security does not exist in the form of an asset just kind of hanging out, waiting to pay. It’s more of a pay as you go environment. Now, we’ll set social security aside. This discussion isn’t really for that.

[03:58] But the old style defined benefit plans did have accounts that backed them up. But the asset value, the half a million, the million dollars, the billion dollars for large, large pensions, didn’t really have anything to do with John Doe employee who got $1,000 a month at age 65, or $1,200 a month at age 67, or whatever the pension’s defined benefit was. So that’s the best introduction I can give, although I’m sure I could answer a couple questions. Is there anything else you think needs to be said or want to ask? Well, I think if we kind of look back on the history of pensions, it was not necessarily a bad idea. We were going through an industrial time where people were using up their physical bodies in labor.

[04:51] And at some point, they were no longer going to be able to do their job, but yet they still needed to be able to take care of their family. So what I like to think of it, of a pension as, is you are exchanging hours of your work time for a promise, is really what you’re getting. You don’t have an actual cash account, you just have a promise of something that’s going to happen in the future. Does that make sense? Yeah, I think that’s a really good description of it, is that promise to pay. So at the time when pensions were created, number one, the actuarial tables of how long people were going to live really indicated that maybe five to seven years past the age of retirement was how long these pensions were going to have to pay.

[05:47] Secondly, we were in an interest rate economy that was, I guess, what, 500, 600 percent minimum higher than what we are now, so that when they decided how much money they needed to contribute, so the idea was is that the company each month or each quarter or whatever sets aside a chunk of money that’s meant to take care of people at the end, really sort of like social security, except that the employer itself is putting that money away. And then all of a sudden, you know, when we got down the road to the point where people really started to use it, and again we keep using this term baby boomers, because now that the baby boomers are hitting the pensions, we’re finding out number one, they didn’t get a good enough return on the investments.

[06:41] In fact, in some cases, the pensions lost money. There’s less money in them than they actually put in. And secondly, we’re finding out that it’s more realistically that they’re going to have to pay out 20 to possibly 30 years of pensions, and they just weren’t properly prepared for that. And I don’t think anything was done intentionally wrong, but it’s causing a problem, isn’t it? Absolutely. And now not only do you have companies that are dealing with this, but you have cities and counties and there are just and states. I mean, there are just more and more examples coming up every day. And if you just Google underfunded pensions, you can see the information. And what’s interesting about that is the fact,

[07:32] and I think I’m saying this right, that the pension arena is technically a public arena. In other words, because of the ERISA, E-R-I-S-A law that came about in, oh, I don’t know, the late 70s, early 80s, I want to say, pensions have a, it’s called a ERISA Red Book, a public environment where you, anybody, could go and see whether the pension was funded properly or not according to a bunch of statistics. And in a way, a pension is exactly like a financial plan, which is, our listeners know, in my opinion, a very false sense of peace of mind, because a pension has done a bunch of assumptions. They assume life expectancy. They assume number of people in the plan. They assume a particular interest rate

[08:26] that the investors and the money managers are going to get. They assume all these things. And then they send out a statement that says, John Doe employee, you’re going to get X dollars at a particular age. And everybody just assumes, there we go again, that this is a guaranteed environment. But it’s not. It’s completely subjected to the investment whims of the stock market, the investment whims of the money managers, and even potentially legal and tax law issues. But those aren’t really, interestingly enough, those aren’t really the problem. Right now we just have really poor assumptions that got made. And in particular, of course, 08 really decimated a lot of the pensions because the actual values were heavily invested

[09:19] in the stock market and they got cut in half, just like people’s 401k plans gotten cut in half. And unfortunately, I know I’ve spoken to some people recently and this is what kind of brought this up in my mind, who really honestly believe that, you know, now that they are receiving the pension, that it’s guaranteed that it cannot be changed. And I’ve had at least two clients that I can remember that were pilots and had retired. Pilots at the time, I don’t know if it’s changed, but pilots aren’t allowed to fly commercially after age 60. That’s it. Correct. That’s right. They were mandatorily retired at age 60. They were retired receiving quite a handsome retirement, but the pension plan was underfunded,

[10:12] so it was taken over. There is a guarantee fund that if a pension runs out of money, it’s taken over by a guarantee fund, but that guarantee fund often will slash benefits 50 to 70%. Right. So here are some of these anticipating that they’re going to have X dollars a month and now that number is drastically reduced. I’m just curious. Have you ever seen a case where they change the time, like the age at which they were going to start or how long they were going to pay? Have you ever seen that? Yes. Matter of fact, it happens quite often, but it’s always going forward. So in other words, if you’re here working, anybody hired past to February 2017 can now start drawing a pension at 67 instead of 62 or whatever.

[11:10] Yeah. So we’ve got a situation here where people are relying on somebody else’s promise and essentially letting other people take care of them. And I think more and more Americans are realizing that the best way to get good results with your finances is to take care of them yourself. And if you have a pension, that’s awesome, but don’t rely on that doing the whole job, just like, obviously, if you have social security, and most people do, there’s a few professions that are opted out, but if you have social security, that should not be the only thing going on. You want to be saving. And as our listeners know, we’re not big fans of people saving into the qualified plan arena to begin with. And a pension is definitely part of the qualified plan.

[12:01] And some pensions are combined with either profit sharing plans or 401k plans or other of the defined contribution type. And that’s why people get confused between them, I think, sometimes. So you may have a 401k at work that you’re contributing to, and you may also have a pension at work. And depending on your company, they may print both of those pieces of information on the same page or what have you. But to the degree that you can, you’ll want to make sure that your savings is 100% controlled by you. Clearly, the pension is 100% controlled by the employer, and the 401k is 100% controlled by the government. So you want to add that third piece where your savings, and then progressing on to your investments,

[12:47] are 100% controlled by you. Tom Sellick, former guy that played Magnum PI, has a commercial out right now where he’s actually advertising for reverse mortgages, but that’s irrelevant. He shows it as a three-legged stool where you have social security, you have pension, and then you have savings. And we cannot control social security. We cannot control or rely on pensions. Really puts a lot of emphasis on that one leg, which is our savings, doesn’t it? Absolutely. And it is interesting, though I agree that the overall points are relevant. How many more reverse mortgage ads were seen, and how many ads of that type were seen by celebrities, which tells me that they didn’t do a good job in controlling their own savings.

[13:43] And a celebrity is often like an athlete, some really high earning years, and how easy it is to confuse those high earning years with any type of sustainable income. So they get into a lifestyle that they get used to that’s not sustainable, and they may or may not have done a good job saving money. And of course, we all know the examples where the celebrity did a good job of saving money and then had it all taken away from them because they didn’t put the proper checks and balances in place, and somebody that they trusted ran away with the money, or maybe they weren’t paying their taxes properly, or they did some other thing that is not normal in society, and they got penalized. I can think of a couple examples

[14:33] I’ll refrain from naming right now, but it’s amazing how many of these celebrities truly need to work and are advertising all kinds of things in order to shore up that, quote, third leg of the stool, if you will, of actual savings dollars. Got it. Well, I’ve got a couple questions directly from our listeners that I definitely want to get to. But before we go any further, I would like to take a minute and let you offer the gifts that you have for our listeners. Absolutely. So we have a book that’s called Financial Planning Has Failed, and it’s available as an e-book or an audiobook. And if you’re interested in this pension and 401k arena, there are some very, I think, apropos statistics around the culmination of laws

[15:26] that were created starting actually back more like in the 50s. And though the section is on just laws in general, you’ll be amazed, and they’re all laid out in this book, Financial Planning Has Failed, you’ll be amazed how many of them are pension or 401k related. So that’s something that people might want to either turn back to if they’ve already got it or grab it if they don’t. And that is available at partners4prosperity.com slash e-book. And that’s the audio version and imprint version specifically available for our podcast listeners. Partners4prosperity.com slash e-book. Awesome. Let’s get down to our questions here. Question number one is we have a client who has a pension. He no longer works at this particular company,

[16:16] but he can start drawing it at age 50, or for every year he waits, he gets an extra 1% up until the max is at 60, he would get 10%, so 10% more. If he’s 51 would be 51%. You get it? Yes. So he gets at age 50, he gets his pension, and each year he could get 1% for the rest of his life more. Is he better to start early now or wait until 60? Yeah, that’s a great question. I’d want to do some quick analysis on it, but I’ll give everybody my rule of thumb on Social Security, which has a similar structure, and that is wait. And the reason is because you are probably going to live another 20, 30 years. So waiting five or 10 or even two or three to get the higher income that you will then get a larger dollar figure on

[17:17] for many, many, many, many more years is hands down the better strategy. So almost always the recommendation is to wait. Now, I do want to bring something else up, and that is a question I got just the other day from a client that I was talking to. They were in a situation where they could roll over their pension at 50. Now, I don’t know if this person has that ability. Some people are able to roll those pensions out of the employer’s environment into a regular IRA. And my recommendation there is to go ahead and do that. And the only downside is there is definitely a little bit more asset protection in pensions and 401ks, by the way, than there is in IRAs. But as long as you have a liability umbrella

[18:06] and you’re not out there doing bad things, you will probably be just fine in the asset protection arena. And the only benefit I can see to leaving a pension at a former employer is if it’s a really, really large company and you’re not concerned about that company’s inability to make good on that pension payout. But most people these days are concerned about that. And of course, if you look and do some Google work on underfunded pensions and you see companies that you know of listed, that might be another additional reason. If you have the ability, people don’t always have the ability. But if you have the ability to roll it over into an IRA and get that thing into your control, that is often the better strategy.

[18:56] All right. Our next question is a husband and spouse. The husband has the ability to start his pension, which he wants to do, and he can take less per month. And then there will be a remainder, a remainder pension payment for the spouse after he passes away. Is it better to take the lower amount, protect the spouse or the higher amount and figure out another strategy for the spouse? Yeah. So again, the rule of thumb here, and some calculations might be necessary, but the rule of thumb here is that typically it’s better to take the higher income and then buy life insurance to protect the spouse. I mean, that’s truly what you’re doing when you take the lower amount, is you’re using that quote difference to essentially get insurance for the spouse.

[19:56] And that is not the most efficient way to do it. You’re much, much better off actually buying the life insurance. Okay, great. Well, that’s really, those were the two major questions. So just to summarize, you know, if you’re, if you have a chance to draw your pension and the pension pays more the longer that you wait, depending upon the financial stability of the pension itself, it would be best to wait as long as you could to get the maximum amount. But again, you know, if you’re 50 years old and you know you have an underfunded pension, those 10 years of pension that you receive might be higher than if you would have waited because of the reduction in the pension, just because they have to make adjustments for underfunding.

[20:44] Did I summarize that correctly? Yeah, that was beautifully said. And I’m just always willing to help people with this. If somebody’s got a question, they should reach out to hello at partners number four, prosperity.com. And we’re more than happy to help. Super every situation is different. So I wouldn’t make a single decision without talking to a qualified prosperity economics advisor before you make the decision. We’re not we’re just kind of talking in a generalized sense here. We wanted people to mainly get the idea that tension 401k, 403b. These are all separate products. And you need to know the ins and outs each one of them. Again, thanks so much to Kim Butler. Thank you to your listeners.

[21:31] Keep sending those questions in. This is No BS Money Guy Todd Strobel for the Prosperity Podcast. Say and take care, everybody. Thank you for listening to the Prosperity Podcast. To take control of your money and have it work for you. Visit us at partners for prosperity.com. If you liked this episode, make sure you subscribe and leave a review.