A defined benefit pension is an anachronism — like Mad Men enjoying a two-martini lunch in their smart fedoras and skinny ties.
Although being a company man in the ’60s had its downsides, retiring with a guaranteed pension for the rest of his life was not one of them.
Defined benefit pensions make a fairly straightforward promise. You qualify for a pension, given the number of years with the employer, age upon retirement and salary. The pension formula then spits out a monthly benefit payment that you can depend on for the rest of your life.
Although such pensions are common among public employers, including the State of Colorado, they’ve gone the way of the dinosaur among private employers. Qwest and IBM in recent years froze their defined benefit pensions, while select companies such as Xcel Energy keep them alive. Inevitably replacing the defined benefit is a 401(k) plan that requires employee contributions and decisions on investment selection.
Many Qwest employees in Colorado are wondering about retirement options with the impending merger with Louisiana-based CenturyLink. Some of these employees qualify for a defined benefit package and must choose from many different options. Would they rather receive a six-figure lump sum check? Or is it better to receive thousands a month for the rest of their lives once they retire?
For those who have lived through the breakup of Ma Bell into US West and the volatile years following the Qwest acquisition, the lump sum may be the most alluring option. If you have your money in hand, then you don’t have to be concerned about the financial health of your former employer. That’s perhaps why many employees may take the six- or seven-figure lump sum in lieu of a pension.
Is this a good idea? There are an army of financial advisers out there willing to help you invest a lump sum. They may even dangle the opportunity to invest in a variable annuity from an insurance company that has some good sounding but complicated income guarantees.
Let’s say you have the option to retire on a pension of $5,000 a month for the rest of your life starting at age 65. You can also choose to receive a lump sum of $600,000 that can be moved into an IRA and invested as you see fit. Many employees would choose the lump sum option.
Imagine that you took the lump sum option and turned around and purchased an immediate annuity — essentially a private pension backed by an insurance company. If you shopped around, you might find an immediate annuity that pays $3,500 a month for the rest of your life in exchange for $600,000. You would have lost about 30 percent of your pension’s value by opting for the lump sum benefit.
But what if your ex-employer went into bankruptcy as did United Airlines in 2002? Would your pension disappear or be reduced? Most corporate pensions are backed by the Pension Benefit Guaranty Corporation, the federal agency that guarantees pensions up to $4,500 a month for those who retire at age 65.
Sure this wouldn’t completely cover your pension as a corporate executive or long-serving 777 captain, but for most pensioners this will cover all or most of their benefit.
If you are lucky enough to qualify for a defined benefit pension, think twice before opting for the initially impressive lump sum and get advice from financial advisers not overly eager to invest it. Having guaranteed fixed benefits for the rest of your life may be the ticket to your financial peace of mind.
Dave Gardner, for the Daily Camera.