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Retiree plans have changed since days of standard pension

4 min read

When our fathers and grandfathers retired, many were promised a defined pension by their employers. Depending on factors such as number of years worked and average three-year-high pay, they would receive a monthly pension check for their entire retired life. Often, they could leave half to their spouses upon death.

The company was responsible for making all contributions to a pension and accepted all of the investment risk. Usually, the investments were bonds that would yield a certain amount of earnings. Actuaries would calculate how much money the company needed to contribute to provide the promised outcome.

When the world became a global economy, firms from overseas started shipping their products to America, competing with domestic goods. Often, these foreign suppliers had lower cost to manufacture goods due to lower wages, benefits and less regulation. To respond to this new competition, American companies started to shift retirement plans from defined benefit to defined contribution plans.

To stay competitive, companies had to reduce expenses with this new competition from foreign companies. In 1978, Congress passed a small add onto the tax code. It was Section 401, Subset (k) that allowed workers to defer part of their income into an account that could grow tax-free until it was distributed to the employees.

Although no one realized it when this section was passed, this would become the accidental retirement plan. Ted Benna, who is often considered the father of the 401(k), noticed this law and realized that if a company provided a match to part of an employee’s contribution, more employees would participate.

In a defined contribution plan such as a 401(k), the employee is funding most of the plan and is responsible for investment results instead of the company. The plan does grow tax-deferred until pulled out during retirement. There is a 10% penalty if someone withdraws money before age 59½.

Most 401(k) plans offer investment choices from a menu of mutual funds. It is interesting to note that the stock market started to experience much greater growth at about this time. That is because all of this new qualified money flowing into the market drove up prices. Remember, when there are more buyers, the market will go up. When there are more sellers, the market will go down.

There is a growing trend in the defined benefit pension plans that you should be aware of. Many companies are now trying to de-risk their responsibilities to former employees. They are doing this by transferring future payment responsibilities to insurance companies. The companies pay money to the insurance companies to handle monthly payments and transfer some of the investment performance responsibility.

Sometimes the insurance company will offer a onetime lump-sum payout. You must carefully analyze whether you can earn more from this amount on your own, or if you would receive more by leaving the money with the insurance company. You may have more control to transfer money to your beneficiaries by taking the lump sum, but you must carefully review everything.

Pensions that are covered by ERISA may offer more creditor protection if you file for bankruptcy. There also is a possibility that the insurance company may have trouble locating where you live. A Met Life study found that 13,500 former workers were not receiving monthly checks because the company did not have a current address. This will most likely happen to former employees, who had left the company before retirement and took new jobs.

Pensions are a valuable thing to have for those fortunate enough to have one. Check your old records and see if you are due a benefit that you may not be receiving.

Gary Boatman is a Monessen-based certified financial planner and the author of “Your Financial Compass: Safe passage through the turbulent waters of taxes, income planning and market volatility.”

To submit columns on financial planning or investing, email Rick Shrum at rshrum@observer-reporter.com.

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