Why Pension Plans May Not Be A Slam Dunk

Should You Reconsider Your Pension Plan?
bottles of cash with coins...
bottles of cash with coins...

Many of us wish our company offered a pension plan, but more and more employers are moving away from these so-called traditional defined-benefit plans. As a result, you often hear the financial media touting how great life was back in the days when you simply had to call it quits and have guaranteed income for life.

There's no doubt pensions can bring a good deal of stability and assurance to your retirement income, but pension plans aren't perfect either. Here are a few reasons the 401(k) self-contribution system might turn out to be the better option for some people:

A pension may force you to stay at a job. Due to how defined-benefit plans are structured, the longer you work for the company, the better the eventual payout is going to be. What ends up happening is that many people may want to leave, but end up staying at their current position just because they can't afford to lose the potential pension benefits.

The emotional effects of staying at a job you hate are obvious, but those who stay may end up losing out financially as well. Sure, you are getting a good pension if you stick at a miserable job for a few decades, but most people perform at their peak when they love their jobs, which will also have a positive impact on their compensation. Perhaps you could be paid a higher salary if you left and found a job that suited you better that would more than make up for that guaranteed payment.

Benefits can change midway through your career. One of the main advantages of a pension plan is that the income is guaranteed. Thus, you may be able to spend more than you could have otherwise because of how dependable the monthly checks will be. But as we've seen in recent years, benefits are being reduced with plan reforms. If you have been counting on guaranteed monthly payments and saved less through the years because of it, you'll be affected even if the benefits are reduced slightly.

Your pension could be eliminated if the employer files for bankruptcy. Private pension plans are protected by the Pension Benefit Guaranty Corporation (PBGC), so most employees will end up getting something even if an employer declares bankruptcy. But at that point, anything is possible because negotiations within the bankruptcy court could change benefits. Monthly benefits may be cut, or the accrual method may significantly change. Everything is on the table. The worst part is that you won't know the outcome while everything is being resolved, which could takes months, if not years.

Benefits usually don't extend beyond your lifetime. And even if they do, the income will only last through your spouse's lifetime. This means that none of your heirs will be able to count on that income. The guaranteed income for life is a double-edged sword. On one hand, you won't run out of income during your lifetime. But if you have enough money to sustain your lifestyle to begin with, you might want to invest on your own in hopes of leaving a bigger payout for your children.

You may be able to get better investment returns. It is difficult to beat the benefits that a pension plan offers with investments on your own, but it's not impossible. Some people want more control over how their money is invested in hopes of achieving a better return on their own.

Yearly benefits are inflexible, which could mean more taxes paid. Having regular income sounds great, until you have to pay taxes on it. With a set amount of income coming to you, you have less room to make tax-efficient maneuvers. For example, you may be able to delay some retirement account withdrawals until years when you have a low income, resulting in a lower tax rate on the distribution. You could also stash some of your money in a Roth IRA, and be able to take tax-free withdrawals in retirement. With a healthy monthly check coming in every month, you won’t have as much room to stay within the low tax brackets.

Many private plans do not have inflation adjustments. Never underestimate the affects of inflation. A few percent a year can make a once hefty paycheck seem puny after a decade. So take care to maintain your purchasing power throughout your retirement. People with pensions that are not adjusted for inflation may need to maintain some other investments that are more likely to keep up with the current cost of living.

Pensions provide stability to many retirees, but having access to one doesn't automatically make your retirement life better. Careful retirement planning is necessary even for people with a traditional pension plan.

David Ning runs MoneyNing, a personal finance site that shares money moves you can make to significantly increase your chances of having a comfortable retirement. He likes to share simple changes that anyone can make, such as picking the best online savings account and figuring out whether a 0 percent balance transfer credit card makes sense.

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