We’ve definitely not shown a lot of love and admiration for the old 401k Plan around here. While there may be circumstances where contributions to a 401k make sense (though relatively few circumstances) we would be remiss not to point out that 401k’s and their sister products (e.g. 403b’s, 457’s, etc.) aren’t the only wholesale retirement product that can let you down.
No, I’m afraid one of the most respected retirement vehicles that many would love to see gain a resurgence in the employee benefits market place can also be just as disappointing for a number of reasons. I’m talking, of course, about traditional pension plans.
For those who need a quick refresher, a bona fide pension is a retirement benefit afforded to an employee that guarantees a certain retirement income benefit after a certain number of years worked based upon that employee’s income while working.
For those who want an even deeper explanation, we detailed precisely what a pension was almost two years ago in this article.
So the cool thing about pensions is the fact that they guarantee a retirement income benefit. This means they completely remove the need to figure out how one will go about taking the money they have and turning it into a lifetime income stream (an elusive idea to many people).
And not only can a pension provide a guaranteed lifetime income, but it can also tell an employee exactly what his or her income will be once they reach retirement given a set of pretty reasonable assumptions.
Unfortunately, though, pensions have also instilled a false sense of security among many Americans regarding their retirement prospects and have also instilled a value that looks to an employer to take care of the an employee’s retirement needs.
While this might have been a really nice perk from many years past, it’s certainly not the paradigm today and Americans have made a very difficult—and mostly unsuccessful—transition into a new reality where retirement planning—and funding—falls squarely on them.
In addition, pensions themselves can be a tad complicated and many pensioners are confused about how their benefits work, and as a result they frequently make poor choices about their pension benefits.
Pensions are—essentially—a contract between the employee and the employer (or pensions itself). And, like everything, pensions do come with a degree of varying risks the most significant of which is counter-party risk.
Counter-party risk is simply the chance that an obligated party will fail to deliver on its promise to another party. For example, bond holders undertake counter-party risk each and every day. It’s the risk that the borrower will fail to repay the debt that it owes to the bond-holder (lender).
Pensions face the same scenario. The guaranteed benefit of a pension comes with significant financial risk to the entity that offers the pension benefit as it must fund the pension to be able to make the benefits a reality to the pensioners.
And, unfortunately, many companies often find themselves in a situation with a pension that has a funding shortfall. And the current economy has accelerated the number of pension plans that have funding crises.
In fact, the Pension Benefit Guaranty Corp. (an independent agency of the United States Government that insures against pension failure) has stated that current funding of the guaranty corp. will likely exhaust all of its funds in about 15 years based on the number of pension failures for which it has had to bail out and likely will in the future.
While there is no quick and simple answer, the overarching theme for a solution is pretty simple, we all need to shoulder much more responsibility when it comes to retirement.
I understand this requires a large degree of sacrifice that many Americans are probably not willing to undertake, but the truth is we all have a limited amount of resources to allocate to life, and we want a healthy comfortable retirement it means that we’re going to have to give up certain things we might really want to have.
Retirement isn’t unique in terms of the work required for it be a success. Just like becoming a good pianist or have six-pack abs there’s a ton of work that goes into it.
A lot of financial advisors don’t like this reality because they fear that if they tell you this, you’ll decide it’s too difficult and shut down. Guess what? It’s a lot of work.
Avoid taking it seriously at your own peril.
If you'd like some additional guidance on how to create your own pension, we explained exactly how you can go about doing that in this article. And if you'd like more help in making this goal a reality, feel free to reach out to us.