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Consider Many Factors When Choosing Retirement Plans and Options

by on August 20, 2017 5:00 AM

Times certainly have changed with regard to building a secure retirement.

When my father retired, he had health and pension benefits from his employer. Being an older parent (he was a veteran of World War II), he retired when I was a senior in high school and he and my mom were able to live comfortably in retirement for 21 years. My mother was a stay-at-home mom and due to the number of years Dad worked for Consolidated Natural Gas (Dominion (D) purchased Consolidated in 2000), my parents had healthcare and retirement income covered for their lives.

Nowadays, private company pensions are only available at 4 percent of companies, down from 60 percent in the early 1980s. There are numerous reasons that pensions are disappearing. Pensions are defined benefit plans that guarantee benefits to workers and the risk for performance and benefits lies with the employer or business. As people live longer, the benefit cost more and more for companies. Another option for retirement benefits, the 401k, became available in 1978, but in 1981, the IRS permitted workers to contribute to their 401k plans, which started a movement toward those plans.

401k plans are defined contribution plans, which put the risk for investment and being able to retire firmly in the employees’ lap. Employees no longer stay with companies their entire lives; in fact, the median worker tenure at a company is 4.2 years as of January 2016, according to the Bureau of Labor Statistics. 401k plans are transferable and permit a worker to rollover funds to an IRA or typically take them with them to the new employer. Because pensions are based on salary and years working at a company, they benefit long-tenured employees the most.

In the public sector, pensions still exist and many of Centre County’s major employers still offer pensions or defined benefit plans as an option or their main retirement plan. Penn State and State College Area School District both offer PSERS or Public School Employees Retirement System. PSERS benefits are based on a retirement factor (e.g. early or late retirement), years of credited service and final average salary.

There are critical choices to make when choosing between a defined benefit (pension), a defined contribution (401k, 403b etc.) and chosen benefits when you retire.

When starting at an employer, such as Penn State, where both pension and 403b options are available, it is important to review your personal information. Are you comfortable with investing? A defined contribution plan requires the participant to make investment choices. How long will you stay with the employer? Pension plan benefits are partially based on tenure so a short stint at a company might make a defined contribution plan more attractive. Usually, once this choice is made, your path is set so discuss with your financial professional before choosing if you are uncertain.

At retirement, many pension plans offer varying benefits. This is a crucial decision that can make or break retirement and is another time consulting with a professional makes sense. It is also a very personal decision and should be based on longevity, health, other financial resources and family circumstances.

For instance, if the worker due the benefit is married, typically a joint annuity is an option. This means even if the pensioner dies early, benefits would still be payable to their spouse for their life. Many pensions allow a portion of the present cash value to be pulled, such as the ‘lump sum’ option through PSERS. Professors and teachers often take advantage of rolling the lump sum into an IRA for two reasons: first, PSERS does not increase for inflation in retirement so the monthly benefit that feels sufficient now may not in 15 years. Second, some retirees do not have sufficient liquid assets for emergencies, etc. In these cases, taking the lump sum and putting it into an IRA can make sense. The worst mistake would be pulling the money and not putting it into a tax-deferred IRA. This would make the entire lump sum taxable in the same year.

Finally, many pensions are offering lump-sum windows for retirees and vested ex-employees. The plan participant trades their entire pension benefit for a present value lump sum. Primarily, a company offers a lump sum payout because it can reduce its risks and costs and limit future obligations to the participant. By taking the lump sum in lieu of the pension, the participant moves the longevity risk (the retiree outliving their money) and investment performance risk from the company to themselves.

This can be a bad idea. For instance, gender is not considered when calculating lump sums, so women get more benefit from pensions because of their typically longer life span. A lump sum can make sense when the pensioner is ill and does not have a spouse. If benefits for a non-spousal heir are of primary importance, rolling the lump sum may make sense since it can be passed onto next generations.

Pensions are an attractive retirement option and, just like social security, can provide a lifetime of income for a retiree and even his or her family. It is key, however, to make the right decisions when dealing with any retirement choices, so work with a trusted professional.

 



Judy Loy, ChFCâ, is a Registered Investment Advisor and CEO at Nestlerode & Loy Investment Advisors, State College, Pa. A graduate of Penn State University, Loy has been with the firm since 1992, assisting clients with retirement planning, brokerage services and investment advice. She can be reached at jloy@nestlerode.com.
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