Non-Inflation Adjusted Pension Redux

[dragoncar]

This topic was discussed a year ago (http://gyroscopicinvesting.com/forum/ht ... ic.php?t=8) but the thread doesn't cover everything.

How do you factor a non-inflation adjusted, defined benefit plan into your PP strategy?  Would you still go with 4x25 if your pension is going to be the primary source of income?  (Social security would likely make the second largest source of income, with PP withdrawals last.)  Assume we are talking very low risk of losing the pension, although possible.

I know someone who will soon (immediate future) have to choose between:

Accelerated payouts over 5, 10, 15, 20 years
Life + guaranteed payments for 5, 10, 15, 20 years
Life + Spousal life + guaranteed payments ...

They are leaning towards 20 years of payments, which could minimize taxes (assuming tax rates don't increase).  On the other hand, the 5 year accelerated payments could quickly fund a PP.  The life options are less appealing due to short expectancy (which is not actuarially accounted for beyond age and gender)

Thoughts?

[MediumTex]

For PP purposes, a non-inflation adjusted pension is sort of like a house.  It's a valuable asset, it just sits outside the orbit of the PP.

Obviously, the risks of a non-inflation adjusted pension primarily involve a loss of purchasing power over time.

Today, however, it is very hard to find lifetime income options with essentially no premium, and this is what you get from a traditional defined benefit pension plan, so it's a very nice benefit even though it is vulnerable to inflation.  If you are concerned that your life expectancy is shorter than the actuarial assumptions used to calculate your benefit, then selecting a 20 year period certain payout (or something like that) might make sense.

No one should ever scoff at lifetime income, though, (and the implicit risk shifting it includes) because it is something that 401(k) plan participants can only dream about.

[KevinW]

I'm in a pension program but, for various reasons, don't expect to collect the benefit.  If that happens I will get my contributions, plus interest, as a cash payout.  I made an executive decision to count that cash value as part of my PP cash allocation.

[MediumTex]

I'm in a pension program but, for various reasons, don't expect to collect the benefit.  If that happens I will get my contributions, plus interest, as a cash payout.  I made an executive decision to count that cash value as part of my PP cash allocation.

Why do you not expect to collect the benefit?

Part of the nice thing about U.S. retirement programs is that they are required to actually be funded to a certain level at all times (unlike programs like Social Security, which has no funding set aside at all).

The problem with defined benefit pension plans is not that those who are in them won't receive the benefits; rather, it is that they have become so expensive to offer that more and more employers are opting to freeze participation to existing employees only and place new employees in less expensive retirement programs like a 401(k) with a generous employer contribution.

[KevinW]

Why do you not expect to collect the benefit?

My Plan A is to retire or change employers before I'm old enough to receive the annuity benefit.

Also I think there's a distinct possibility that, in the Plan B scenario where I do stay there long enough to qualify, the DBP will have been dismantled by that time.

So for now I'm only counting on getting my contributions back.  If I wind up getting an annuity, it'll be found money.

[MediumTex]

Why do you not expect to collect the benefit?

My Plan A is to retire or change employers before I'm old enough to receive the annuity benefit.

Can you tell me a little more about the plan?  Once you are vested, normally you just have to wait until normal retirement age and you get your annuity whether you are still working there or not.

Also I think there's a distinct possibility that, in the Plan B scenario where I do stay there long enough to qualify, the DBP will have been dismantled by that time.

You can't dismantle it for current participants other than freezing future accruals.  Whatever you have accrued to date will be there when you reach retirement age.

So for now I'm only counting on getting my contributions back.  If I wind up getting an annuity, it'll be found money.

This sounds like a governmental plan, but I would like to know more about what type of plan you are in.

[KevinW]

It's CalPERS.  Since this is California we're talking about, I'm anticipating some kind of future bankruptcy/bailout situation where all the established rules go out the window and get rewritten through a rushed, inscrutable political process.  So I've adopted a "plan for the worst, hope for the best" mindset.

[MediumTex]

It's CalPERS.  Since this is California we're talking about, I'm anticipating some kind of future bankruptcy/bailout situation where all the established rules go out the window and get rewritten through a rushed, inscrutable political process.  So I've adopted a "plan for the worst, hope for the best" mindset.

I think you have the right attitude.

California has made an astonishing array of promises to different groups (for retirement benefits as well as other things).

I think that reality will come into friction with these promises more and more as we move forward.

Private sector retirement plans are insured by the PBGC (sort of like an FDIC for retirement plans), but public plans are not covered by the PBGC.

[stone]

Medium Tex "Part of the nice thing about U.S. retirement programs is that they are required to actually be funded to a certain level at all times (unlike programs like Social Security, which has no funding set aside at all)."


To my mind it is easier to trust a pension such as Social Security that has a defined income stream in the form of current workers paying payroll tax. That gives reasurance that the retiree will be able to get payments in line with the earnings of the retiree's neighbours. So long as the payroll tax still gets collected and demographics don't go haywire (nobody of earning age ??), how could it go wrong? Pensions that are calculated on the basis of presumed asset yields/asset price inflation seem to me much more flaky. From what I can see asset based pension schemes do in fact implicitly also rely on the mechanism of asset prices depending on inflows from current savers. The difference is that there is an added slew of risks. Your pension scheme might hold mostly US equities whilst current savers might only be buying  foreign equities, gold, bonds or whatever.
In the UK, military, school teacher, police, fire service and civil service pension schemes have a "pay as you go" structure like the US social security system. I envy those pension schemes and wish we all had them

[MediumTex]

Medium Tex "Part of the nice thing about U.S. retirement programs is that they are required to actually be funded to a certain level at all times (unlike programs like Social Security, which has no funding set aside at all)."


To my mind it is easier to trust a pension such as Social Security that has a defined income stream in the form of current workers paying payroll tax. That gives reasurance that the retiree will be able to get payments in line with the earnings of the retiree's neighbours. So long as the payroll tax still gets collected and demographics don't go haywire (nobody of earning age ??), how could it go wrong? Pensions that are calculated on the basis of presumed asset yields/asset price inflation seem to me much more flaky. From what I can see asset based pension schemes do in fact implicitly also rely on the mechanism of asset prices depending on inflows from current savers. The difference is that there is an added slew of risks. Your pension scheme might hold mostly US equities whilst current savers might only be buying  foreign equities, gold, bonds or whatever.
In the UK, military, school teacher, police, fire service and civil service pension schemes have a "pay as you go" structure like the US social security system. I envy those pension schemes and wish we all had them

Aren't all Ponzi schemes "pay as you go"?

[stone]

Medium Tex "Aren't all Ponzi schemes "pay as you go"?"

The difference between a Ponzi scheme and a "pay as you go" national pension arrangement, is that in a Ponzi scheme, the subscribers are told that, at some later date, they can withdraw, as a lump sum, the money they paid in. That is not true for a "pay as you go" national pension where people are simply told that they will get an income from current earners paying in. To my mind, the global asset market is much closer to being a Ponzi scheme than is the US social security "pay as you go" pension set up. In the global asset market, investors have the delusion of liquidity. Of course in reality there is only liquidity for individuals and not for the herd. If everyone rushes for the exits, then the Ponzi nature of it all manifests.

[KevinW]

California has made an astonishing array of promises to different groups (for retirement benefits as well as other things).

I think that reality will come into friction with these promises more and more as we move forward.

It's a pretty big mess.  It doesn't help that there is simultaneous majority support for expanding entitlement programs and business regulation, and majority opposition to tax increases.  So expenses keep rising while revenues are flat or falling.  You can't have it both ways and sooner or later that bough has to break.