Pensions offer what may be the ideal source of retirement income. If you are fortunate enough to be vested into a Pension Plan, consider yourself lucky. You should ask, though, What would happen to your pension if the plan were to terminate or fail?
If you are a participant in a private sector pension, check if your plan is covered by the Pension Benefit Guaranty Corporation here. The PBGC is a federal agency that was chartered to protect pension plan participants; it’s funded through required employer contributions and receives no tax dollars.
Even if your pension is insured, there are limits on the amount of coverage available through the PBGC. If a plan terminates and you are vested, but not yet retired and receiving benefits, you would be covered only for your currently vested benefits and would not receive any further credit for future work.
This is important: you need to understand whether your Pension Estimate is based on past contributions, or an estimate based on the assumption you are going to work to age 65 or other future date. The PBGC will only cover vested benefits and a plan termination will halt the accrual of future benefits.
If you are retired and already receiving benefits, the PBGC has limits on the monthly benefit they cover. If a plan terminates and is taken over by the PBGC, you could see your monthly benefit drop by a significant amount.
The limit of benefits available through the PBGC depends on four things:
- Whether your plan was a single-employer plan or a mutliemployer plan.
- Your age at retirement.
- The number of years you were a participant in the plan.
- Whether your benefit is a single-life annuity or a joint and survivor benefit.
For single-employer plans, the limit of the PBGC coverage is capped based on your age and the year the plan was terminated. For example, if you are 65 years old and your plan were to terminate in 2017, your PBGC benefit would be capped to $5,369.32 a month for a single-life benefit or $4,832.39 for a Joint and 50% Survivor Annuity. Link: PBGC Monthly Maximum Tables.
The PBGC benefits for single-employer plans are generally quite strong. However, if your pension benefit is above the monthly guaranty amount, and the plan were to fail, your benefit would be reduced to the PBGC maximum.
This can happen! Years ago, I met an airline pilot who retired at the mandatory age of 60 and started his six-figure pension thinking he was set for life. After 9/11, his former employer went bankrupt and his pension was slashed to around $3,000 a month. They hadn’t saved very well because they were planning on the generous pension. The reduction to his monthly pension check was devastating.
If your pension offers a lump-sum payout upon retirement, we can determine the limit of your PBGC coverage and investigate the funded status of your pension plan. If your plan is in critical status, or your company has a credit rating below investment grade, you will seriously want to consider the lump sum, if your payment exceeds the limits of PBGC coverage.
The PBGC coverage for multiemployer pension plans is unfortunately much, much lower than for single-employer plans. If you are a participant in a multiemployer plan, your maximum coverage under the PBGC is based on the number of years of service. This is regardless of how your plan may calculate benefits.
PBGC formula for multiemployer plans:
100% of the first $11 of monthly benefits,
Plus 75% of the next $33 of monthly benefits,
Times the number of years of service.
The maximum monthly benefit under the PBGC then is $35.75 times the number of credited years of service. For example, if you were a participant for 30 years, your maximum benefit would be $1072.50 a month, or $12,870 a year. And in order to get $35.75 from the PBGC, you’d have to be receiving at least $44 from the pension. In other words, to get the PBGC benefit of $12,870 a year, your pension benefit amount would need to be at least $15,840.
The amounts for Multiemployer plans are not indexed for inflation and do not receive Cost of Living Adjustments. Link: Multiemployer Benefit Guarantees.
The PBGC only covers private sector pension plans. Participants in a federal, state, or municipal government plan do not have any separate insurance or guaranty. And there are significant problems with funding in municipal pension plans. Here in Dallas, there is a billion dollar short-fall in the Police and Fire pension plan. Recent problems have prompted a stampede for the exits, as members retire early so they can take a lump sum payment. All of which is further driving the plan over the edge.
There are lots of municipal pension plans that are ticking time-bombs. It’s not clear to me that the public has the willingness to accept increased taxes so we can cover generous employee retirement plans. It seems inevitable that there will be some plans which will be forced to reduce the benefits they have promised.
All of which means that investors need to have multiple legs on their retirement plan: pension, Social Security, investment accounts including IRAs, and other sources of income. If you try to have a plan that rests entirely on one leg, you are potentially asking for trouble.