Why Have A Pension?


The end of a lifelong journey towards financial independence, and the start of an entirely new journey altogether.

Retirement for some could mean traveling the world. For others, it could mean making up for lost time with children and grandchildren. Still others, it could mean redefining who you are and what you will become.

What Have A Pension-2

Whatever the word, “retirement”, means to you, how it is being paid for has dramatically changed over the years.

For your father and grandfather, retirement was paid for using a company pension.

What Is A Pension?

Per BankRate, a pension is a retirement fund for an employee that is paid into by the employer, employee, or both. Pension plans are also called defined benefit plans since the employer supplies the pension money to the employee.

When the employee retires, they are paid by the employer as an annuity. This means that the employee receives regular, fixed, monthly payments for the rest of their life in retirement. Pensions are transferable to spouses but not children.

What this means is that no matter the stock market conditions, state of the economy, or financial health of the company, the retiree will receive their monthly check for the rest of their life.

Pension Funding Retirement

The pension income payments are determined by a formula and based on the following factors:

  • Years of service to the company
  • Current Age
  • Compensation Level

For example, a pension plan might offer a monthly benefit of 70% of your current pay if you qualify for one of the following: work 30 years or more for the company, start by age 55 and have a minimum of 10 years of service with the company, or retire by 55 with at least 20 years or service with the company.

With that same pension, a person might be able to work longer and retire at 65 with greater than 30 years of service. This pension scenario could provide an income of 85% of your pay. In other words, more years of service usually means more money.

Pension plans must follow specific rules set by the U.S. Department of Labor. The rules state how much a company must place into a pension fund each year to provide their workers with an income when they retire.

Pensions can also be subject to a vesting (pension ownership) schedule that dictates how much you would get based on how long you have been with the company. In the energy and automotive industries, the typical pension vesting period for 100% vesting (aka 100% Pension ownership) is 5 years.

Pensions (aka defined benefit plans) can be unfunded or funded. Unfunded means the benefits are paid for by the employer as the employee receives the benefits. There is no reserve fund to pay the retirees and the company pays as they go.

Funded means the employers has a cash reserve fund built over time and set aside to pay the retires exclusively from it. Usually, the employer pays in a percentage of your paycheck as well as yourself (say, 3% each paycheck from both company and employee). The company uses it 2 ways: to fund the current retirees AND invest for future retiree payouts.

The company actually has an investment team whose sole job is to manage the pension fund investments and ensure that it consistently grows over time in a positive direction. If for some reason, the investments do not produce enough to cover pension payments, the employer would have to pump additional money into the pension fund to offset the losses.

Pension funds are much less common than they used to be. In fact, only about 21% of all Americans currently receive a pension. This figure is declining by the year since most companies have phased out their pension plan.

Why would companies phase out pension plans? Let’s dig into this to find out.

Why Are Companies No Longer Offering Pensions?

I mentioned before that companies have 2 ways to fund a pension: pay as you go or build up a reserve fund.

If a company pays retirees each year, there is risk that the company does not meet its other financial obligations because it must use current cash to fund the retirees. In order of obligations, funding retirees is high on their priority list.

Having to pay now means the company may not have enough funds for expansion projects, acquisitions, or maybe even to meet payroll. Plus, if a company loses money in a given year, the rules state they still must pay the retirees. No way around that.

Well, what about making a reserve fund and using that to pay retirees? Actually, a lot of companies have done just that years. At first, this worked beautifully.

Since the investors had to guarantee positive growth, they invested very conservatively in investment-grade bonds, blue-chip stocks that pay dividends, municipal bonds, and Treasury Inflation Protected Securities (TIPS) like Treasury Bills (aka T-Bills). If there was a bad investment year, the company would have to pump money in the reserve fund. Lord knows that was the last thing they wanted to do.

Initially this went great because bond yields and TIPS yields were very high.

For example, see the historical annual global corporate bond yield from the website:  Marketwatch.com

Bond Prices

From the 1920’s thru the 1980’s, the bond yields were between 4% – 13%. This was safe, easy to implement, and offered a good return for their investment. Funding a pension was no problem since they could invest most of the funds in bonds and just ride the wave.

However, starting around 1990, bond prices began to dip and continued to decline until they are at approximately 0.25% today. With this yield, the only way companies could net positive returns year-in and year-out was to begin investing in riskier alternatives that had higher payout but also a greater chance to lose money. The only other alternative they had was to pump additional money in the pension reserve.

This decline in bond yield happened to coincide with a rise in the use of 401K’s (if working in private sector) and 403B’s (if working in public sector). For the rest of this article and when referring to both, I’ll use the term, “401K’s”.

401K’s were initially designed to supplement a pension, NOT take it over. 401K’s were designed to allow employees another option for investing additional money if they so choose to.

Instead, companies used this as a reason to phase out pensions and allow 401K’s to be the primary employee retirement vehicle.

The reasons were simple:

Risk Transfer

Implementing 401K’s meant transferring the risk to the employees instead of the employer. With bond prices decreasing and companies taking on more risk, if the investments went south, companies would have to dip into other funds to cover it.

401K’s allowed the investment risks to be transferred directly to the employees. The employees had to manage the funds and assume the associated risks. A win for the company.

No Longer Need Cash Reserve

Implementing 401K’s also meant that companies did not need to have a cash reserve to fund the pensions. The employer had to hire a team of professional investors just to manage the fund. With the advent of 401K’s, this no longer was the case.

Plus, not having a reserve fund means that more money could be pumped back into the company especially if the company experienced some lean years.

It also means that companies do not have to have as much in liabilities on their books and can use the extra cash to re-invest into the company.

401K’s sound like a good deal for the company but is it enough for funding the retirement of the employees? No, it’s not.

Which leads me to the next part of our discussion.

Why Having A 401K Is Not Enough

As I stated before, 401K’s were never designed to replace pensions. Pensions were easy for employees. Each month, they received a known sum of money, made their budget based on that amount, and lived a stress-free retirement.

Most people who just funded a pension had enough to live on and very little else to spend in their golden years. If an unexpected expense occurred (a new car, a new roof, medical bills, etc.), to put it bluntly, they were screwed.

Enter the 401K. This was designed to supplement pensions so people could have extra money for unexpected expenses, pass an inheritance onto their children, or just to simply enjoy themselves more in retirement. It was NEVER designed to replace a pension.

Having a 401K is a double-edged sword. It gives employees the ability to potentially earn more than the same amount supplied to a pension. On the flip side, employees can potentially lose A LOT more money than one ever would in a pension.

This risk doesn’t stop at retirement. If investing in the stock market is a person’s sole source of income, there is a lot of inherent risk. With a 401K, the company does not absorb the risk, you do.

Therefore, having a 401K is not enough. When the risk is all on you, you need to protect what you have because no one else will. Companies had professional investors managing their funds and sometimes struggled.  How do you think you will hold up?

Sure, you can teach yourself finances and there is a wealth of knowledge out there now that did not exist even 10 years ago. However, this takes time, effort, and perseverance to do. I am not saying this cannot be done (I’m doing it today). I know from experience it is not easy and some mistakes will be made along the way. The fact of the matter is that the average employee does not have a lot of investment knowledge to manage something like this and 401K’s don’t protect them from life’s pitfalls.

Some people claim that they will simply hire a financial advisor to manage their finances. IMO, no one is going to protect your interests more than you and I discuss my thoughts further on why not to hire financial advisors here.

Why am I proponent of pensions? Here’s why.

Why You Should Want A Pension 

IMO, having a steady income stream for life’s daily expenses is the way to go. Why? Let me walk you through an example.

Say, for example, that a person has $2 million dollars in a 401K and was their only means to fund retirement. They are living off $80,000 per year ($2M * 4% withdrawal rate = $80,000). One day, the stock market tanks, and they lose 50% of their life’s savings. To maintain their current standard of living, they now must withdraw 8% of the remaining life’s savings ($1M * 8% = $80,000). This is HUGE!

On top of that, in retirement, there is no additional money coming in to build the reserves back up. You are now stuck for the rest of your life living off that amount and now run the risk of having your money expire before you do. Even with what you have invested still growing on the rebound, your finances may never recover from this setback because you must spend a greater percentage each year than originally thought.

Having a steady income stream that covers daily living expenses helps to offset this risk from happening. With a financial cushion, you can absorb life’s unexpected occurrences.

For example, let’s assume a person needs $7,000 a month to live on in retirement and have a pension worth $5,000 a month. This means they need their 401K to supply the remaining $2,000 a month. If they have a $2M portfolio in their 401K, they will only need to withdraw 1.2% a year to live off of it. ($2M*1.2% = $24,000). This is well below what experts say is needed to be withdrawn annually.

Well, what if their portfolio is cut in half to $1M? No problem. Now they will need to withdraw 2.4% to maintain the same cost of living. This is still well below the 4% withdrawal rate experts recommend and it sure beats the alternative of not having a pension at all. You’re covered! 😊

Having a pension takes the pressure off you in retirement and allows you to enjoy yourself. In an ideal world, you would live off the pension and use the 401K for life’s unexpected occurrences as well as any fun hobbies you choose to pick up.

The best part about a pension, it is not tied to the stock market. This is because the employer is required to provide the funds not the results of the stock market. How they fund the pension is under their discretion.  They assume that risk. You do not.

Now What?

I hope you can now see the benefits of having a pension. It was eye opening for me and hope it was for you too.

Now the $10,000 question:

How Do I Acquire One?

While it’s true that fewer and fewer companies are now offering traditional pensions, this doesn’t mean that a person cannot create a pension on their own.

Pension Shock and Awe


That is a discussion for the next article where we dive into the criteria for creating a pension and we’ll discuss 5 financial tools we can use to create our very own pension.

Stay tuned…..

Live The Life You Love, Want, and Deserve 😊