Are Old-School Pensions Out of Date?
A closer look at my government pension.
As my wife and I have started getting more serious about investing for our future, we realized that we needed to know exactly what options were available to us.
We started with our employer retirement accounts, since we were already contributing to them.
- Amelia works at a university and has access to their 403(b), which has the same limit as the standard, private sector 401(k) of $19,500 for 2021.
- I work for a municipal government and have access to a 403(b) and a 457(b) plan, both of which have the $19,500 limit.
- I also have access to a pension plan and will meet the 10 year vesting period in two years.
It’s this third line, the increasingly rare, often misunderstood pension that is the focus of this article.
Is My Pension Worth It?
To see if a pension is worth keeping, we first have to figure out my remaining vesting time and how much the pension pays.
As mentioned earlier, I am two years away from being vested in the State of Indiana pension.
I shouldn’t be this close and am only this close by a stroke of luck.
Unbeknownst to me at the my time of hire, I was forced into the Indiana Hybrid Plan, which has both defined benefit (pension) and defined contribution (investment account).
Come to find out, my time working the state of Indiana set a baseline of 4 qualified years, to which I have added 4 years working for a municipal government.
Not only does this reduce my retirement age but also increased the overall pension benefit.
What Does My Pension Pay?
Nothing is ever straightforward with retirement, and pensions are no exception. The formula for my monthly pension amount is this:
High 5 Income * Years of Service * 1.1% / 12 months
Let’s go through each of these, then run the numbers.
- High 5 Income — the average of my highest 5 years (rather, 20 quarters) of annual salary
- Years of Service — total employment time at a contributing employer
- 1.1% — Arbitrary multiplier chosen by the actuaries
- 12 months — breaking my annual amount into monthly payments
Since I still have two years left, I’ll just assume a 2% salary increase each year to get to my vested 10 years, which puts my High 5 at $66,764.
$66,764 * 10 years * 1.1% / 12 months = $612/month
Not great, but not bad for just working at my current job for an extra two ears.
Keep in mind, though, that cost of living adjustments are added to this. Plus, through some arcane rules of PERF, I’m not eligible to take this retirement until I’m almost 59.
Let’s run the numbers again, assuming a 1% cost of living adjustment (COLA) for the next 19 years, with only 10 years of service.
$66,764 * 10 years * 1.1% * 1%¹⁹ / 12 months = $739.30
Meh.
Given today’s inflation rates, that amount might not buy much, but there’s still hope.
- The COLA will probably be higher than 1% with inflation the way it is.
- Second, it’s guaranteed money just for working.
Let’s take a look at one more situation where I work until I’m eligible for retirement, assume 2% salary raises, plus a promotion every 5 years with a 10% salary increase.
The rough math makes my High 5 $112,742.
$112,742 * 29 years * 1.1% / 12 months = $2,997.06
No we’re getting somewhere. $3,000 a month, every month, for the rest of my life, with cost of living adjustments, starting at age 59.
Can I Make More Money Elsewhere?
We know what the pension pays out, but what about the alternative? What’s the opportunity cost of sticking with my government job and avoiding the probable higher salary at a private sector job?
Let’s do the math using the following assumptions.
- 19 years to save and invest
- Starting salary of $80,000, investing 10%
- 100% Employer match up to 5%
- 6% return on investment
The retirement calculator from the fine folks at Vertex42 shows a total private sector retirement amount of $658,891 (which I’ll subsequently burn through in 10 years).
But how does this compare to a pension?
Assuming I live to 85, I’ll have 26 years of $36,000/year with 1% increases, my pension is worth $1,212,360. That is 84% more than all of my private sector retirement.
Risks of a Pension
The last part of the discussion centers around the risks of a pension. A common misconception is that pensions are rock solid and will always pay out.
Not really.
All pensions require investment in assets that produce returns, so the pension fund is much like any other mutual fund or personal retirement account in that they are subject to market risks.
Do pensions go bankrupt and need to reduce benefits?
Absolutely.
The Territory of Puerto Rico, City of Detroit, and City of Central Fall, RI all went bankrupt and wrecked havoc on their pensions.
That being said, I have 19 (or more) years for Indiana to recover from the pandemic funding shortfall.
The Takeaway
When first starting my career, I distrusted pensions and was an evangelist for private retirement accounts.
Being thisclose to receiving a pension on my own made me take a hard look at their worth and has changed my mind.
In short, a pension plan cannot replace your personal investing, but it can definitely act as the third leg of the retirement stool.
My pension story is just one of myriad examples of a) how you can find money in your company’s benefits and b) the variety of retirement strategies that are offered during our careers.
Do yourself a favor and take the time to look at what’s available to you. Seeing that I could have over $1,000,000 in retirement savings on top of my additional accounts I contribute to has changed the calculus for shifting careers.
I might just be a public employee for life!
This article is for informational purposes only, it should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.
