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AUTHOR: Dan Smith on 10/14/2024

The year was 1988 and I was sitting across the table from my employer and his attorney, I was not a happy camper when they proposed to freeze the defined benefit (DB) pension. Instead, they would divert their contribution into a new 401k plan. I had been a pension trustee representing the union’s interest and had some awareness of some funding issues looming. Most employers are desperate to freeze those DB plans in order to escape the financial liability that can plague their bottom line.

At the end of the day the company got their way, but not before agreeing to a matching contribution (in addition to the fixed amount initially proposed) up to $2k per year. The new 401k did a couple things. First it transferred all the risk onto the employees, and second it created the potential to provide those workers with retirement income that far exceeded that of the old pension…. Or not. It all depended on choice.

36 years later I’m able to see the results and can report that they are mixed. The guys that chose to take advantage of the match are now enjoying comfortable retirements. The guys who didn’t plan and save adequately are either struggling or still working.

At the time the old pension was frozen, the maximum benefit was only $690 per month. I only had 10 vested credits, and had to split them with my x-wife, leaving me with a whopping $84 monthly check.

Fortunately for Chris and me, we choose to live within our means and took full advantage of every saving tool out there. Now fully retired we are more comfortable than we ever imagined possible. In a recent forum topic some commented that not having a lucrative DB pension was detrimental to automating ones finances. I contend that it doesn’t have to be that way. Bad luck aside, it depends on choices.

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Harold Tynes
4 months ago

As a former CFO of several companies with DB and DC pension plans, I found that many plans gave great benefits for long term employees. What was missing was portability for those who did not retire from the company. A solid 15 year career would only yield a modest pension if the employee did not retire from that company. Less than 10 years of service may not yield anything. Back end loading the benefits detracted from recruiting new employees and encouraged older, burned out employees into staying beyond what their mental and physical condition warranted. They had to hit the “magic number” of age and service or they would be severely impacted.

I have had many employers in my over 45 years of working. I’ve also had significant stretches of self employment.Today, I have a very modest ($1000/month) pension from one employer, my wife has a similar size pension from a 15 year career as a teacher. Without the investments we made in 401K/403b plans (with and without matching) and in taxable savings, we would be struggling. You can cobble together a great retirement but it takes work. A little luck never hurt either.

R Quinn
4 months ago
Reply to  Harold Tynes

DB plans were always designed for long-term employment and were born in industries with unions and that typical had such tenure – in the good old days. My pension is based on over 49 years in the plan and calculated on the five highest years of earnings in the last ten years of service. My five highest years of compensation were the last five years I worked and if I had retied before I did, the five year average would have been substantially less.

The 401k is a better fit for most people, but could and should be enhanced so that the plans have an employer contribution that is not dependent on the employee participation. In addition, adding profit sharing would be fair.

R Quinn
4 months ago
Reply to  Dan Smith

Absolutely

stelea99
4 months ago

If the CPAs had been doing there jobs right when the first pension was proposed for a publicly owned company, it would never have seen the light of day. And, when in fact they forced companies to put their unfunded liabilities onto their balance sheets, it was a sign that the days of defined benefit retirement plans were over. CPAs have a lot to answer for. They also created the Savings and Loan crisis by forcing S&Ls to mark the mortgages they originated and carried on their books to market value. Pensions are just one more CPA roadkill.

The USPS is still suffering from Congress requiring it to fund its real pension liability unlike the rest of the Federal government and most state and local governments.

So, all of you who are enjoying an old style defined benefit pension were just lucky.

R Quinn
4 months ago
Reply to  stelea99

There is no doubt that accounting rules along with ERISA spelled the demise of the defined benefit plans such as they were. I was forced to step down to a CB plan (still DB) because of the costs of the old plan that had been around since 1911, but only actually funded since 1967.

William Perry
4 months ago
Reply to  stelea99

I use my bathroom scale to measure my weight over time because what I am measuring is the same.

I agree there have been times when accounting reporting standards have trailed when new financial events occur but does that mean we should not strive to use fairly stated comparable financial statements that report financial position and results of operations on a consistent basis using the best agreed upon current standards?

CPA’s attest to the fair presentation of management prepared financial statement so that the public may rely on the historical data in accordance with the current generally accepted accounting principles as part of the users financial decision process.

There are inherent conflicts of interest when the CPA firm issuing a public attestation on financial statements is hired and fired by the the organization who owns and prepares the financial statement being reported upon. The laws and standards that regulate a CPA’s practice attempts to mitigate those conflicts on matters that the CPA firm reports upon. Changes in reporting standards have subsequently occurred after existing accounting standards failed to reflect the economic reality of events such as the past failure of a standard that did not require recording certain liabilities associated with defined retirement plans. The structure of CPA firms serving the public with fees paid by the entity it reports on does cause a conflict by trying to serve two masters. A better structure for independent financial assurances has yet to emerge.

My new digital scale provides a more accurate weight than my old one but I do not blame my old scale for a result that it was not designed to measure or report. I get additional information about my health from my doctor by getting additional test results and seeking additional relevant knowledge. A historical financial statement provides important but limited information for a good financial decision about the future, but it is only a starting point. Plan accordingly.

stelea99
4 months ago
Reply to  William Perry

Somehow, I don’t think that accounting is like physics or other hard sciences. There are no “new’ particles discovered that upend all current assumptions in the field. Pensions (for those who still offer them) create a liability for future payments from a point of view is pretty much the same as it was when the idea first became widespread in WWII. So saying that the standards were trailing events is a bit of an understatement. The same is true for the S&L crisis. I think that if the big inflation bulge on the late 70’s with its associated giant interest rate increase hadn’t happened we might still have the old pension system and S&Ls holding their own paper.

When I worked, our Controllers’/Finance department was mainly staffed by people with CPA designations who used to work for big accounting firms. They were all pretty sharp. I think you have to be smart to pass that test. So, why did it take 50 years to make such an obvious change in the standards until a point when it has had huge detrimental effects on society. Both companies and their accounting firms knew there were significant unfunded liabilities.

Harold Tynes
4 months ago
Reply to  William Perry

William, you make a good point about consistency and Generally Accepted Accounting Principles (GAAP). Consistency does not always yield meaningful reporting. I would suggest today’s GAAP for pension’s does a poor job of stating the reality of the impact pensions have on a company’s financial condition. The reporting given to pension holder’s is even worse. There has been a great deal of politics involved with the financial presentation of pensions. Some of the political impacts includes setting discount rates (how liability is calculated), taxation of funding (did you know pension funding is tax deductible, but don’t overfund!), amortization of gains/losses (this makes the plan look better), and if you happen to participate in a multi-employer plan (Teamsters for example), you pray for a government bailout. I have dealt with these issues as a financial executive. This is why management should be willing to pay for a lucrative match in a 401k/403b plan to escape a pension plan. Predictability in expense is always preferred to the craziness of pension accounting.

William Perry
4 months ago
Reply to  Harold Tynes

I agree. The compliance, risks and uncertainties as to expense (both current and long term) of a pension plan typically made pension plan adoption or retention a nonstarter for most companies I use to work with before my retirement.

Defined contribution plans with a good match and making effective plan education of covered employees available seems to be a best practice for buy in by employees.

R Quinn
4 months ago

In 1995, I negotiated to replace the traditional pension with a cash balance plan for new hires only.

A CB plan is legally a defined benefit pension plan and the normal payout is an annuity, but it accrues and looks like a defined contribution plan and a lump sum payout is available. Workers also had a 401k.

They had in many ways the best of both worlds except if they had the old pension and were employed 30 years.

Unfortunately, many workers blew it by not maximizing the value of the 401k and then taking a lump sum instead of the annuity from the CB plan as intended. These were high paid union workers who with readily vailable OT often earned six figures or very near.

Yes, indeed it depends on paying attention to your options, learning to maximize them and making prudent choices. It takes a bit of work and no excuses.

Rick Connor
4 months ago
Reply to  R Quinn

This is an interesting topic, and one I have a little experience with. My division of Lockheed Martin was sold to a PE firm in November 2010. Amazingly, Lockheed transferred to the PE fire a fully funded DB pension plan. The new owners continued it unchanged for those of us in the plan (about 1400 of the 2000 employees that were sold). In April of 2014 they announced the DB plan was being frozen, and replaced with a cash balance plan. The stated reasoning was the traditional DB plan was unsustainable, but the CB plan would be sustainable as “far as the eye cold see”. It turned out we could only see 14 months. At that point they changed the employer contribution from a fixed percentage based on years of service to $25 per quarter. This change was done so there was no thought that the plan had been closed.

Those of us who retired after April 2014 had 2 components of our pension – a traditional DB part and a small Cash plan portion. They calculated differently – the DB default was a monthly annuity plan, the CB was a lump sum. At retirement you had to pick either a lump sum or an annuity. I worked with highly educated engineers and scientists (rocket scientists!!) and many were confused by the hybrid plan and their choices. I provided many an educational session individually and with groups explaining the choices and how IRS 417(e) conversion rules worked. I’m not sure why, but in my experience, financial literacy is not positively (or negatively) correlated to education, work ethic, or individual decency.

I also spoke with family members who had various pensions – teachers, union carpenters, and insurance company, and state employees. Each plan had some unique nuances that made them different. The lesson for me was that not all pension plans are the same and I needed to careful about any advice I gave.

Michael1
4 months ago
Reply to  Dan Smith

Plus one. Well said.

Ken Cutler
4 months ago
Reply to  Rick Connor

I hear you, Rick, about the non-correlation of financial literacy to those other characteristics. For whatever reason, I had more interest in the details of the cash balance plan than the vast majority of my engineer coworkers. It took me years, but I eventually felt like I understood all the nuances and why the projections in the pension model would change they way they did. I was surprised at how little many of these very smart people knew about their plan. They were happy to get the Cliff’s Notes version from me.

Ken Cutler
4 months ago
Reply to  Dan Smith

Dan, I’m one of the few people in my company to take the annuity on my CB. Admittedly, for many years the interest rates did not make that an attractive choice. I advised a lot of people over the years to take their “frozen” traditional benefit as an annuity (it had a fixed, favorable interest rate assigned) and the remainder–the bulk of it–as a lump sum. Still, when my turn rolled around, the 417(e)(3)(D) interest rates had improved enough that the full annuity was again a viable choice. A friend’s financial advisor recommended he take the annuity, as he was retiring around the same time I was. I told my friend he had an honest advisor–hold on to him.

bbbobbins
4 months ago
Reply to  Ken Cutler

I think this highlights the absolute problem with using a savings pot of any description to purchase an annuity. One is highly vulnerable to the ups and downs of interest rates and the bond market at a very specific point in time. In the rest of investing the general advice is to avoid trying to time the market but anything structured around a default annuity purchase clearly depends to a certain extent of chance at the point of purchase in ways that can a material impact on financial wellbeing.

R Quinn
4 months ago
Reply to  bbbobbins

Doesn’t the interest rate at the time of purchase determine the annuity buying power? It doesn’t change after that does it?

It’s no different than selecting a lump sum. I had vested terminated employees see a lump sum amount in December of a year and then see a lower amount two weeks later in January because interest rates increased.

Then I had to explain why the lump sum declines when interest rates go up – greater lost earnings for the trust.

bbbobbins
4 months ago
Reply to  R Quinn

I don’t understand your point. If an employee parks the lump sum in cash their capital isn’t eroded when interest rates rise. If they invest in a broad portfolio say 60: 40 the impact of a single interest rate rise shouldn’t be catastrophic. Only if they invest in bonds which fall in value to reflect the lower coupon are they immediately harmed. And even then they have the option to rebalance into equities to achieve longer term growth.

Only if they are forced into an annuity at retirement date, which you seem to be suggesting would be best practice by your negative wording around people taking lump sums, are they engaged in a true luck of the draw one off gamble.

Last edited 4 months ago by bbbobbins
Rick Connor
4 months ago
Reply to  Dan Smith

Dan
i can only speak to our CB plan but the annuity generated from the CB plan had the same joint and survivor options as the traditional pension. If you chose a lump sum it was just that – a one time payment.

R Quinn
4 months ago
Reply to  Dan Smith

Wrong way to think about it.

CB plans are pension plans subject to the same survivor annuity rules as traditional plans a person is not buying an annuity, it is the normal form of payment just like any pension. The lump sum is the alternative because the benefit formula creates the impression it is a defined contribution plan and shows an account balance – purely notational, not like a 401k.

Participants see a contribution sometimes based on length of service, an interest rate credited to the accumulated funds and the accumulated monthly future benefit. The annual employer contribution credited to the notational account typically increases with years of service.

Look at it this way. Say you have a regular pension and at retirement you will receive $2,000 a month based on the plan formula which considers your age and service and some accrual factors- say a % of average wages in the last five years multiplied by years of service. The intention is to provide a life annuity.

In rare cases, you may be eligible to take a lump sum and the risk that goes with it while giving up any federal guarantee insurance that applies to your pension.

Some peoole will jump on the large pool of money shown them. Others, like me, see that as foolish and will take a life annuity possibly with survivor benefits.

A CB plan is a pension plan, the only difference is the way benefits accruing under the formula and a lump sum option is standard.

And, they are cheaper for the employer because they accrue less of a benefit.

Rick Connor
4 months ago
Reply to  R Quinn

Dick, our CB plan was different than you describe. Our original BD plan was as you describe – the standard benefit was based on years of service, and the average of the 3 highest salary years of the last 10. These inputs went into a benefit formula to calculate a monthly benefit at full retirement age of 65. You could retire as early as 55, but with an actuarial reduction in the benefit.

When they froze the BD plan and switched to a CB plan. employees were credited an amount based on yers service. These funds accumulated, and an interest payment was made at year end IF, and only IF, the corporation deemed it feasible. The default benefit for the CB portion was a lump sum. You could choose an annuity on this portion, but it was not based on the same factors or formula that the DB plan used. Instead, the lump sum would be converted to an annuity using IRS specified interest rates and methods (see IRS pub 417e).

At the time they switched to a CB plan they added a lump sum option to the original DB portion – that had never been an option before. The traditional DB lump sum was calculated using the same IRS 417e methodology. The part that confused many employees was that you were forced to choose the same benefit method – annuity or lump sum – for both parts of the pension at time of retirement. Because they only funded the CB for about 14 months before effectively freezing it, the CB portion was relatively small. The lump sum calculated from the DB annuity was a fairly big number, high 6 to low 7 figures for long-term employees. It was tempting but not many employees elected it. That is one of the reasons the CB plan was effectively frozen after 14 months.

Sorry for this convoluted story – but it is illustrative of the complexities of pension plans. I’m still trying to figure out my brother-in-laws Carpenter’s Union pension. Apparently there is a monthly benefit and a lump sum amount – but they call the lump sum the annuity. No wonder folks are confused.

Ken Cutler
4 months ago
Reply to  Dan Smith

Ours certainly did not. They are lifetime annuities, with 50%, 75%, or 100% survivor options.

bbbobbins
4 months ago
Reply to  R Quinn

When we talk about tone does the characterisation of individuals as “blowing it” and ” no excuses” not imply some sort of moral judgement?

We’re presumably talking about people who weren’t or aren’t financially sophisticated here. I guess my point is under “old” DB pensions one could simply operate on autopilot no matter your level of sophistication, provided you stayed with the same employer. Give unsophisticated or undereducated people choices and it won’t be a surprise if some take the wrong ones or get carried by crowd fallacies and the like.

Heck I know there is an epidemic of people engaged in the amateur landlord game, inspired by property porn on TV. They confidentially assert that “my properties are my pension” without considering the issue of over exposure to a single sector or lack of liquidity/impact of capital gains taxation.

R Quinn
4 months ago
Reply to  bbbobbins

Judgement yes. I will address this more in a future post, but in short i spent nearly fifty years educating, and communicating everything and anything people needed to know about their retirement and other benefits – on a regular basis using various methods.

The audience was everyone from the CEO to a street laborer and all between – even engineers, including their families.

Those people who took advantage of all we offered thanked me, but the majority simple ignored our efforts and often suffered the consequences. It had nothing to do with education level or financial sophistication, but rather their own priorities and lack of responsibility.

Nothing has changed.

bbbobbins
4 months ago
Reply to  R Quinn

Well what’s changed seems to the value of your 50 years experience given you seem to take pride in advocating for a no budgeting/ no modelling lifestyle. Yet you accuse the huddled masses of a lack of responsibility.

BTW we’re into a tortuous semantic wormhole when you claim never to give advice but clearly defame other people for their actions.

Last edited 4 months ago by bbbobbins
baldscreen
4 months ago
Reply to  bbbobbins

Bbbobbins, your second paragraph was us. Definitely unsophisticated and uneducated. We made many mistakes along the way. Believe it or not, the beginning of my financial education came from listening to Christian radio in the early 1990s. There was a program that taught finances to the everyday person like we were. I also checked out books from the library. I am still learning, here at HD and other places. I have taught our kids, so hopefully they will do better than us. But, in the end, we are ok. Chris

bbbobbins
4 months ago
Reply to  baldscreen

Glad to hear it. The main problem in all retirement planning is time horizons. In one respect that’s helpful with the power of compound interest/RoI but due to the nature of our caveman brains we’re really not adapted to looking 30+ years into the future and organising our affairs around that.

So for those who don’t talk money with adult kids I really think they need to. Inflation is real, you need to sacrifice early and continually and take every opportunity you have in terms of free cash to boost your position. There is no longer such thing as a benevolent employer who will ensure you do OK regardless.

For people midflight sites like HD and other forums can be very helpful as resources and encouragement for course correction. Personally I think I’m now benefiting more from “retirement psychology” type podcasts that focus less on the technical and more on attitudes to spending vs preservation.

baldscreen
4 months ago
Reply to  bbbobbins

Thanks, bbbobbins. Did you have any recommendations for the podcasts? We are still working on the technical, since we are new retirees and turning on income streams. The psychology so far is that we know we have to make our assets last at least 25-30 years. Also part of our psychology is our Christian faith and we believe God owns it all and we are just the stewards. I would be interested to know what you think would be good podcasts for us. Chris

bbbobbins
4 months ago
Reply to  baldscreen

Humans v Retirement is a good one. Hosted by a British financial adviser but with lots of US/ global guests

– Bill Bengen, Ken Honda, Christine Benz etc

https://www.humansvsretirement.com/

Really about mindset not technical investing.

Ken Cutler
4 months ago
Reply to  R Quinn

So, what about the old timers who had started their career in 1965? Did they get to keep accruing benefits under the old pension plan?

mytimetotravel
4 months ago
Reply to  Ken Cutler

I’m not Dick, but I can tell you what the megacorp I worked for did. It started reneging on promises to employees in the late ’90s. I was grandfathered into the old DB plan (made it under the wire by two years), but my pension was frozen when I hit 30 years. There was a lump sum option added at that point, but the annuity I could have bought with it was nowhere near my pension, which I was able to take when I reached 30 years. No COLA, and retiree medical has been continually downgraded.

luvtoride44afe9eb1e
4 months ago

What a conundrum back in 1988! I don’t envy the position you were in. I’m sure that many of the employees of the company who were not as diligent as you in their savings are struggling today and that’s a shame.
in 1989 I joined a company with a good Defined Benefit pension plan AND a 401k plan with a lucrative Match. This match was at an increasing % amount based on years of service. After 10 years it reached 117% of the Employee’s contributions. I was fortunate to be able to “max out” my 401k contributions just about every year of my employment (some tight years in their raising my family) until I retired last year after 34 years with the company.
The security of having a healthy pension along with an investment portfolio built with a great 401k plan makes retirement a much more enjoyable prospect. I don’t know how my kids and their families will achieve a retirement even close to this with NO Pensions and less lucrative 401k plans for their 30-40+ years working careers. 🤷‍♂️

bbbobbins
4 months ago

I don’t think you can’t automate a lot. Just those retirees need to be slightly more on top of their portfolio and drawdown strategy to replenish the spending pot because in the absence of conscious actions too much sits in cash, risk averse strategies or isn’t drawn down in the most tax efficient order etc etc.

Some people who’ve maxed out 401ks, stayed the course in broad equities etc will of course beat whatever pension they would have got in the alternate universe. But the point is that they will have needed to be more disciplined, have stayed the course, and of course weathered more volatility to get there.

Andrew Forsythe
4 months ago

Dan, you’re right that so much depends on choices and the individual’s willingness to follow a disciplined savings plan. I always envied anyone with a defined benefit plan, but that wasn’t available to me.

The light bulb went off in my head a little late, but when it did I started a SIMPLE IRA plan for our small law office and contributed regularly for decades. Now in my “golden years”, I’m glad I did.

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