Pensions - maybe I'm just ignorant

I’m not sure I understand how anyone thinks pensions make sense and are sustainable. As I understand it, pensions basically pay retired employees forever (until they die). Is this right?

How can this work? How does a company have enough money to do this? Pay current employees as well as retired employees.

Aren’t pensions just like an annuity but from a company? You pay into it, they invest the money and then offer you a stipend in retirement.

Fwiw an annuity that offers around $1000 a month in retirement costs maybe 200k if you buy it at age 65, but maybe half that if you buy it at age 50.

So if assume pensions collect money from employees, invest it in stocks and then pay out to retired employees.

And there’s nothing that says a pension has to be at a certain amount. If I invest my pension fund so that it averages 4% interest per year, but only pay out at a 3% rate, the money will last indefinitely.

The trick is balancing present contributions with future payouts.

A company has to decide what to offer their employees that still nets them a profit. Pensions are just another part of that package. If a company can’t afford to pay pensions, then either they go out of business, or they offer their employees a compensation package that doesn’t include a pension. And not offering a pension might result in them not being able to get the employees they need.

Now, they could instead eliminate the pensions, raise the salaries, and tell the employees to make their own investments for their retirement. But most companies hiring career workers have found that they can put together a benefits package that costs the company less but which the employees prefer, if it includes a pension. So they do.

In the more traditional pensions, you didn’t need to pay into it. The employer paid all contributions. In others, both the employer and employee pay in. The money is invested, usually in very safe funds, to generate the money paid in retirement.

One of my retirement accounts is from TIAA-CREF (for education professionals). I never paid anything into it; all contributions were made by my employer. The funds were invested in an account which is now about four times larger than the money originally paid in. I now have the option of converting these funds into a lifetime annuity.

Paying pensions is, for many firms, a cost of doing business. Based on actuarial tables they will calculate how much they need to set aside or invest in order to pay out an average employee over their average lifetime after retirement.

By that reasoning, all retirement saving is impossible. You mean you have to accumulate a big pile of money and live on that until you die? How can that work? How do you have enough money to do this?

Of course, if an individual can do it, a pension fund can do it on an individual’s behalf just as well. In fact they have a couple of advantages over the individual trying to do the same thing:

[li]The can employ professional money managers at a scale that individuals can not.[/li][li]Bigger ones can more effectively demand returns from the companies they invest in.[/li][li]If one of their beneficiaries dies early, they can use the unclaimed funds for beneficiaries that die late. Individual savers all need to save extra money in case they live longer than expected. Pension funds can target for the average.[/li][/ul]

Of course, that just meant that the individual effectively paid into it by forgoing the additional pay they could get at a competing employer that doesn’t offer a pension.

Most of the current pension-having jobs (e.g. teachers, public servants) are much more known for their benefits than their high pay.

Keep in mind that there are two types of retirement schemes; defined benefit and defined contribution. Most pension plans are the former, where the company promises a fixed amount each month in retirement and it’s up to them to ensure there’s enough money to meet the commitments. The latter is what most people see nowadays and is what a 401(k) or IRA is. You and/or your employer contribute money and you may have some choice in how it is invested. How much you have at retirement is dependent on how much you contribute, how well you invest and how slowly or quickly you choose to withdraw the money.

Some companies and public sector employers with traditional pension plans get into trouble if they have not set aside enough money over the years to meet their obligations. There are even companies, like Bethlehem Steel, that are a shadow of their former selves but still have massive pension obligations.

It’s also true that negotiating pensions is something that unions like to take credit for (maybe with some justification, maybe not, prefer not to argue about it here). Pensions are a benefit that may cost a company noticeably less (due to the power of compound interest) than paying a higher salary to make up for the lack of a pension.

Where I worked, workers became vested in a pension after 7 years, and the amount of the pension was based on a formula that calculated years of service and an average of the worker’s highest 3 years of income. I think there was a maximum number of years of service beyond which one’s pension would not increase, I think it was 40 years.

Unfortunately, my pension does not have any cost of living increases built in, so inflation is a serious problem. Fortunately, I don’t rely entirely on my pension and social security for my income. But I can’t deny that having a pension is great.

Do you accept that it’s possible for someone to save money during their working life in order to live in retirement? A pension scheme is simply a formalization of that process. Conceptually, it doesn’t make a difference whether the company pays you all your compensation in cash and you save some of that money yourself independently, or if part of your total compensation goes directly into a pension scheme that is administered by the company on your behalf.

The reason for the formalization is that the government chooses to give tax breaks to incentivize people to save for retirement; and that the government makes those tax breaks contingent on you not raiding your retirement savings for hookers and blow before you retire.

The element of validity in your question relates not so much to private pensions, which must be actually funded with earmarked money, and public pensions that may not be. With public pensions, the government generally doesn’t set aside specific amounts from your taxes to later specificually pay you in retirement, the funding for current pension expenditure just comes from current taxation. That creates a problem if the size of the current retired population increases relative to the size of the current working population. This a growing problem in most Western countries (Japan in particular), with declining birthrates and increased life expectancy. The obvious way to address it is simply to increase the retirement age for state pension benefits, but you can imagine how popular that is.

You can see the impact of this by reading up on the Rhode Island Retirement Security Act (RIRSA) of 2011. The state cut back on benefits to the public employees (teachers, firefighters, police) including people already retired and on a fixed income. Basically the State didn’t put aside the money there were supposed to and spent the money they had saved on other things, then blamed the workers for wanting to get what they were promised. Major cluster.

In the US, most companies have eliminated pensions so they are no longer common for non-government employees. Instead, companies have found that it is cheaper to set up pre-tax nvestment/savings plans for employees. The company only contributes if the employer does. Employees love it because they are ‘in control’ of their own money - but seldom save enough or invest wisely.

My parents retired on a pension but only one in my generation (of thirty) has done so.

First off, remember there are two types: defined benefit and defined contribution.

With defined benefit, there’s a formula based on your years of service and your salary, and that’s used to calculate a figure you get for the rest of your life.

Underfunding of these is a very real concern - years back when I worked on a project for the Federal government dealing with retirement plans, it was fairly well known that the plans were underfunded. Many companies have gotten rid of them for this reason, and some existing ones have failed outright.

Defined contribution means the company puts aside x dollars a month, or x percent of your salary, and that’s invested somehow, and when you retire you can convert it to an annuity, or take it as a lump sum, or some combination thereof. If the market underperforms those last few years - oh well, sucks to be you. These annuities typically have the option of reducing your payout so your spouse gets something once you croak.

A further variant on defined contribution is where it’s invested in something much like a 401(k) - where YOU have to make the investment choices. The rules regarding withdrawal / rollover are different from a regular 401(k); as it’s a pension vs a straight 401(k), you have to get spouse signoff before moving the money elsewhere (as I found when I was rolling over my 401(k) from my previous employer; I wound up leaving the pension portion in place).

The traditional defined benefit pension - you get x dollars a month forever - is essentially a thing of the past, at least in the private sector. Public sector still has them, though the benefits are not nearly as good as someone starting work decades ago.

Using the Federal example, CSRS (Civilan Service Retirement System) gave a better pension overall for someone who was a career employee. It was a full defined-benefit plan. In the 1980s, the government implemented the FERS (Federal Employees Retirement System) which is a hybrid program. It still has a defined benefit component, but also requires you to contribute to Social Security and offers the Thrift Savings Plan, which is essentially a 401(k). As with most private employers, this has the result of shifting some of the burden on you to see that you’ve saved enough and are invested correctly.

When a pension scheme is converted to an annuity at retirement, it gets crunched by actuaries who look at a lot of different factors when computing the benefit, including (I assume) average lifespan, marital status, and so on. Their assumption is that John might live til 90, but Mary might croak at 70, so they figure out a payout amount assuming people live on average to age 80 or whatever. So they lose money on John but win on Mary.

I think these are typically offered by insurers. As long as those insurers are sound, you should be OK under their rules - but if, say, Prudential were to fail, a lot of people would be screwed. I don’t know if those plans are covered under the Pension Benefit Guaranty Corporation or not (most defined benefit plans are).

My own career’s retirement coverage has gone from:

  1. Defined benefit - if you stayed there 10+ years (I did not)
  2. 401(k) only, with some employer matching
  3. 401(k), with some matching (though you couldn’t contribute until you’d been there a year or so, and it was a while before you were vested in their portion), as well as a defined benefit plan (I’ll get 250 a month when I retire, woohoo!)
  4. 401(k) with some matching, plus a defined contribution plan that was not market-based: they credited it with interest each year. You got that benefit even if you did not participate in the 401(k)
  5. 401(k) with matching, plus a separate defined contribution plan that was 401(k)-like i.e. market-based. The company put a percentage of your salary into that.
  6. Pure 401(k) where the employer’s contribution goes directly into your 401(k) and is managed along with the rest of your money.

In this last scenario, the company money does not fall under the “pension” withdrawal rules. I could cash it all out on retirement without consulting with my spouse at all. It’s a risky option; with the 401(k)-like plans, you can’t get to that money as easily and are far more likely to leave it in place vs spending it.

So - all in all, the companies do in fact realize that pensions are economically unsustainable, and are getting away from them as fast as they legally can. The push to 401(k)-only plans is especially interesting. If your investments do well, you can wind up better off. But as noted: you could cash that out on leaving a job, and wind up with nothing (under schemes where the company money was separate, you couldn’t touch it).

When my employer went to a 401(k) only scheme, their matching changed. You’d get x % free even if you didn’t put your own money in, then they’d match 1-for-1 up to a certain percentage. If you saved enough of your own money, you’d get the same matching overall as before - but if you saved less, you’d get less matching. Used to be, you got 5% free, and they’d match half of up to 6% - so you’d get a total of 8%. Now, you get 2%. If you save 6%, you wind up with the same 8%. If you save 2% of your salary, the old plan would get you 6%; the new would get you 4%. If you save 4%, the old would get you 7% and the new would get you 6%.

AND, companies are now changing their plans so that you don’t get the matching unless you stay there the full year. Get laid off or quit December 1? Too bad, so sad, thanks for the money, sez the employer.

401(k) plans have tax issues if you retire early - like before 59 1/2 years old. You can’t just dip into them willy-nilly; there are rules about “substantial equal payments” or some such if you need to use them before that age, otherwise penalties apply. I don’t know how other defined contribution plans would work; presumably they could be converted to an annuity, or withdrawn as a lump sum (despite the tax consequences), but I don’t know if penaalties would be assesed. A defined benefit plan would, I think, just be taxed as normal income… when my company that had one divested our division, I could have started collecting that pension right then. As I didn’t need the 50 dollars a month, I opted to leave it be :).

Adding to that list of advantages: an institutionalized savings program is a lot easier to stick to that simply putting x dollars aside yourself each month. That money I have withheld each paycheck is money I never see and don’t have any opportunity to spend. I might not put that same money aside otherwise, and if I did, it would be a lot easier to raid.

There is always the risk that a company will mismanage pension (or even 401(k)) funds. It has happened in the past. But by and large, they’re a very, very good option.

This is a big part of why the City of Chicago and the State of Illinois are facing budget nightmares. They spent decades skimping on putting enough into their pension funds, and now face huge pension obligations to retirees. A few years ago, the state attempted to cut pension payouts, but this was struck down by the state Supreme Court, which ruled that doing so was a violation of the state constitution.

I worked for many years as a computer programmer, computer lecturer and then teacher.
In each job both myself and my employer paid in a % of my salary each month to the company pension fund.
Now I’m retired, the pension funds (which have invested all those contributions) pay me a monthly pension.
I also paid taxes throughout, so I qualify for a State Pension.

Bear in mind that companies are constantly receiving such contributions from new employees and that as pensioners pass away, those pensions no longer have to be paid.

It’s not necessarily cheaper, but it is significantly more manageable from the company’s standpoint. You pay today for today’s labor, and pay nothing for yesterday’s labor and nothing for tomorrow’s labor. My books are clean, and my CEO isn’t going to fund this year’s bonus with a disaster 20 years from now.

Pensions also suffer from changing health demographics. People keep on living longer.

Looking at a quick Google check

1963 - life expectancy was 69.92
1970: 70.81
1980: 73.66
1990: 75.22
2000: 76.64
2010: 78.54
2015: 78.74

Adding years makes the math used when first offering the pension problematic. Over time, as companies radically change (or go under), you can see the pensions hit hard.

United changed the rules when they went through bankruptcy, leaving a lot of retirees hanging.

Back when companies first started offering pensions to all wage earners, people typically lived only a few years beyond retirement age. Some combination of poor life habits (smoking, drinking, poor diet), chronic illnesses that were not treatable by medicine of the day, and influenza and other periodic infections would kill a statistical number of people. As medicine as improved and people have in general adopted healier lifestyles (other than diet, which has arguably gotton worse), retires can typically expect to live two or three decades beyond retirement age, which was not accounted for in the original actuarial tables. In addition, many large companies have stagnated in growth so there are fewer people paying into retirement funds, which reduces the capital need for sustainable investment and growth. Pension funds also became a favorite for companies to borrow against, reduce contributions to increase apparent net profits, or just outright steal from, and pension funds can become defunct if a company goes bankrupt and leaves a fund without sufficient capital to maintain itself independent of new contributions. Because of this most of the public sector has moved away from defined benefit pensions and to defined contribution personal investment funds (the 401(k) and similar). Pretty much the only large scale retirement pension funds are in the public sector and by labor unions, both of which have come into significant difficulties.

Contract employees, on the other hand, get no pension or retirement benefits other than what they arrange personally, and many industries are moving over to having a significant number of contractors instead of salaried employees and full time hourly workers with benefits. Contractors and non-benefit hourly workers who do not have enough money or fiscal expertise to sensibly invest and manage a retirement instrument can either ‘depend’ on Social Security or volunteer for the Soylent Green factory. So…that solves that problem.


It could be worse. They could have promised to cover retiree medical expenses and then not set up any retiree insurance accounts. That caused some excitement.