Contributed by: Nick Defenthaler, CFP®
In many cases, the decision you make surrounding your pension could be the largest financial choice you’ll make in your entire life. As such, the potential risk of your pension plan should be on your radar and factored in when ultimately deciding which payment option to elect. This is where the Pension Benefit Guaranty Corporation comes into play.
The Pension Benefit Guaranty Corporation or “PBGC” is an independent agency that was established by the Employee Retirement Income Security Act (ERISA) of 1974 to give pension participants in plans covered by the PBGC guaranteed “basic” benefits in the event their employer-sponsored defined benefit plans becomes insolvent. Today, the PBGC protects the retirement incomes of nearly 40 million American workers in nearly 24,000 private-sector pension plans.
Municipalities, unions and public sector professions are almost never covered by the PBGC. Private companies, especially larger ones, are usually covered (click here to see if your company plan is). Each year, companies pay insurance premiums to the PBGC to protect retirees. Think of the PBCG essentially as FDIC insurance for pensions. Similar to FDIC coverage ($250,000) that banks offer, there are limits on how much the PBCG will cover if a pension plan fails. It's important to note that in most cases, the age you happen to be when your company’s pension fails is the age the PBGC uses to determine your protected monthly benefit.
For example, if you start receiving a pension at age 60 from XYZ company and 5 years later, XYZ goes under when you’re 65, your protected monthly benefit with the PBGC would be $5,2420.45 – assuming you are receiving a straight life payment (see table below). As we would expect, the older you are, the higher the protected monthly benefit will be due to life expectancy assumptions.
When advising you on which pension option to choose, one of the first things we'll want to work together to determine is whether or not your pension is covered by the PBGC. If your pension is covered, this is a wonderful protection for your retirement income if the unexpected occurs and the company you worked for ends up failing. If you think it will never happen, let’s not forget 2009 when many unexpected things occurred in the world such as General Motors filing for bankruptcy and Ford nearly doing the same. If your pension is not covered, we'll want to take this risk into consideration when comparing the monthly income stream options to a lump sum rollover option (if offered).
While PBCG coverage is one very important element when evaluating a pension, we’ll also want to analyze other aspects of your pension as well, such as the pension’s internal rate of return or "hurdle rate" and various survivor options offered.
As mentioned previously, the decision surrounding your pension could quite possibly be the largest financial decision you ever make. When making a financial decision of such magnitude, we’d strongly recommend consulting with a professional to ensure you’re making the best decision possible for your own unique situation. Let us know if we can help!
Be sure to check out our previous blog discussing survivor benefits posted April 5th and our next blog explaining what the “Restore” option is for pensions will post soon.
Nick Defenthaler, CFP® is a CERTIFIED FINANCIAL PLANNER™ at Center for Financial Planning, Inc.® Nick works closely with Center clients and is also the Director of The Center’s Financial Planning Department. He is also a frequent contributor to the firm’s blogs and educational webinars.
The information contained in this blog does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Nick Defenthaler, CFP© and not necessarily those of Raymond James. This is a hypothetical example for illustration purpose only and does not represent an actual investment. This is a hypothetical example for illustration purpose only and does not represent an actual investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation.