By Jennifer Gomori, MAP Editor
Having a pension is an important part of a successful retirement savings plan, but something many employers are taking away from their workers and replacing with 401k plans. In the public safety realm, pensions are an even more crucial component of retirement since a majority of these employees are not eligible for Social Security benefits. MAP works hard to maintain Defined Benefit (DB) plans, a type of pension plan, for its members.
When 401k plans were introduced to employees in the 1980s, it was never the intent of early backers that these would replace pensions.
“401k’s were not designed to take the place of (pensions),” said MAP Executive Director Fred Timpner. “If all people have is a 401k and Social Security, that will not be enough to maintain the lifestyle they’ve become accustomed to.”
In an effort to save money, employers are substituting these market-based plans for pensions. The problem is market volatility can negatively impact 401k savings compared to the steady growth of a DB plan.
“(Pensions are) the most important part because they’re not environmentally changed,” said Stuart Raider of Raider Dennis Agency. “The Defined Benefit is a payout based on a formula, like Social Security. Social Security is the cornerstone of most people’s retirement, although most police and fire aren’t eligible to receive this benefit.”
That makes DB’s even more important to public safety employees, assuring them a certain amount of money will be set aside for their retirement. The plan is ‘defined’ because the formula for calculating the employer’s contribution is known ahead of time. However, DB’s are different from other pensions, where the amount of payout depends on the return of the funds invested. If there is a shortfall from investments set aside to fund the employee’s retirement, employers must make up the difference.
“One of the advantages is the Defined Benefit puts all of the responsibility of the risk on the employer,” Raider said.
But that doesn’t mean DB plans will become a hardship for the employer, Timpner said. “If a DB plan is properly funded by the parties, then there could be minimal or no cost at all to the employer,” Timpner said. “For example, the City of Sterling Heights went years without putting one cent into the pension fund. There were no employer contributions due to the fact that the pension fund was overfunded.”
Some employers are opting instead for Defined Contribution (DC) plans, which are 401k plans. DC plans allow employers the option of making contributions at their discretion and they don’t assume any of the market risks of losses - the employee assumes all the risks. Another drawback of DC plans for employees is that they are accessible to workers before they retire, unlike DB plans.
“You’ve got market risks. You have the risk of human nature where I may actually access my money,” Raider said. 401k’s can be tapped by employees for loans to themselves or be cashed out when they leave a job. If cashed out, the employee pays a 10 percent penalty plus taxes, and depending on their tax bracket, that could be up to an additional 39 percent loss. If taken out as a loan, workers must payback their retirement funds with interest while missing out on potential market gains on the funds borrowed.
“Lack of access during your working years is a benefit during retirement years," Raider said. "One of the other disadvantages of the 401k is how do you know it’s the right amount to contribute? That’s one of the reasons you work with a financial planner.”
While the rule of thumb is to put away 10 percent annually, it is difficult to tell what individuals will actually need when they have no idea how long they will live. Raider said most individuals expect to maintain the same lifestyle they have, but factors such as when you retire can impact whether or not enough has been saved.
“When you retire, you don’t want to live a lesser lifestyle,” Raider said. “One of the other risks (with DC’s) is timing. If someone were to retire in 2007 and no longer be working and 2008 happens, they’re devastated,” he said of the economic recession that hit Michigan. “You could have one person retire in 2007 and one in 2009 and one have 40 percent less. If you have a market crash while you’re working it bothers your stomach. If you have a market crash when you retire it bothers your lifestyle.”
These factors show why pensions are such a key part of retirement and, Raider said, MAP members can thank their union reps for negotiating DB plans for them.
“You can pat MAP on the back,” he said. “Unfunded accrued liabilities can increase the cost of a DB plan. With people living longer, especially with municipal workers retiring at age 55, they could live to 90 and the plan has to set aside enough money for that time period.”
A good economy helps employers offset DB costs. When interest rates climb, which they are finally starting to do, DB’s become less costly to employers. If interest rates are higher, Raider said, the employer puts aside less of their own money to fund the pension plan.
For those without access to a pension plan, Raider advises, “You have to overcompensate. It’s not a government rule that you have to have one.”
When employees consider job offers, Raider said, one of the key deciding factors should be whether they offer a DB. “A DB should weigh heavy in your decision,” he said. “And secondly you should have someone actively looking at your retirement plan to make sure you’re contributing enough.”
“Retirement is a tough subject because if you do it wrong, you may never have a chance to recover,” Raider said. “Make sure you have a DB plan if you can and make sure you’re preparing properly. That’s the moral of the story.”
“Or buy lottery tickets,” he quipped.
Professional financial planning is offered at no cost to all members via a professional relationship with expert Stuart Raider of Raider Dennis Agency. He assists MAP members in such vital areas as pre-retirement planning. To reach Raider directly, please call (248) 770-1604.