If you are enrolled in a pension plan at work, you can roll over money from your employer’s 401(k) plan into the pension plan, thereby increasing the size of your monthly pension check during retirement. And if the pension goes broke, the Pension Benefit Guaranty Corp.—which is to pensions what the FDIC is to banks—will, thanks to new rules, step in and pay benefits.
So, great, you can now do this. But should you?
If you’re reading this article, probably not. That’s because you’re the kind of person who pays attention to personal finance issues—and that makes you far more aware of, and involved in, crucial financial planning efforts than most Americans.
That means that while this new opportunity is pretty good, you can do even better. Let me explain.
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There is a real fear among policymakers that Americans are woefully unprepared for retirement. Most workers don’t save enough, and many of those who do save are choosing the wrong investment vehicles.
The result: They won’t amass enough money to support themselves in retirement, and they will spend all their money within the first decade or two of retirement. Being broke is bad enough, but being broke in your 80s is downright horrifying.
So enter PBGC’s new rule: People who transfer their 401(k) balances into a pension plan will get larger monthly pension checks throughout their retirement, no matter how long they live, and PBGC will provide coverage if the pension plan goes broke. No wonder AARP and the AFL-CIO both support the idea.
So do I—for the ignorant masses. And by “ignorant” I don’t mean stupid. I’m simply referring to those who are uneducated about proper investment management strategies.
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Given the choice of letting the uninformed fend for themselves versus offering them the opportunity to place their funds into an account that literally guarantees they will receive a monthly check for life—with that guarantee backed by an agency created by the federal government, no less—I’d encourage them to place their 401(k) funds into their pensions, too.
But if you have a good understanding of personal finance (which is easy to do) and you learn how to manage your money properly (which doesn’t take long), you’ll agree with me that choosing that pension-rollover option is a bad idea. Or, rather, that there is a far better idea than that.
Here are the reasons why educated consumers and their financial advisors will dismiss the “opportunity” created by PBGC’s new rule:
- Most pension plans provide monthly incomes that don’t increase with inflation. Getting a check for, say, $3,000 a month at age 65 is nice, but if you’re still getting that same $3,000 at age 80, you’ll be suffering dramatically—because everything you spend money on (health care, energy, food and taxes among them) will cost so much more in the future. In as little as two short decades, the buying power of that monthly check could be cut in half, due to inflation. So although you’re guaranteed to get the check, you’re also guaranteed that it won’t be worth as much in the future.
- Placing that 401(k) balance into the pension plan means you’ll forever give up access to the principal. All you’ll get is a monthly check—and you’ll have to wait until retirement to begin getting it. If you ever need a lump sum due to, say, a medical problem, marital issue, family need, job loss or whatever, that money will be unavailable.
- When you die, the monthly checks stop—and the principal is gone forever. That means no inheritance for your spouse or children. (If you want your surviving spouse to continue receiving that pension income, you’ll have to agree to take less each month during your lifetime. You and your spouse will have to give up hundreds of dollars every month for the rest of your lives.)
- Although the pension plan guarantees to pay you income for life, that guarantee is only as strong as the employer that created the plan. Thousands of pension plans are currently underfunded (some of them by hundreds of millions of dollars), and if the company goes bankrupt, the promise it made is void. Although PBGC now promises to pay, PBGC itself notes that it is notoriously underfunded; its deficit in 2014 was $62 billion, the largest in its 40-year history.
- If your company does go bankrupt and PBGC is called upon to take over its pension plan, the most PBGC will pay (as of 2014) is $4,943 per month. For some retirees, this could represent a 50 percent reduction in pension benefits, perhaps even more. As noted above, if PBGC goes broke, it will take an act of Congress to fix it and restore pension benefits that PBGC is supposed to pay. Until and unless Congress acts, PBGC-dependent retirees (currently there are 1.5 million of them) will receive nothing.
A far better approach than placing 100 percent of your life’s savings into a pension plan—and hoping it all works out—is to do what educated investors do: Create your own monthly income.
All you need to do is create a globally diversified portfolio using exchange-traded funds and low-cost, passively-managed mutual funds. Then, generate monthly income using a “systematic withdrawal plan.”
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The SWP lets you decide how much income you want to receive (keeping in mind that the more you withdraw, the greater the risk you’ll run out of money). The good news is that you can change your income at will, increasing it over time to offset inflation, and whatever you don’t spend during your lifetime remains available to your spouse and children.
And best of all, you can probably provide yourself with more income monthly than you would have gotten from an employer’s pension plan.
“Before you decide to transfer your 401(k) balance to your pension plan, get information from your employer as well as from an independent financial advisor.”
If you don’t know how to construct the portfolio you need or design it to produce the income you need, just talk with a financial planner—we have the skills and experience to do it for you.
Are there risks of handling your investments on your own? Sure. You might buy unsuitable investments or investments that fall in value—placing at risk your ability to generate the income you want.
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You might incur commissions, fees and expenses when investing, and these would erode the value of your account or its ability to generate income. And the biggest problem? You might withdraw too much or live too long—and therefore run out of money.
So carefully evaluate your situation and your options. Before you decide to transfer your 401(k) balance to your pension plan, get information from your employer as well as from an independent financial advisor. Consider all the information before you make a decision.
—By Ric Edelman, special to CNBC.com. Edelman is the founder and CEO of Edelman Financial Services.