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Can My Pension Plan Payout Change?
You’ve worked for a while and have access to your company’s retirement plan. Can what you get change from when you start work to when you retire? It certainly can. When you sign up for a pension plan, you expect to receive a certain payout each month when you retire. If the payout is higher, that’s great, but what if it’s lower? If you rely on this money to live, what can you do? The resulting payout can be determined by multiple components, so each one is highlighted. The first thing to do is find out what type of plan you have and what you’re entitled to.
What type of plan do I have?
The two main types of pension plans are defined below. Some people may have both types of plans or a mix of the two from different employers. If you had a pension plan with your employer and then transferred the money into your own locked account, this article does not apply. You would be making your income and payments from your investment earnings and that is a different set of circumstances.
Defined benefit and contribution plans are defined
A defined benefit plan is a retirement plan in which the future payout at retirement is determined by a defined formula upon joining the company. This is a calculation that usually includes your highest average salary, how long you’ve worked for the company, and how much money you and your employer contributed. The money is invested on your behalf and the company bears the risk if something goes wrong. Typically, your employer guarantees an implicit rate of return each year, which is the return on investment your money would earn if you saw your retirement plan sitting in a bank account.
A defined contribution plan is one where the money you pay into the plan is defined: an amount contributed by you or a company on your behalf. This is a set dollar amount based on your salary for the year you worked. You can think of the company (and sometimes you and the company) making contributions to your retirement account. It’s similar to a Registered Retirement Savings Plan (RRSP) account, except it’s locked. Locked means that the money is in your name and you are entitled to the money, but you cannot withdraw it unless there are very exceptional circumstances. (ie this is the only money I have and I have to pay my bills). Like an RRSP account, you can determine investments in a defined contribution scenario, and you take risks. If you invest in a fund and it loses money, you have to deal with the consequences. It is for this reason that it is good to have a plan. If you’re in a situation where you have a defined contribution account, you have decisions to make.
What features do I have planned?
Many defined benefit pension plans have a provision for retirement health insurance. This tends to come automatically with the pension payout. What is covered by this health insurance? What are the coverage limits? Should I pay a deductible or a fee each year? These fees come out of your pocket, so they reduce the amount of money you actually get for health benefits. Can these requirements change over time? Definitely. Because retirement plans are a long-term idea, even small changes in coverage or higher deductibles can mean more costs over time. There are cases when certain procedures are no longer covered or the allowable amounts that can be claimed are reduced. These changes are usually not very large, but over time they can add up to a lot of unforeseen expenses. As health benefits become very expensive regardless of who pays for them; I assume this problem has been around for years.
When most pension calculations are done, it is assumed that there is no inflation in the figures. When you see the term “real rate of return,” that rate includes inflation and would equal the nominal rate of return, or typical quoted interest rate, minus the rate of inflation. For example, if you got a 5% return on your investment last year and the inflation rate was 2%, your real return would be 5%-2% or 3%. Why is this important? Pension payments are usually fixed – once the payment is calculated at retirement, it remains the same throughout retirement. The problem is that when you retire, you should have enough money to cover your expenses with that pension payout. If the inflation rate increases by 2% every year until you retire, that’s like saying you can buy 2% less stuff every year. If the allowable retirement payment today is $2,000 a month and you retire in 20 years, that 2% inflation rate would reduce the amount of things you buy by 40% (2% x 20 years). If this continues into retirement, say another 20 years, that money will buy 80% less stuff than it does now. Imagine paying your bills with 80% less money! Indexing increases payout calculations by the rate of inflation to prevent monetary value from declining. Inflation is actually a very personal thing – the price increases of the things you personally spend money on will affect you the most. Pension plans expect you to buy the same amount of stuff and in the same proportions as average or quoted inflation. It’s probably not true, but it’s better than no indexing at all.
Another thing to keep in mind is what level the indexing goes up to. Some plans cap indexing at a certain level each year to avoid exploding costs. If you happen to have a year with high inflation, it could cost you because your payment won’t keep up with the cost of living for more than that cap. This has not been a problem for the past 20 years, but should inflation rise rapidly, it should be watched closely. Ask your employer to check the calculation.
How long will my pension payments last?
Some pension plans pay you until you roll over and then pay your spouse your contributions until you roll over. Other plans pay for a certain number of years to keep their costs down. This should be looked into, and if there is an age set at which pension benefits expire, it should be included in your financial plan so that you have some form of income to replace the lost pension income at that time. In many cases, you will not reach the intended age, but since life expectancy has increased recently and these retirement plans were designed decades ago, this issue is bound to come up eventually. Many plans are struggling with funding problems and the risk of longevity among their members – meaning pension plans are not getting as much return as they used to and underestimating how long people will live and receive pension payments. The longer a retiree lives, the more money the pension plan has to pay and the greater the longevity risk. Plan sponsors don’t look favorably on a person receiving money over a longer lifetime because it means your payments will cost them more. The payout duration can also be changed at any time.
What if I divorce or divorce?
Many plans provide for payments to be made if you leave, divorce or your spouse dies. Over time, these provisions can be changed to exclude these types of situations. Lack of coverage can also occur after many years of service, being married for a certain period of time, or under certain circumstances of separation. In these cases, it’s time to take a closer look at your retirement plan so you can prepare for what to expect. In the case of separation or divorce, dividing the value of a retirement plan between spouses is a complex calculation and can hinder an otherwise straightforward divorce settlement. If property value calculations are approximate, one spouse may feel that he or she is not being treated fairly, and this may lead to lengthy litigation that is otherwise costly. In a retirement scenario, if you have a financial plan that takes into account the value of the pension plan and you find out that you won’t get that money because of changes to the pension plan rules, that might not be pleasant either.
What if I am laid off before I retire?
If you’re laid off or reorganized as an individual, you probably won’t have many problems with changes to your retirement plan. If there is a layoff in the company that affects many employees, special benefits due to retirement cancellation or restructuring should be investigated. If the company is going out of business or bankrupt, this is another situation where everything should be researched before signing. It may be helpful to obtain legal counsel and/or a retirement professional to ensure that a termination agreement is in your best interest.
What can I do with these changes?
For the most part, these changes are inevitable because pension plans say they don’t have the money to live up to the gilded promises of the past. This may or may not be true, but it doesn’t affect your strategy. The first thing to do is to be aware of such changes. Be aware of which ones apply to you. Sometimes the changes apply depending on what year you joined the pension plan, how old you are, how many years you have worked or what your length of service is. If you see a change that affects you, find out what can be done about it. Take your current financial budget or financial plan and adjust the numbers for the change to see what the bottom line will be. Not all changes will make things worse for you, but it doesn’t hurt to know. Your retirement plan should be reviewed every so often—either after each union contract negotiation or with each annual report or budget. Changes happen slowly in retirement plans, but checking back often is a precaution to keep you informed.
If a change is happening with a large number of people and you have enough people and a strategy to fight the change, it may be worth joining together and lobbying the plan sponsor to reject the changes. In many cases, these battles are expensive and time-consuming. If you are aware of a change that affects you and there is nothing you can do to review it, make changes to your financial plan to accommodate it. This could mean leaving work earlier, planning for retirement on different terms (such as a dropout), or setting aside more money for bigger expenses. In other cases, the changes may not be major and you can just get on with your life – but you won’t be surprised if your payouts aren’t what you were expecting.
Much of the information about changes comes from the plan sponsor or pension plan administrator. If you are in a unionized environment, talk to your janitor about the pension plan and try to find documents that explain exactly what the current status of your pension plan is. Human Resources is another good place to ask questions, especially in a non-union environment. Finally, keep the documents you receive from the plan sponsor so you know in writing what, if anything, changes. This keeps the facts straight for you and reduces miscommunication.
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