(Money Magazine) -- I'm 26 years old and work for a company that has a pension plan in addition to a 401(k) that matches my contributions. How realistic is it that I'll collect this pension in 30 or more years? And should I factor this pension into my long-term career decisions and do all I can to stay at this company so I'll get it? -- Dave L., Holland, Penn.
Traditional pension plans that give retirees the option of receiving a check-a-month as long as they live and regardless of what's going on in the financial markets are going the way of dial-up internet service.
For example, a recent Towers Watson study found that only 17 Fortune 100 companies now offer new employees such plans (which are known in pension circles as defined-benefit plans), down from 89 in 1985.
You can argue about whether the trend from traditional pensions to 401(k)s and similar "defined contribution" plans is good, bad, reversible or inevitable.
But as I noted in a previous column, research shows that people who get steady pension checks for life tend to be happier than those who have the same level of wealth but only a 401(k) plan. (And people who have both feel better still.)
But even though a traditional pension may be nice to have once you're retired, I also think someone with decades of work ahead of him like you would be making a mistake to try to hang on at a company just for the possibility of collecting a pension in the future.
To understand why, you need to know a little bit about how defined benefit pensions work and what many employers have been doing with their pension plans in recent years.
The basic idea behind a traditional pension is that the longer you stay on the job -- and the more money you make later in your career -- the bigger your pension benefit. These pensions reward longevity on the job. The formulas for calculating a monthly benefit can vary from one company to the next and get quite complex.
So just for purposes of an example, let's assume a simple methodology that goes something like this: At retirement age, you receive a benefit equal to 1.5% x the number of years you worked for the company x the average of your five highest years of salary.
So, if you make $40,000 now, get 2% annual raises and stay at your employer to age 65, under this formula you would be eligible for an annual pension of just under $49,000 (1.5% x 39 years of service x $83,000 average salary for your highest five years of salary).
That looks pretty attractive, but in some ways that figure is a mirage. First, it assumes you'll actually remain at your current job from your mid 20s through your mid 60s, or nearly 40 years.
But most people don't stay with the same employer anywhere near that long these days. They may switch to a better job, move to another part of the country for personal reasons, leave to go back to school or they may be forced out, whether due to a layoffs in a recession or a company-wide restructuring.
Indeed, Department of Labor statistics show that today's workers have been with their current employer only four years or so on average, a tenure that's been relatively stable over the past 15 years.
So unless you're a real anomaly, I don't think it's likely you'll stay with the same employer long enough to get that big annual pension. If you leave earlier, you'll still get any benefit in which you're "vested" (pension-speak meaning legally entitled to). But it could be a lot smaller.
For example, if you stay with your employer for 10 years and then leave (or get cut loose), you might be eligible for just under $7,000 a year ($46,000 average salary x 1.5% x 10 years of service).
Keep in mind that in most cases you won't actually be able to collect these amounts until you reach the plan's stipulated retirement age, commonly 65, which in your case is 39 years from now.
Many pensions allow you to collect earlier -- say, age 55 -- but in that case the amount will be reduced because you'll start receiving checks 10 years earlier. So in the example with 10 years of service, instead of $7,000, you might receive $3,500 at age 55, a reduction of 50%. (You may have the option of taking a lump sum instead of annual income, but the same reductions would apply.)
Remember too that you're talking about a sum you'll receive in future dollars, which, assuming we continue to have inflation, are worth far less than today's dollars.
What's more, corporate pensions rarely have cost of living adjustments, so the value of whatever amount you begin collecting will be eroded by inflation year after year.
There's another issue you've also got to consider. Even if you're still around at the company 10, 20, 30 or even 40 years from now, the pension plan may not be, at least not in its present form. In recent years, a number of well-known firms have terminated, frozen or converted their plans into a cash-balance or other hybrid plans.
In such cases, you are still be entitled to vested benefits you'd accumulated up to the point the plan was terminated, frozen or changed. But you would stop accruing any new benefits under the old plan.
Point is, the earlier you are in your career, the harder it is to gauge what size benefit you might actually get from a defined benefit pension. There are too many unknowables, the biggest being how long you'll actually be at the company (which, at best, is only partially within your control) and whether the plan as it currently exists will still be around in the future (totally outside your control).
All of which is to say that I think it would be imprudent to base your career decisions on a future pension the size and value of which is highly uncertain. In fact, you may be doing yourself a disservice if you do so.
What if, for example, you pass on lucrative offers from other companies only to be laid off a few years later or find that your employer has decided to freeze your plan. In that case, you would have given up opportunities to build a rewarding career elsewhere for a benefit that turned out to be a lot smaller than you'd hoped.
Of course, the situation is very different for people who've been at a company with a traditional pension for a number of years who are closer to retirement (or closer to an age at which they can collect benefits from the plan).
In that case, a person may not only have already earned a sizeable benefit, but he or she is also probably closer to actually getting it. What's more, since people far along in their careers are likely earning bigger bucks, staying on a few extra years may substantially boost their benefit.
For example, someone who's 55, has 15 years of service, average salary of $80,000 for the past five years and a 1.5% annual credit would be eligible for a pension $18,000.
Even without figuring in salary increases, hanging in an extra five years would boost that benefit to $24,000 -- and any early-retirement reduction would likely be smaller at age 60 than 55.
In short, later in one's career, one's accrued pension benefit -- and what one may give up in future benefits when leaving a company -- should loom larger in deciding whether to stay with an employer or jump to another position.
So by all means, get all the facts about your pension plan from your HR department so you know when you actually vest for benefits in the plan (typically five years, but that can vary), how your benefit is calculated and how much you might receive under different scenarios.
And while you're at, take a look at this Department of Labor site that provides detailed information about how pensions work. But for now at least, I think you should focus more on factors such as pay and other benefits, the opportunities for advancement and fulfillment at a job in determining where to work.
At this stage of your career, a pension is just too iffy. Which, by the way, is all the more reason to fund that 401(k) -- which has an actual account balance you can take with you wherever you go -- as much as you can.
|Overnight Avg Rate||Latest||Change||Last Week|
|30 yr fixed||4.42%||4.43%|
|15 yr fixed||3.44%||3.46%|
|30 yr refi||4.41%||4.42%|
|15 yr refi||3.44%||3.46%|
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