Illustrations: Elwood Smith
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7 Costly Pension Pitfalls
By Russell Wild
You're expecting a nice pension—enough to keep you comfortable over the long haul. Better take a closer look at the fine print.
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Advertising executive Jerry L.'s 30-year lump sum retirement check came to barely half of what he was expecting. Oops!
Jane S. worked 20 years for her company—and got credit for only 19. Ouch!
Peter and Marie D. assumed their old employers would keep track of where they retired to. Hello?
What's going on? Each of these people made little errors in judgment—ranging from not understanding the fine print on their pension plans to not bothering to read it at all. Unfortunately, this blissful ignorance ended up costing them thousands.
After Social Security, employer-sponsored pensions provide more income to retired Americans than any other source. A pre-retirement checkup can mean the difference between a comfortable retirement and, well, an uncomfortable one. The most common complaint— "Why is my pension benefit so much less than I expected?"—almost always comes after the first check has been issued. "By then, it may be too late to do anything," says John Hotz, attorney for the Pension Rights Center in Washington, D.C.
Read on for a crash course in how to avoid the most costly mistakes:
Look before you reap
"Blindly grabbing the lump sum benefit could be the costliest mistake that people make with pensions," says Hotz. "They look at their pension options and see $1,250 a month versus $166,000, and they think, gee, that $166,000 sounds like a lot more. I'll take it." In reality, unless you're at death's door, you're almost always better off not taking the lump sum, says Hotz. Either leave it be and take your monthly check, or roll the bundle directly into an IRA account. Which of these options is best depends on your expected lifespan, your ability and willingness to take investment risks, your tax situation, and the like. So many factors are involved that it's always good to consult with a certified financial planner before making this decision.
Count the days
You might think that retiring on the date of your own choosing will get you credit for a portion of your last year on the job. Not true. Some pension plans require that you stick around until a predetermined day (usually the anniversary of your hire). Others say you have to work at least 1,000 hours (about 25 weeks) in your final year. Quitting on the wrong day could mean being credited for, say, 19 years instead of 20. The problem is magnified if you received a substantial raise in the last few years, since many plans calculate your pension based on your average pay for your last three to five years of employment. Special note: If you're thinking about retiring before age 65, consider this: In some plans, pension income can be cut by as much as half if you retire at, say, age 55, even if you've worked the same number of years.
Learn the secret lingo
The first phrase you need to commit to memory is "Social Security integration." Yeah, it's a doozy. Say it out loud several times so you don't forget. The phrase signifies that your company uses a tricky formula to calculate your pension that in effect mingles projected Social Security earnings with your company benefit to make your future look rosier than it really is. "It can be completely devastating," says Hotz. For example, if your pre-retirement company statement tells you you're going to get, say, $1,000 a month as a pension, and Social Security tells you you're going to get $1,000 a month, you may logically conclude that you'll get $2,000 a month to live on. Instead, with Social Security integration, you could be looking at $1,500, since pension pay is reduced by up to 50 percent of the amount of Social Security you receive. About half of all companies use Social Security integration.
Run the numbers
Figuring pension benefits is no walk in the park, and it's getting more complicated all the time. Mistakes happen frequently, and—surprise!—they most often are in the company's favor. One especially complicated kind of pension plan called a "cash-balance" plan requires Einstein-level math to figure out. A just-released audit from the Department of Labor revealed that one-fifth of all companies with such plans shortchanged workers who left their jobs before age 65. Protect yourself by 1) making sure that all of the basic data in your file are correct, including your birth date, years of service, salary, date of your last promotion, etc., and then 2) pulling out your calculator and verifying the plan's calculations as well. If the math is more than you can handle, get professional help (see Where to Get a Pension Tune-Up).
Stay single
Okay, seriously now, we're not opposed to the noble institution of marriage, but it often happens that if you're hitched when you start receiving your pension checks, you'll get less than you would otherwise. That's because the default payout with most pension plans is the 50-percent joint and survivor annuity option. This benefit gives you a little less money up front, but continues to pay your surviving spouse a portion of your benefit as long as he or she lives. That's a good thing for many people. If, however, you have good reason to believe that you will outlive your spouse, or if your spouse is covered by another pension plan, you might do better choosing a single life annuity, which could boost your monthly benefit by as much as 25 percent, but would provide no benefit to your spouse after you die.
Retrace your steps
"People move. Companies move. Companies go under. Companies merge. Pensions can get lost," says AARP senior attorney Mary Ellen Signorille. If you or your spouse at any point in your careers worked for a company for any length of time—especially five years or more—then you may have a pension waiting for you that you know nothing about. It's worth checking. Send a letter to the Pension Benefit Guaranty Corporation, Pension Search Program, 1200 K Street NW, Washington, DC 20005, or call 800-400-7242. Be sure to include your name, address, phone number, Social Security number, birth date, the companies you've worked for, and, if possible, dates of employment. Or log on to www.pbgc.gov.
Watch for new rules
Many companies today are switching from traditional "defined-benefit" plans to something called "cash-balance" pension plans. This can be a raw deal for older workers. A defined-benefit pension is based on three factors: your age, your salary, and the number of years you've toiled away. Because of this, your pension benefit grows slowly at first, and then blasts off—thanks to all three factors getting bigger. With a cash-balance plan, the size of the benefit increases at a steady rate throughout the worker's career. A switch from a traditional pension to a cash-balance plan means some older workers lose out on the pension growth spurt that happens later. Corporate workers in mid-career whose companies switch from one plan to the other could wind up with hundreds of thousands of dollars less than originally promised. It's not easy to fight this policy change, but some older employees have banded together to lobby against the switch. At IBM, for example, employees raised hell, claiming age discrimination. The company backed down, and allowed some of them to keep their original pension plans.
Finally, should you find yourself on the receiving end of a pink slip, your pension can (and should) be considered a point of negotiation. If you're, say, just a year or so shy of being vested, or from a magic anniversary like 15 or 20, ask that the extra time be credited to your pension. "You can also request to have all your severance paid to you in a single year, which would up your income for that year and ultimately increase your final pension pay," says Signorille. "It can't hurt."
Having a pension is like having a friend for life. And just like friendship, all it needs to flourish is a little bit of time and attention.
Russell Wild is a freelance journalist based in Allentown, Pennsylvania. Additional reporting on this article was provided by Linda Stern.
Now, read the helpful AARP Bulletin Online article 8 Things that You Should Know about Your Finances as a Couple.
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