For anyone with a pension benefit through their employer, you know how confusing it can be trying to understand the value of your benefit and comparing the different options for how to collect it when you retire. In this episode, we share some background on pensions, talk about how the pension system has changed over time, and break down the various pension options and how to think about each. Specifically, we provide a framework for making the biggest pension-related decision, which is whether to choose a lump sum payout or an annuity.
Outline of this episode
- Compelling question or topic, written to elicit curiosity [0:30]
- The history of pensions and how they go to where they are today [1:30]
- Understanding your projected future benefit options [7:23]
- Which option is best for your situation? [10:54]
- Your pension in the overall context of your retirement plan and paycheck [14:11]
Pensions are not what they used to be — here is why
It’s normal and natural to assume that the benefits employers offered to their employees in the 1940s and 1950s would be different than the benefits offered to employees by their employers today. Why? Because lifestyle, mode of work (remote or in-person), and many other things are different today than they were back then. Different needs exist now than did at that time, so employers have flexed to meet those needs in a variety of ways. Previous generations would often work at the same company for 30 to 40 years and in return they were eligible for a set monthly benefit, called a pension. But today, the tenure of the average employee is less than a decade. As a result, pensions are not all they were back in the day. In fact, many employers don’t offer traditional pensions at all today.
Physicians today may have pensions in spite of the changes over the years
Pensions are general terms used to refer to retirement plans, and though it’s not as commonly referred to or offered as it once was, physicians many times do have this kind of benefit to consider in their financial planning. You can think about the current form of pensions as future money you’ll have access to in some form, through funds set aside by your employer for that purpose. There are several common variables that determine the future money you’ll receive…
- Years worked
- A set investment return or assumption
- When you elect to start receiving pension benefits
The older you are, the higher your salary, the more years you worked, and the later you start drawing your pension, the higher the amount you receive will be. Think of your pension as a shared investment account where you have a set investment stake in it. For specifics, you’ll need to find out from your employer how your pension is structured. Employers are required by law to provide a plan document that describes exactly how your benefits will accrue.
Which pension options are best for your situation?
Calculating the financial logic is a relatively straightforward calculation once you know what to compare. Compare what rate of return you’d have to earn on the lump sum payment in order to be better off than the guaranteed monthly payment options. The goal is to project out to various ages and look at the various pension options to figure out what the “hurdle” rate is — often it’s between 2% and 4% as the rate of return you need to earn to be better off investing that money yourself, rather than taking the annuity or monthly payment option.
A pension plan is only one potential piece of your retirement plan, so don’t make decisions about your pension without considering all the other items that are part of your retirement plan. This episode contains many more details, please listen to learn more details.
Resources & People Mentioned
- Podcast episode #12: How to Create a “Paycheck” in Retirement
- Download our guide: The Toolkit for Optimizing Your Finances as an Employed Physician
- Download our guide: The Financial Checkup