How To Create Your Own Pension

Over the years, defined benefit (pension) participation has largely declined due to companies shifting to the defined contribution model (401k/403b). Why? Candidly, companies have shifted their priorities over the years toward maximizing profits. Companies have realized that it is much easier to forecast retirement liabilities by only contributing a predetermined amount of money, effectively leaving the employee responsible for managing it, and making it last through the latter years of life. Not every business operates this way today but most do. When you start a new job, the most common question asked after health insurance pertains to what? The 401(k). How much do they match? The good old days of getting a check from retirement to death are mostly gone, save mostly for government employees and a few blue-collar industries (steel, coal, etc.)

In fact, with a defined contribution plan, the employer contributes whatever match they’ve arranged, and that is where their financial obligations end (aside from record keeping and general investment guidance). With the old pension model, employers were responsible for earmarking money, ensuring that it was invested prudently, and essentially making money last for the duration of time obligated to the employee (typically for life). Some pensions offer additional benefits, such as health insurance with sufficient years of service. These pensions are common for state employees such as teachers, civil employees, police officers, and firefighters.

While it has been well-documented that underfunded pensions pose the most significant risk to retirees, the ability to effectively move the goal post (longer retirement, higher contributions) for younger employees affords a little flexibility to employers who are on the hook for ridiculous amounts of benefits owed to older participants that entered under more favorable terms. For example, many blue-collar jobs might allow an 18-year-old to begin service out of high school and retire with full (or nearly full) benefits and half of their salary after twenty years of service. How can someone financially afford to call a 38-year-old retired and pay them benefits for life? It’s very unsustainable.

Here’s how you can build your pension. Step One: max out your and your spouse's IRA each year. Whether you opt for a traditional or ROTH IRA is another discussion for another day. Start doing this every year at a young age. You should have several hundred thousand dollars saved up by the time you reach 65 if you keep your money invested prudently in the market and ignore annual fluctuations and constant paranoia created by the financial media.

Why age 65? Step Two: This is when Medicare benefits become available for health insurance. Unless your employer is willing to pay your health insurance premiums during retirement, health insurance premiums in your early 60s will cost several hundred to several thousand dollars per month (the lower your income, the more the government subsizides your premiums). These figures don’t include any deductibles, co-pays, or co-insurance. It adds up fast. When you turn 65, you can go on Medicare with a Supplemental Plan G and have most all of your healthcare expenses covered for under $300 per month.

Step Three: When you reach the time to draw income from your portfolio, exchange the accumulated sum of money for a life annuity. An annuity is ussued by an insurance company that will pay you a monthly benefit for the remainder of your life. While shopping around for the best company with the highest guaranteed payout is essential, this annuity can ensure you have monthly income to supplement whatever benefits you receive from social security. Many pensions effectively do the same thing; they manage your money (but you have no say in how the funds are invested) and then annuitize the balance at retirement to guarantee your payout for the remainder of your life.

With a sound investment plan, there is no reason to think you can’t do the same thing as companies offering a pension plan. You just need a good plan and understanding of how to realize your ultimate goals.