Episode G discusses guaranteed benefits in qualified retirement plans. Do any of the plans guarantee benefits? The answer is yes .... to a certain extent, depending on what happens in the future and when you take your benefit. We break it down for you, to give you the gist without being overwhelmed.
Episode G discusses guaranteed benefits in qualified retirement plans. Do any of the plans guarantee benefits? The answer is yes .... to a certain extent, depending on what happens in the future and when you take your benefit. We break it down for you, to give you the gist without being overwhelmed.
This episode focuses on the letter G: Guarantees. Are any of these benefits guaranteed? And if yes, is it REALLY guaranteed, or “Social Security” guarantees, meaning it’s guaranteed at some point, but the amount and the age isn’t known yet? Answer – yes, some bens guaranteed … to a certain extent. Let’s talk it through.
Episode G - Guarantees 1st, define guarantee: “a formal promise or assurance (typically in writing) that certain conditions will be fulfilled”. Qual plans have formal plan docs that define how the plan is structured, what contributions are allowed, etc. But is the ben guaranteed?
· For 4 of the 7 plans that we talk about, the answer is no – the bens aren’t guaranteed. These are the SIMPLEs, SEPs, PS and 401k PS. Why not, you may ask? Well, listen to Episode F – talks about flexibility. How can a benefit at retirement be guaranteed, if the biz owner can choose how much or how little to put in each year? In SEP, for ex, 0% to 25% of pay, decided year to year. What’s the ben in 5 years? Who knows, right? Plus, how are the dollars invested? Earn 5%? Earn 25%? Lose 30%? All of these things move the balances forward differently – so no, nothing here is guaranteed.
· What about the other 3? Trad DB, CB, and fully insured (412i, 412e3) have benefits defined at a particular date in the future, an expected retirement age, usually somewhere between ages 62 and 65. So, yes, a particular amount at a particular date in the future is guaranteed by the plan document. For example, my plan document says that I’m expected to retire at age 65, and the formula says that I’ll get 10% of pay for each year that I work. If I work for 10 years, and my pay is $50,000 per year, 10% x 10 years is 100%. My guaranteed benefit at age 65 is 100% of $50,000, or $50k per year.
· FUN FACT: A common guarantee is a money back guarantee, which thousands of businesses offer if you aren’t satisfied with their product within a particular time frame. The origins of this go back to 1868, when a door to door salesman JR Watkins offered customers a full refund on his home-cooked natural remedies if they didn’t like it.
· Let’s get back to our plans that provide a guar. Ben. Sounds pretty good – and it is, if I’m 65. What if I’m not? Well, that’s where it gets a little funky. And no, funky isn’t an official actuarial term, but if the shoe fits ….. why does it get funky? Plan owes you 50k when you turn 65. What if you’re 60? 55? Well, similar to social security, your 50k gets reduced. Why? Because the plan is likely going to make more payments. Think of it this way – what if everyone dies at age 66? Then the plan is expected to make 1 payment of 50k, and be done. But what if you start payments at age 56? The plan is going to make not 1, but 10 payments – so you’re certainly not going to get 50,000 x 10. No, you’ll get closer to 5,000. So, at the end of 10 years, you got the same 50k that the 65 year old got. So an earlier benefit isn’t going to be the same as sthe promised benefit at retirement age, because the plan is going to try, on average to pay you the same amount. Same thing if you retire later – you’ll get a little more, because you’re expected to get fewer payments.
· That’s one way where you won’t get exactly your 50k. Another way is if the owner shuts the plan down, and there’s not enough money in there. There’s a govt agency called the PBGC – Pension Ben Guarantee Corp – gov’t run organization that provides ins for pension plans. Businesses pay premiums to them for pension plans, and if the business goes under the PBGC takes over. If you remember in the early 2000’s – 2005, actually – when Delta and Northwest went bankrupt? Well, the PBGC took over their plans, and made sure everyone got their benefits, at least up to a minimum amount. Co has 1 of those 3 defined ben plans, and goes bankrupt – PBGC will take over the plan, and will guarantee bens (its even in their name!) – but only up to a certain amount. IN 2020, this amount is just under $70,000 per year at age 65 – so it’s pretty high, and as long as your benefit is less than that, the PBGC will guarantee that you get it. Backed by the full faith and credit of the US government – however much faith you put in that! We won’t go any further than that comment ….
· Fun fact about PBGC: established on Sept 2, 1974 by Gerald Ford, after Studebaker terminated it’s ee pension plan in 1963 and over 4,000 auto workers lost some or all of their bens. In 1967, legislation was proposed, and in 1974, ERISA – EE Ret Income Security Act – was passed to protect workers, which included a provision for the PBGC.
· Looking for a promised benefit? The 3 defined benefit plans will do it for you, if you get to retirement and the plan is still in place. Why would you want this? One key worry for a lot of people ,owners and not, is that their ret savings will run out. They’ll live too long, and they won’t have enough. In a defined benefit plan, one of the options is to take a payment over your lifetime – it’s called a life annuity. This would help mitigate these fears, knowing that you’ll receive a set amount, every month, for the rest of your life. Down side is that prices, and costs, go up in the future, and it’s likely that your benefit won’t! But this kind of payment can really help with budgeting in the retirement years – we talk more about life annuities, and other distributions, in Episode D.
· Another way a guaranteed benefit helps is if you know you’re going to be short at retirement – and you have a good idea how short. If you work with a financial planner, advisor, or anyone helping you look into the future, they have probably come up with an amount that you’ll need when you retire in order to maintain your standard of living. Between your regular savings and social security you may be short. If you’re a business owner, throw in the sale of the business – even then, you may be short. A defined benefit plan can help make up that shortfall. Let’s say I’m a business owner, and I know that I need $5M in total when I retire. If I can sell my business for $2M, I’m good to go – but when I ask my CPA if my business is worth $2M, all I hear is laughter – in between the snorts, I hear “$2M? Close to $1M”….. So, I’m $1M short. I can sponsor a plan to target a PRETAX benefit of $1.5M, knowing that after taxes I’d have my $1M. It’s important to look at your finances earlier rather than later, to make sure you have enough saved for the future to get you to your retirement goals – Episode X relates to Xamining your finances, and we’ll go into more detail there.
· Wrapping it all up – guarantees are great, as long as you know exactly what’s guaranteed! The 3 types of defined benefit plans guarantee a benefit at retirement, which is really helpful for long-term planning and for making sure you have enough at retirement. Taking the benefit early will change those guarantees, so make sure you talk to a financial advisor before you start any payments – this includes the most well known defined benefit plan of them all, Social Security!
· Want to hear more? The other episodes mentioned here are D (Distributions), F (flexibility), and X (xamining finances)
Have any questions? Shoot me an email at MRS@gmail.com. Thanks for listening in – and have a great rest of your day.