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What Is All the Fuss About?!

It seems that the entire free world has run amok over the prospect of losing - or having to pay for - pension benefits. From Athens, Greece to Madison, Wisconsin, for the past several months I have not been able to turn on a news broadcast without seeing and hearing about protests. It seems that people are taking to the streets, staging demonstrations, and getting highly agitated about proposed changes to their pension plans. So what’s all the fuss about? What are these mythical plans and why are so many people so upset about them?

Well, it turns out they are an outstanding way to secure one’s financial security in old age and, as designed and refined here in America back in the middle of the 20th century, they did their job splendidly. Until…the 1980s, when corporations found a way to sidestep the responsibility (and expense) that such plans also require and persuaded the Congress to authorize use of private 401(k) accounts as a (poor) substitute. For a better understanding of all this, let’s go back and review what a traditional “defined benefit plan” really is.

Under a traditional defined benefit pension plan, an employer typically promises to pay the employee (as an element of compensation) a specific monthly benefit for life beginning at the employee’s retirement age. The benefit is calculated in advance using a formula based on age, earnings, and years of service. The employee cannot outlive this benefit and their spouse will usually continue to collect a portion of the benefits when they die. A very valuable benefit if you are lucky enough to have earned one.

The liability for funding, investing and administering the pension plan lies with the employer. Every year, the value of the money invested in the plan is compared to the expected future benefit obligations to ascertain how big the employer’s current year contribution must be.1 Besides increases or decreases in the number of employees and the steady slow accretion of future benefits earned by loyal employees, the ups and downs of the investment markets affect these calculations and can make the contribution somewhat unpredictable. Despite a certain amount of “smoothing” that is permitted from an accounting standpoint, corporations still didn’t like the variability.2 It is no real surprise companies stopped offering these plans when permitted to do so. Good for workers but costly for employers; hence the protests we are now witnessing.3

The rapid disappearance of traditional pensions comes at a time when many workers have seen their retirement savings eviscerated by the bear market while the equity they once held in their home turned to smoke. [Now I am getting depressed.] In any case, it seems clear that the current generation of employees may no longer be able to rely on traditional pensions to fund their retirement. So what’s a worker to do?

Well, let’s look a little deeper: how did corporations actually make good on that promise of lifetime payments once the worker actually retired? They purchased none other than our old friend a single premium immediate annuity contract. That’s right, those wonderful and fiercely fought-over pension plans purchase an annuity contract to cover the employee’s retirement just as we do for injured claimants. These contracts provide guaranteed monthly benefits to the retiree for life. But there’s one significant difference: pension plan income is fully taxable and structured settlement income is tax-exempt. Perhaps this is a fair trade off; the retiree is collecting on an element of compensation while the recipient of a structured settlement benefit must sustain some injury (or literally bleed) for their benefits.

The thing is, every injured claimant you come across has already done the hard part: they got hit, burned, cut, fell down, or fell victim to some other calamity as a result of another’s negligence. After having survived and persevered through all that, they now have literally arrived at an opportunity that half the world seems to be fighting over: guaranteed lifetime income. The only real question they have to answer is this: how much of their total settlement proceeds do they never want to run out of? One example:

“Serge” is a 54-year-old male flight simulator technician working for a major airline. Like many people in his industry, he saw his traditional defined benefit pension frozen in 2005. While the company did increase their matching contributions to his 401(k) plan, Serge says that between the reduction in benefits and the losses his portfolio took over the past few years he'll never be able to contribute enough to make up for the loss of his pension benefits. Serge was injured and recently agreed to settle his claim for $350,000 after applicable fees and liens.

Serge can take his settlement in a cash lump sum and try to find a safe place to invest the funds while hoping he can beat the investing odds and still have enough left to help pay for his under-funded retirement. Or he can choose to take $100,000 in a cash lump sum and use the remaining $250,000 to boost his retirement income with a guaranteed tax-free lifetime income of $2,522 per month beginning on his 65th birthday. With this plan, Serge can expect to receive in excess of $530,000 in tax-free benefits – the taxable equivalent of over $750,000 for workers in most states. At long last Serge may have found his way back to the Promised Land of a truly secure retirement (guaranteed lifetime income).

If you were settling a claim like Serge, how much of your recovery would you never want to run out of? Today more than ever, it is an important question to ask.

Do you have a case where the claimant could benefit from a guaranteed lifetime income? Call Frank C. Kilcoyne, CSSC at 800-544-5533, I am here to help.

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1These contributions are actuarially determined taking into consideration the employee's life expectancy, prevailing interest rates, and the earned retirement benefit amount.
2In a flip, some companies that used to “smooth” are now suddenly “marking to market” to eliminate the overhang of as-yet-undeclared pension liabilities to effectively toss them into a prior year.
3Low current interest rates increase how much money must be set aside by the employer at a time when they may not have much spare cash lying around.