You Won't Believe How Much Your Pension is Really Worth

On a coarse level, it was the German Empire under William I and Otto von Bismarck that created the first general (non-military) welfare program for older workers introducing the concept of retirement for the working class. It was a plan, along with mandatory health insurance, to counter growing support for Marxism. One would get a modest pension from the state at age 70, a seemingly cynical choice for a population with a life expectancy in the mid-40s that was declining. 

Fast forward 130-ish years and life expectancy in the USA in 2022 is about 77, having dropped a few during the pandemic. A male worker deciding to ‘retire’ at 65 has a 50% chance of living to 84 according to the social security tables. Women have a 50% chance of living to 86. So it’s unsurprising that the largest worry for Americans is not having enough money to last a whole retirement with a long lifespan. (Financial Advisors call this ‘Longevity Risk’ and it’s the other side of ‘Mortality Risk.’) 

For a long time, there was a great solution to this: defined-benefit pensions (DB Pension) in which the employee usually gets a fixed payment from the day they retire until death. Pensions do so much to simplify planning and reduce longevity risk. It puts retirement responsibility on institutions, not the individual. 

But there are issues. Companies go out of business or go bankrupt.  Even with the Pension Guarantee fund (PBGC), a dead pension might be only worth 60 cents on the dollar. And pensions couldn’t be moved as one changed employers. (Boomers have changed jobs on average about every 5 years, Gen X, Y, and Z, even more frequently.)  

But the real issues are the economic incentives. Yes, pension liabilities are difficult to estimate, and yes, stock markets are unpredictable. But for-profit companies have an incentive to underfund pensions, and they might suspect the government (taxpayers, really) will bail them out if the company pension collapses.  

In the late 1960s, over half of Americans in the private sector workforce were covered by some kind of pension plan.  But they weren’t perfect. In 1974, ERISA was enacted along with the PBGC to help shore up issues with corporate pensions, and participation in DB pensions increased until 1980.  With unions in decline, poor US stock market returns in the 1970s, and the introduction of the cheaper 401(k), the pension fell out of favor in the private sector. A 2006 bill signed by George W. Bush was supposed to strengthen DB pensions, but it has not worked. 

Social Security is a pension. It’s not big enough and has issues, but it’s not going completely away, and we all have it. And the public sector (about 15% of the US population) still get modest pensions.  

However, in the private workforce, less than 15% of private sector workers have access to one, and they don’t look like the pension plans of the past. Most companies now use the cheaper alternative, the defined-contribution plan (e.g. 401(k), 403(b)) most of us know today.  So how much 401(k) would one need to create an equal stream of payments from a pension? 

For 30 years of retirement, a good rule of thumb is to start with about 25x the before-tax annual income you get from a pension and invest it in a 60% stock/40% bond portfolio (this is commonly called the 4% rule).   

A relative of mine, a former schoolteacher, has a seemingly modest $72,000/year pension. They were astonished that as a rule of thumb, they would need to have saved $1,800,000 in their 401(k)! Another comparison: the average social security benefit of $20,000 per year would require about $500,000 in 401(k) savings. The top social security benefit of $39,000 would require saving about a million dollars. Dang. 

It’s not an apples-to-apples comparison, but it gives a rough idea of how powerful, easy, and helpful pensions can be. Pour one out for the private pension.