The Florida Pension Experiment
Public sector employees who are part of state or local government plans are not entirely immune to the trend I’ve described. If you live in Florida, you might know this already. Between mid-2002 and ending in mid-2003, every one of the approximately 625,000 government employees who were members of the state’s pension fund were presented with a unique decision. Basically, each existing and new employee was granted the option to switch from a traditional defined benefit pension plan to a self-managed investment plan. In other words, they could take the lump-sum value of their retirement pension, and instead invest the proceeds themselves in a wide range of carefully vetted mutual funds. Alternatively, they could choose to maintain the status quo and remain in their current traditional defined benefit (DB) pension plan until retirement.
The upside or gain from pension switching was twofold: The employees would be given the chance to manage and invest the money that they have already earned and accrued, and they will be given the opportunity to do the same with any future contributions. Again, this “investment plan” is not a pension plan. It is a tax-sheltered investment account that will (hopefully) grow over time, the investment returns will (hopefully) beat inflation, and the nest egg will provide a nice cushion for their retirement. However, at some point the employee is going to have to turn this money into an actual pension that provides a respectable income for the rest of his retirement.
In fact, both General Motors (GM) and Ford offered the exact same option to many of their employees and retirees. They could keep their pension annuity income or exchange it for a lump-sum. Hundreds of thousands now face the same decision across the country.
So, here are the fundamental questions they faced:
- Would you take a lump sum in lieu of a pension and invest it yourself, together with all the contributions you would receive from your employer over the next 20 years? Or would you say, “No, thanks” to the offer and just wait until retirement and take a pension based on your 35 years of service?
- If you did decide to take the lump sum and invest it yourself, how exactly would you allocate the money over the next 20 years?
Although I don’t live in Florida I, too, face a similar decision at retirement. I am in a defined benefit plan that gives me the option to cash out in retirement and manage the funds myself for the rest of my life. Luckily, I have about 20 years to decide. How about you? Do you think you could manage and invest a nest egg yourself and grow the money to an amount that would generate a greater lifetime income compared to a pension? What if you live much longer than you expected? What if the market declines just when you are about to retire? What if inflation is higher than expected? It’s a tough decision, no question! And yet, if demographics and corporate trends are any indication, many millions of Americans will be making this exact choice over the next 5 to 10 years. They have a number—an amount of money in a tax-sheltered savings account—and must decide how to convert it into a pension.