If you have a defined benefit plan - like the AbbVie Pension Plan or Illinois TRS Pension - you’re in luck. Pensions, although rare in today’s world of defined contribution plans (think: 401ks or 403bs), are like a retirement planning unicorn. They guarantee you an income stream in retirement, and often offer a relatively sizable portion of your pre-retirement income that covers the vast majority of your expenses.
In these cases, knowing how else you need to prepare for retirement can be a little bit confusing. After all, you’re getting a huge chunk of guaranteed funds already – how else should you be saving? I have several clients who are going to receive a hefty pension benefit during retirement, and I typically see them veer in two different investing directions:
They know their pension will cover most expenses, so they aren’t worried about portfolio growth. This means that they’re relatively conservative investors, and don’t wish to take a lot of risk when choosing where to invest.
They know their pension will cover most expenses, so they take this opportunity to aggressively pursue returns. They want to grow their funds and take risks, because they know that their pension acts as a kind of safety net.
The truth is that neither of these options is 100% correct. Even if you have a pension that’s covering a big portion of your retirement expenses, it’s still smart to plan for contingency plans and to invest wisely. Let’s break down how investing works when you have a pension plan you’re counting on.
Should You Invest Conservatively?
I understand the case for conservative investing if you have a pension. You’re not looking to grow your additional retirement savings dramatically. Anything you save in addition to your pension is really icing on the cake, so why push the limits?
However, it’s important to keep in mind that pensions aren’t always going to be a failsafe. Sometimes companies go bankrupt, or you’re forced to change jobs that could result in receiving a reduced pension amount during retirement. That’s why it’s critical to have a savings plan that balances risk with your retirement timeline, and helps you to build toward it steadily just in case you end up needing those funds, after all.
Should You Take More Risks?
On the other side of the coin, I can also understand wanting to be more aggressive with your investments if you have a pension to fall back on. You have a safety net – why not go big or go home, right?
This approach needs to be taken with caution as well.
First of all, stock picking, timing the market, or chasing returns is never a good strategy – even if you have a pension that you can count on. This is especially true as you get closer to retirement. The likelihood of needing the savings you’ve grown beyond your pension benefit is probably higher than you think. Even if you’ve dialed in your retirement expenses, and know that your pension covers most of them, it’s wise to save for the unexpected:
Medical expenses
Long-term care that isn’t covered by Medicare or insurance
Losing a spouse or partner early in retirement, and having to cover expenses on your own
There’s no telling what your life will bring during retirement, and although it’s never fun to plan for the worst-case scenario, it’s necessary. Even having a diversified portfolio that is beyond the risk tolerance with what you’re comfortable is never advisable.
What’s The Right Answer?
So, what are you supposed to?
There are a few things to consider when developing an investment strategy when you’ve got a pension coming your way:
Taxes. Your pension benefit is taxed as regular income, potentially at a Federal and State level. If your benefit is what’s going to be covering the majority of your expenses because it’s a large payout each month, it’s wise to calculate how taxes will impact that income stream. You might be surprised to find that the government will take more out of your pension than you had originally thought, which could reduce the actual amount of cash flow you have during retirement.
Inflation. Your pension plan may not cover inflation. So, even if you retire with a sizable salary, and your pension pays a large percentage of it back to you as your retirement benefit, it may still not be enough as the cost of living slowly rises with time. You may need more savings than you think to keep up!
Lifestyle. As always, I usually recommend that people take a close look at the lifestyle the expect to live during retirement before setting any savings goals for themselves. Although it may seem like your pension benefit will cover many of your basic expenses during retirement, you may want to set some bigger lifestyle goals for you and your spouse that you start saving toward. Your benefit, for example, might not cover the month-long trip to Europe you’ve always dreamed of taking every June during retirement or the scholarship fund you wanted to set up at your alma mater.
Even though your pension is sizable, your best bet is likely to still pursue a balanced investment strategy that takes into account your timeline to retirement and your corresponding risk tolerance. Investing too conservatively could mean you don’t have a big enough nest egg to cover your basic expenses and beyond for the rest of your life. Investing too aggressively could lead to major losses as you get closer to retirement, which could be just as problematic.
Building a Plan That Covers Every Circumstance
Although having a big pension can be an incredible financial “win” during retirement, it doesn’t mean you’re completely off the hook when it comes to saving and investing strategically. From planning for unexpected expenses during retirement, to creating a plan that mitigates the impact of taxes on your retirement income, creating a comprehensive saving and investing strategy is key. You want your strategy to cover every circumstance – not just the one you want to happen.
Need help? Let’s talk. Schedule a call with me today by clicking here. I’d love to learn more about your retirement aspirations, and to help you figure out a savings and investing strategy that balances your tolerance for risk with your goals.