Pension Maximization

Helping pensionable workers determine the value of their defined benefit (DB) pension to make well-informed Golden Albatross decisions is the raison d’être for this website. Thus, I write most of my articles for pensionable workers trying to determine whether staying for their DB pension is worth it. However, those aren’t the only articles I write. Although much smaller in number, I also publish articles for pensionable workers who decide to stay. If a unifying theme to those articles exists, it’s pension maximization.

What’s pension maximization? In practical terms, pension maximization ensures your pension’s positive impact in retirement is as significant as possible. You maximize your pension by taking active steps during your pensionable career. My Gap Number, Roth vs. Traditional, buying back years, and pension geoarbitrage articles provide examples of actionable steps pensioners can take. That said, unlike my Golden Albatross-themed articles, I never laid out a framework for pension maximization. In other words, after a worker decides to stay, I never answered the simple “now what?” question.

The remainder of this article, and its follow-on, layout my framework for answering “now what?” I call this framework Grumpus Maximization.

Yes, it’s a somewhat cheesy metaphor. But, Grumpus Maximization is a catchphrase designed to stick, much like the Golden Albatross. Who knows? It might even aid future marketing attempts like printing t-shirts with “Got Pension?” on the front and “Get Maximized @ grumpusmaximus.com” on the back …

That’s not helping, is it? Fine, I’ll sidebar the marketing discussion for now.

Introducing Grumpus Maximization!

Grumpus Maximization begins with two preliminary steps. The first is setting expectations by baselining what a DB pension represents in retirement and, more importantly, what it does not. The second step orients on you and your pension. For it, I provide a list of questions you should answer. Those two steps conclude the content for this article, Pension Series Part 30.

In Pension Series Part 31, I show how to take the information gathered in step 2 and use it in step 3 to determine your retirement Gap Number. Step 4 combines the data from steps 2 and 3 to identify pension maximized retirement investing and tax strategies. Finally, in step 5, I provide methods for spotting and assessing further pension maximization opportunities.

Many of the subjects I address as part of the Grumpus Maximization pension framework are not new, like determining your Gap Number. In fact, most topics tie into the building blocks of knowledge used for the Golden Albatross pension decision framework. If you’re unfamiliar with that framework, I explain it succinctly in my book. It also resides for free in the form of numerous articles in the Pension Series. However, the Grumpus Maximization pension framework is distinctly different. It combines the knowledge resulting from a person’s decision to stay with additional steps to maximize their DB pension’s positive effect in retirement.

“What It Is, What It Shall Be, What It Was”

I can never say “what it is” without thinking of the Good Morning Vietnam scene where Robin Williams’ character (Adrian Cronauer) imitates Walter Cronkite providing the weather report. It’s invariably stuck in my subconscious, so I made it the title of this section. Much like that scene, I want my explanation of what a DB pension is (for a retiree) to stick. I also want my comparison to what it is not to do the same.

https://youtu.be/qXdmTtk1Mm4?t=12

Grumpus Maximization Step 1: Setting Expectations

For a retiree who chooses to annuitize, a DB pension represents passive fixed income. Passive means no work is required to create the income stream in retirement. In fact, all the work was done in the past. Thus, no selling stocks, chasing renters for late rent or renewing bonds as part of a bond ladder. Much like I mentioned in my 18 months as a Pensioner article, my only work in retirement is to check my bank account each month. For non-pensioners, only an insurance annuity approaches this level of passiveness from a retirement investment perspective.

Fixed income implies that the amount doesn’t change, which is literal for some pensioners. They start retirement earning $1,000 monthly, and 30-years later, they still make the same amount. However, fixed is also relative when it comes to inflation.

As discussed in-depth in my Pension Series Part 3 and Do-It-Yourself COLA articles, many pensions have a cost of living adjustments (COLA) linked to inflation. This means their purchasing power remains fixed relative to their first retirement year, even though the annual amount increases to keep pace with inflation. For non-pensionable retirees, the only method for creating this type of feature is to add an expensive inflation rider to an insurance annuity.

Why This Matters

I emphasized the passive and fixed nature of an annuitized pension for two reasons. First, a steady retirement income stream from a former employer, which requires no effort in retirement to produce, is really nice. As many writers before me have noted, a DB pension is essentially payment for not working. Or, as Leon LeBrecque noted on Forbes.com, “Under a DB plan, retirement almost always means ‘don’t work here.’”

Many developed nations’ retirees will experience this to some degree through programs like Social Security. However, DB pension earners typically get to experience it sooner and longer. That places them in a privileged position they shouldn’t waste, and pension maximization ensures they won’t.

Second, and more importantly, the passive and fixed nature of a DB pension means there’s little a retiree can do after retirement to maximize it. In most cases, once annuitized, a pension doesn’t change. Essentially, an annuitized pension locks in whatever pension-related decisions you made in the run-up to retirement and those you make at retirement.

Are there exceptions? Sure, and I’ll talk about one below. But, in general, most decisions made around annuitizing a DB pension are irreversible. Thus, if you want to maximize a pension, you must do it during your working career. In other words, pension maximization requires proactivity on your part. The good news is that if you’re reading this article, you’re well on your way.

What It Is Not: A Bond

A pension annuity is not the same as, or equivalent to, a bond. I mention that because many pensioners have told me over the years that they treat their (future) annuity income as the bond portion of their retirement investment portfolio. Thus, they invest more aggressively with the money they would’ve allocated to bonds. While I understand the thinking which drives this behavior, as I point out in my Gap Number in ACTION article, there are several reasons why pensionable retirees shouldn’t do this. One reason, in particular, is germane to the pension maximization discussion.

A pension annuity is not a bond because it is non-liquid. In other words, a pensioner can’t sell all or part of their annuity to generate cash. To my knowledge, a person can’t even borrow against it. So, pensioners shouldn’t treat their pension as equivalent to bonds if they ever foresee the need to generate more cash in retirement than their pension generates.

Remember, you hold bonds in a retirement investment portfolio mainly because of diversification. Most of the time, bonds perform independently of stocks. Meaning if stocks take a downturn, bonds probably won’t. Thus, you’d sell your bonds if you needed to generate cash while those stocks were down. However, you can’t sell a pension annuity. Or, more accurately, you can’t sell it like a bond because there is no market mechanism for securitizing the pension annuity for sale to interested bidders.

A Lump Sum Offers Liquidity, But…

That said, accepting a lump-sum offer is a method for extracting the future value (FV) of a pension annuity in present-day dollars. However, lump sums are not universal features of the DB pension landscape. Most often, it’s up to the employer and the rules governing their pension plan as to whether or not they offer retirees a lump sum.

Also, when available, lump sums are typically offered as a replacement for the entire annuity at the beginning of retirement. In other words, a soon-to-be retiree either takes the annuity or takes the lump sum, but they can’t have both. Although exceptions exist (see below), this either/or dynamic works to the advantage of the pension fund because, if accepted, a lump sum transfers longevity and volatility risk from the pension fund to the retiree (AAOA, 2016). Or, more succinctly put, the soon-to-be retiree inherits the risk of running out of money in retirement by accepting a lump-sum offer.

Mid-Retirement Lump Sums?

Again, typically, a pensioner cannot cash out their pension annuity after receiving it. Although, in 2019, the US government reversed its previous decision, limiting employers from offering lump-sum buyout offers to pensionable retirees already receiving their annuity payments (DePillis, 2019). In other words, US pension funds can now offer lump-sum buyouts even after pension payments start.

Mid-retirement lump sums are offered through what the Internal Revenue Service (IRS) calls “retiree lump-sum windows” (IRS, 2019). Once again, though, it’s entirely optional for the pension fund to offer such a window. And, in all likelihood, the lump sum takes the place of the entire FV of the annuity. Unlike owning a bond fund, you can’t sell only what you need.

Exceptions to the Rule

As with all things pension-related, especially in the US, there are exceptions to all these lump-sum scenarios I just described. So, it’s best to check with your specific pension fund if you want to learn more about their position on lump sums. Please note there are multiple pros and cons associated with lump sums. I’ve addressed most of those in previous articles, which you can access through my Article Index or here.

Finally, suppose you’re 100% convinced that you will take a lump sum. In that case, Grumpus Maximization doesn’t really apply to you. Walking through the first two steps wouldn’t hurt, as it may help you prepare for retirement and provide one last sanity check on your lump-sum decision. However, by step 3, the framework no longer applies, and by step 4, it turns counter-productive.

What It Is Not: Risk-Free

A pension annuity should be risk-free for the pensioner (Benartzi, 2011). In the US, at least, that is not always the case. Many pension funds are underfunded when compared to all future obligations. In fact, pension safety fears drive many would-be pensioners towards accepting a lump-sum offer. I’ve written several articles on the pension safety topic, so I’m not going to expound on it at great length. While I don’t want to oversell the concern, when it comes to maximizing your pension’s effect for retirement, I advise caution based on your assessment of your pension’s safety.

Grumpus Maximization Step 2: Orienting on You and Your Pension

Given the variance from one DB pension to the next, I think it’s worth asking the following questions to determine what yours either does or doesn’t provide in retirement. However, these questions aren’t simply limited to examining your pension plan. They also force you to examine yourself and your retirement goals while establishing an intent for your future pension dollars. Moreover, by the end of step 2, you’ll also have an established benchmark for comparing your future pension income against in the form of a retirement spending plan.

As mentioned in the introduction, a lot of information required for step 2 of the Grumpus Maximization pension framework carries over from a Golden Albatross decision. So, if you’ve worked through that decision point, you’re already ahead of the power curve. Don’t worry if you never heard of the Golden Albatross before this article, though. I take time to explain and justify why I think each questions matters. I also provide links to numerous resources to help you through the process.

Finally, the questions are open-ended, meaning they utilize the Who, What, Where, When, Why & How method, which I call the 5Ws for short. Some 5Ws have more than one Grumpus Maximization question, while others don’t. A few have corollary questions embedded in the explanations, so don’t miss those. I kept the questions in the standard 5W order, but truthfully, as long as you answer all of them, the order doesn’t matter.

Question #1: Who Are You?

This question isn’t just the chorus to a great rock’n roll song. My personal and other’s academic research shows that people often place more or less importance on their pension based on their age, tenure, and gender. Not only that but the role a pension plays in positive retirement outcomes is also affected by race and gender. Thus, understanding where you fall in the demographic spectrum is crucial as you consider specific pension maximization issues like retirement investment risk profile.

You can read more about how demographics impact the importance a person places on their pension in Pension Series Part 28 (Age, Tenure, and Gender). Additionally, you can read about how race and gender impact retirement outcomes for different types of pensioners in Pension Series parts 24 (Black Pensions) and 29 (Women’s Pensions). All articles come replete with numerous citings for further reading if you’re interested.

Question #2: Who Provides the Pension Annuity?

Answering this question will help determine the pension safety issue, among others. That determination will probably result in you identifying your pension trust fund’s funding percentage. Most pension annuities are financed through pension trust funds, be they government (i.e., federal, state, or municipal) or private sector sponsored. A much smaller percentage of pensions annuities are funded through employer purchases of insurance annuities.

Pension Series Parts 1, 15, and 22 explore the pension safety issue in detail for the various types of pensions offered in the US.

Question #3: What Design Elements Are Built Into Your Pension?

All pensions are not created equal, but most are designed to entice workers to stay with an employer long-term. Still, employers face different challenges to worker longevity based on unique factors such as industry and geographic location. Thus, the combination of features and penalties designed into a pension are typically tailored to a specific employer’s workforce. I call these features and penalties pension design elements. Pension Series Part 25 addresses pension design in detail. In Pension Series parts 3 and 6, I explain which features I consider most valuable.

There’s a corollary question here. What pension design elements do you need in retirement? Granted, most design elements are baked into a pension. For instance, you don’t get to choose whether or not your pension comes with a cost of living adjustment (COLA). It’s either a feature of the plan, or it isn’t. However, some optional design elements exist, like pension subsidized healthcare and survivorship.

Optional Design Elements?

For my US readers lucky enough to have healthcare designed into their defined benefits package, healthcare coverage often starts at a pension plan’s normal retirement age (NRA). This means a retiree either waits to retire at NRA or goes without pension subsidized medical coverage until Medicare starts. There are, of course, exceptions, but generally speaking, this is the case for most. Thus, healthcare is optional for most. You can read more about the value of pension subsidized healthcare in Pension Series Part 6. The article will help you determine whether or not you need it for your retirement.

Survivorship, or the ability to pass on your pension to a spouse and/or non-adult offspring should you die prematurely, is also optional. However, it’s mandated by US law that pension plans offer the choice. I explain survivorship in-depth in Pension Series Part 5. I also provide a model for determining if you need to elect the survivorship. You can also read my post-retirement thoughts on my survivorship decision in my Death Binder 2.0 article.

Question #4: Where Are You Going to Retire?

I ask this question for two distinct reasons. First is taxes. Different states in the US, and countries around the world, tax DB pension income differently. Retirement locations that differ from where you lived and worked may present opportunities or expose you to new and different tax regimes. Truthfully, I’m not one to let the tax tail wag the retirement dog. But, your retirement spend plan must incorporate them as an expense, which ultimately impacts Grumpus Maximization efforts.

Second, where you choose to live in retirement directly impacts how far you can stretch your monthly pension check. Minimizing cost of living expenses in retirement through geoarbitrage is a well-known tactic within the Financial Independence (FI) community. In fact, a slew of websites like GoCurryCracker cater to those interested in saving money by retiring abroad. However, geoarbitrage isn’t limited to living abroad. A regional move can achieve the same effect in a large country like the US. No matter what, though, if you intend to stretch your pension dollars further by retiring in a different location, it will impact Grumpus Maximization efforts.

You can read more about the overall advantages and disadvantages of geoarbitraging with a pension both in the US and abroad in Pension Series Part 10. You can also learn from my personal attempts to stretch my pension dollars further through my family’s move to New Zealand. I’ve navigated the issues of international taxes, cost of living differences, and exchange rates for multiple years now and learned a lot along the way. You can find those articles here and here.

Question #5: When Can Your Pension Payments Begin?

Answering this question serves several purposes. First, it familiarizes you with the rules and formulas governing how and when your pension pays out. These rules and formulas often incorporate age and tenure requirements, which I discuss extensively in Pension Series Part 3. Second, answering question 5 defines the art of the possible regarding your pension payment start dates. It doesn’t necessarily mean that you’ll take your pension as soon as possible. Still, it identifies how soon the payments could start.

The answer to question 5 is crucial for pension maximization efforts. I say that because knowing when payments start allows you to theoretically calculate payout totals over your entire retirement lifetime. Needless to say, though, the timing issue is double-ended. In other words, to determine how much your pension could payout in retirement, you need to estimate when you might die. And, since none of us knows when that will be, it injects uncertainty into any model. It’s worth keeping in mind as you apply the answer to question 5 further in the Grumpus Maximization pension framework.

The Pension Sweet Spot

Since I mentioned timing, it’s worth noting the following. Depending on the design of your pension, there is a retirement sweet spot for plan members that combines such considerations as tenure, age, career earnings, and expected lifespan. Often, this sweet spot prompts early retirement among pensionable employees. This is a well-known unintended consequence of defined benefit (DB) pensions. In fact, many pension plans added early retirement penalties to discourage retirement before their normal retirement age (NRA). You can learn more about this in my Early Retirement Penalties article.

Of all pension design elements, immediate annuity payouts based on tenure alone (like the US military’s) are the most lucrative. They provide the best opportunity to maximize the amount of money a pension pays out over time. They also create the most substantial mathematical pressure to retire early. I address immediate payout as a pension design feature in Pension Series Part 25 and the importance my Golden Albatross survey participants placed on it in Part 27.

However, Pension Series Parts 3 and 4 are where I get to grips with the importance of timing pension payments from a mathematical perspective. I also discuss some of the funkier effects that delaying the start of pension payments creates for early retirees. Readers of my book will be intimately familiar with the content in these articles, as they formed the heart of the “objective” side of the Golden Albatross pension framework.

Questions #6 and #7: Why and When Do You Want to Retire?

A double-barrelled open-ended question is poor form. But, I lumped these two questions together because they are inextricably linked. That said, the when question most definitely follows why.

Whereas most of the questions on this list orient on your pension, the why question decidedly orients on you. However, this question isn’t philosophical, and your answer needs to be as concrete as possible. It impacts everything because it translates directly into the amount of money you’ll need in retirement. In other words, there’s a big difference between a retirement designed to spend more time with the grandkids who live in the same town versus one designed to slow travel the world for 10 years.

I address this “why” issue most succinctly in chapter 3 of The Golden Albatross (my book) entitled “Why One Would Stay.” That chapter was based, in part, on my About Me page on this blog. However, the About Me page doesn’t really do the issue justice. My first article showcasing my retirement planning method is a far more practical look at how my retirement goal(s) influenced my retirement planning (and, therefore, my pension maximization efforts). You can also find an updated version in my retiring retirement anxiety article.

Why vs. When

The when question flows naturally from the why because life generally, and a DB pension particularly, is bounded by time. For example, a pensionable retiree motivated to travel the world would be wise to implement their retirement plan before the frailty of age makes international travel too difficult. As mentioned above, though, most pensions have age and tenure-related conditions designed to make people stay until NRA. Leaving too early may create unsustainable early retirement penalties in the form of a pension check that’s too small to sustain world travel. Thus, a tug-of-war between why and when often exists that you cannot overlook in pension-related retirement planning.

From my viewpoint, where I routinely interact with pensioners and pensionable workers, the result is typically an age-based condition that achieves the why-based retirement goal. In other words, a person intends to retire by a certain age to achieve a specific thing in retirement. That said, the age-based condition could just as easily be a conditions-based timed requirement.

Conditions-Based Examples

An excellent example of condition-based timing is meeting the 20 years of service (YOS) requirement for the US military’s pension. I can attest that I never walked around stating I was retiring at age 44. I simply told people I was retiring at 20 YOS, and everyone understood what that meant. It meant I intended to serve long enough to earn my pension and government-subsidized healthcare.

Healthcare is another conditions-based timing example I often see among US pensionable workers. In other words, people often tell me they are working until they qualify for pension subsidized healthcare, not the pension itself. Sometimes, the healthcare age and/or tenure requirements are more restrictive than pension annuity requirements, creating severe tension between the two. Whether or not pension subsidized healthcare deserves such special consideration from your perspective is something I address in the updated version of Pension Series Part 6.

Question #8: How Much Income Will Your Pension Generate at Retirement?

The answer to question 8 is where questions 5 – 7 come home to roost. As just discussed, “at retirement” implies some sort of time-bound condition like age or tenure (or both). The importance of identifying these time-bound conditions is that they allow you to calculate your estimated pension income at the start of your retirement. You accomplish this by using the pension formula, as mentioned under question 5, and discussed in-depth in Pension Series Part 3.

It’s important to note that at this point, your retirement timing is still a non-maximized ideal. There are multiple issues left to consider that might significantly change that ideal. The good news is that by this point, you’ve collected most of the data you need for pension maximization if you’ve answered all the questions. Now it’s just a matter of experimenting with all the inputs to see how they interact.

It’s also important to note that I didn’t ask, “how much fixed income can your pension generate?” Theoretically, your pension plan might allow you to work long enough to earn a pension that replicates 100% of your annual salary. Although, you might be 80 by then, with an average four-year life expectancy to follow. Thus, you’d have little hope of recouping enough pension payments to equal the amount you could’ve earned by retiring sooner with a smaller annual pension income.

This is why I mentioned the pension sweet spot under question 5. Ideally, Grumpus Maximization will identify your personal pension sweet spot that maximizes your pension at a particular time (or under certain conditions) to achieve your retirement goal(s). It’s not about reaching the theoretical maximum because earning the largest pension payment possible is not the goal. The pension money is just a means to achieving a retirement end that you’ve identified.

Question #9: How Much Money Do You Need in Retirement?

Now we’re getting to the crux of the matter! The answers to all the previous questions don’t mean much if you don’t have a benchmark to align them against. Your spending estimate for retirement, be that an annual or monthly amount will provide that benchmark. You can develop that spending estimate by creating a retirement spending plan or what others might call a budget. However, Grumpus Maximization doesn’t require complete knowledge about retirement income just yet, which is typically needed for a budget. I leave that to step 3 of the Grumpus Maximization pension framework, identifying your Gap Number.

Long-time readers have probably tired of me saying this. Still, you can’t effectively determine how much money you will spend in retirement without tracking how much you’ve spent in the recent past. In my opinion, historical spending is the most accurate predictor of retirement spending. The longer you’ve gathered that data, the better your predictions will be. But, a 2-3 year window should be sufficient if you’re new to spending tracking. As I discussed in Chapter 10 of my book, other methods exist for building rough estimates of your retirement spending needs, but they inject more uncertainty than historical spending.

It’s Worth the Effort

Furthermore, tracking your money unlocks all sorts of better-informed financial decisions in retirement. My Death Binder 2.0 article noted that my money tracking data allowed me to create a life after Grumpus budget for my family. This helped me determine if I needed more life insurance than the survivorship coverage I elected through my pension. Spoiler alert! I decided I needed more.

Suppose you’re new to tracking money and don’t want to slow down the Grumpus Maximization process. In that case, several internet articles show you how to build a retirement “budget” by backtracking through your previous spending. Some even provide pre-formatted worksheets to fill out. Annuity.org’s article is probably one of the most thorough I’ve read. It’s well researched and cites academic resources, but practical and easy to read.

At the other end of the spectrum for length, The Balance (a personal finance website) published a short article that hits many of the same topics. Also, Investopedia posted an interesting article on how retirement spending changes over time, which is designed to assist those building a retirement budget. Your previous work identifying your pension’s design elements will help you because some features mitigate retirement budget costs.

A Temporary Conclusion

That’s it for steps one and two of the Grumpus Maximization pension framework! Remember, these are just the initial steps for answering “now what?” if you decide to stay for your DB pension. My follow-on article, Pension Series Part 31, will cover the remaining steps for maximizing your DB pension’s positive impact on your retirement plans.

I hope I didn’t scare you with this article’s length or the amount of work it implies. I wrote it under the assumption that someone entirely new to the Golden Albatross blog may choose this as their first article. So, much like a recipe for a novice baking a cake, I decided to list all the ingredients and explain why they’re essential. A veteran baker (i.e., a seasoned reader of this blog) probably has most of these ingredients at hand, which means a lot less work before moving on to the next steps.

Right! Speaking of baking … until I work up the energy to write Part 31, I’m off to work on my half-baked t-shirt idea with my marketing department of one. Feel free to post thoughts on Grumpus Maximization (or Golden Albatross) merch in the comments section below!