Story by Pete “Coach Pete” D’Arruda

Over the last decade, many companies have phased out company-sponsored pensions in favor of plans that shift most of the savings burden onto employees. With pensions becoming a pipe dream of the past, it has become more important for people to realize the need to develop a firm, consistent and guaranteed retirement account on their own.

Pre-Funding a Pension

The most common plan these days is the 401(k), but as with the pension, it comes with its own set of problems. The main drawbacks include inconsistent participation by the employee; uneven market performance in the form of market risk and fees; and the uncertainty of what your yearly income at retirement will be.

However, an option exists for parents or grandparents to pre-fund a pension-type retirement account for a child or grandchild to provide them with a retirement foundation.

With a lump sum of at least $50,000, a pre-paid pension can now be funded for children as young as 30 years old to be applied to retirement at age 60 or 65. A true personal pension will, with pinpoint accuracy, identify for you what the guaranteed lifetime pension paycheck will be. Because of the design and contract of these plans, they cannot be exposed to risk and must have a guaranteed compounding interest element.

Example: John & Sally

Let’s look at an example to examine how it works. John and Sally, both 72, have a grandchild named Susan who is 31. Susan is a hard worker but has not accomplished her dreams yet. She has worked with three companies since college but only one had a 401(k) plan. She was unable to contribute a lot of money to the 401(k) plan due to her circumstances. Her plan also lost value in the last market crash.

John and Sally, on the other hand, have done well in their lives and both not only receive a regular pension income check but also have $400,000 in underperforming CDs. They decide they would like to decrease Susan’s retirement planning worries while giving her a head start toward a comfortable retirement.

The rates on John and Sally’s CDs were terribly low and they could not buy life insurance because of some health problems. A life insurance policy could have been another option, since it would give Susan a nice lump sum upon their death.

These circumstances lead John and Sally to their decision to take $100,000 out of the underperforming CD and prepay on a pension-like account for Susan. The $100,000 they put aside would guarantee by contract that upon reaching the age of 65, Susan would get $64,000 a year for life.  Susan now has a core account which will enable her to take more risk with her own 401(k) in the future or allow her to build two or three additional defined benefit plans as she ages.

Of course, it is fully expected that yearly inflation will exist over the next 30-plus years. Therefore, Susan knows the $64,000 a year she will receive will not be worth what $64,000 is today. Nevertheless, it is better than not having anything when she retires or having what she built up cut in half because of a negative swing in the market.

This is not the complete answer for Susan’s retirement planning dilemma but it will help her when we look at time and money. Pre-funding a pension-like account that will give Susan yearly checks for the rest of her life in retirement truly is the gift that keeps on giving. The sooner one can fund a plan for a 30-year old adult the more time there is to accumulate a compounded yearly growth rate that provides a yearly guaranteed income for life.

This is not a do-it-yourself solution, so make sure you meet with a financial planner who fully understands retirement planning and pensions.

Pete D’Arruda’s radio talk show, “The Financial Safari” is heard weekly on many radio stations locally (Sat 8-9am on WRDU 106.1 FM). Have a question? Send him an email.