4. What Can I Expect From My Defined Benefit Pension?

Most public employees will qualify for payments from a defined benefit pension. See your benefits administrator to determine if you are eligible for this benefit. As with all sources of retirement income, it is essential that you thoroughly understand your pension, particularly the formula that determines the amount you will receive and optional features, if any, of your plan. Just as important are the critical decisions involving survivor options.

While this is a general overview of features found in some defined benefit pensions, every employer’s plan is different. Ask your plan’s administrator for specific information about your own plan. Your pension may provide your basic retirement income. It is worth the effort to understand how it works.

Retirement Income From Defined Benefit Pensions

In a typical defined benefit plan, the amount of pension you will receive is determined by a formula that usually includes years of service, your salary, and a predetermined percentage factor all multiplied together. Each of these factors is defined by the specific rules of the retirement plan.

Well before you retire, meet with your pension administrator to understand how your pension payment will be calculated, the specific values used in the formula, and how and when you will qualify for and receive this income. Although your benefit is determined by a formula, there may be some important decisions about your pension for you to make. Find out about any optional features you may have available and about your joint and survivor payment options.

Optional plan features. Many public employee defined benefit pension plans have features that allow you some flexibility in deciding how to take your pension. If any of these features are available to you, understanding and managing them is an important part of your planning. Remember, there is a great variety of plan features and not all plans have all, or even any, of these features available. Understand the rules specific to your own retirement plan. In any case, the best decisions will be made as part of a retirement plan, considering such matters as other income, your basic spending needs, life expectancy, and your need for secured lifetime income or a flexible source of money. Note that these optional plan features must be applied before retiring.

The following discussions provide some examples of optional features to alert you about planning issues. Your individual plan governs specific features that may be available to you.

Purchasing Service Credits

The number of years of service credit you have earned, perhaps equal to the years worked under your pension system, is one of the three factors used to calculate most pension benefits. The more credits you have, the higher your pension. You may be eligible to increase your defined benefit pension payments by purchasing service credits. Credits can be purchased for past military service time; other public employment; or, in some plans, for nongovernmental work.

Costs vary - you may be required to pay for 100 percent of the value of the credits or your employer might subsidize the cost.

Deferred Retirement Option Plan (DROP)

Another plan feature that may be available to you is DROP - the deferred retirement option plan.

To use a typical DROP, you must be eligible to retire and start getting your pension. Instead, you postpone retiring and continue working, and the benefit for which you are eligible is contributed to an account for you. You earn no additional pension credits. You might be allowed to direct the investments of the contribution account, or the account might be managed in a pooled investment.

At the end of the DROP period (typically three to five years), you retire and begin receiving the pension you had earned earlier. In addition, you have access to assets in the DROP account, which may be taken in any form and at any time as the plan allows. You may even roll it into an IRA and use it as needed in retirement. DROP rules, including enrollment eligibility, vary greatly from plan to plan.

Partial Lump Sum Distribution Option

Some public pension plans allow a participant to elect to take some of the earned pension benefit as a lump sum, with an offsetting reduction in the pension benefit. As happens with the DROP, this feature creates an account under control of the retired employee to help meet needs for a flexible source of funds but at the cost of lower pension checks. Also, as with the DROP, availability and program rules vary greatly, so consult with your retirement plan administrator and consider such a distribution in the context of your total retirement situation.

Joint And Survivor Options

Defined benefit pensions offer a pension benefit for a surviving spouse of the covered worker. The surviving spouse must get at least 50 percent of the amount paid to the couple.

The pension check for a couple is usually less than the amount paid to someone who will leave no survivor benefit. Benefits for the single person with no survivor benefits stop on his or her death, while the couple’s pension covers two life spans, with payments likely made over a longer period. The total value of the expected payments for a couple is generally designed to be equivalent to that of a single person.

Couples may usually elect to receive a higher joint pension if the spouse agrees in writing to waive his or her survivor benefit. Public pensions often offer a variety of joint/survivor pension combinations. It is essential that you understand the options available from your pension system before you make any commitments, because once pension payments begin, the decision is normally irrevocable.

When considering joint and survivor pension options, understand how the surviving spouse’s income needs and sources will change. For example, Social Security income will be reduced by one-third or more, compared to benefits paid to a couple when the higher of the two benefits being paid is lost. It is best to make this important decision after carefully understanding and comparing the spending needs and all income sources for both the couple and for each individual, as a survivor.

Beware of relying on insurance in place of survivor benefits. A strategy sometimes promoted by insurance interests suggests that a married retiree take the single life pension, waive survivor benefits, and suggest buying a life insurance policy to meet the survivor’s needs. However, unlike private sector pensions, most public sector pensions include cost-of-living adjustments and perhaps liberal actuarial assumptions, so it may be less beneficial for public employee retirees to make use of this strategy.

Before taking a single life pension, it is essential that you thoroughly understand this complex matter. Some of these options are not in the best interest of a surviving spouse. Do not rely on the insurance salesperson to advise you. Consult with your pension system to understand the consequences of taking the single pension and to understand all your survivor options.