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The Richest Day of Your Life

"The Richest Day of Your Life

By Cora Daniels

Mark your calendar: The day you qualify for early retirement, the value of your pension could go through the roof. If you gave more than a moment's thought to your pension last year, you either (a) care more about actuarial science than the average salaryman, or (b) have way too much time on your hands. We're talking here about the old-fashioned defined-benefit pension, the one that paid your father a check a month in retirement and that is promising to do the same for a new generation of employees today. Four out of five large corporations still offer them, and they mean it: Today's pension promises are backed by more than $1.9 trillion held in pension trust funds, according to research firm the Spectrum Group. That's almost twice as much as in all 401(k)s.

But that's not why you might want to focus a tad more on your pension. The reason is that if you are within shouting distance of qualifying for early retirement, this boring, misunderstood asset may offer the highest potential return of any investment you own - more than your house, more than your 401(k), more than your company's stock, more than your personal portfolio. Once you reach the combination of age and years of service that your plan defines as the threshold for early retirement, the typical pension metamorphoses from a vague promise into what is essentially a richly leveraged option on your career longevity. The day you qualify for an early out, the potential lump-sum value of your benefit could literally double - creating what could be the single best-paid day of your career.

From that moment until you reach the standard retirement age of 60 or 65, the value of your pension continues to grow at an accelerated pace, whether the stock market goes up, down, or sideways. "Pensions are like a crazy relative in the attic," says William Arnone, Ernst & Young's national director for employment and financial education. "You're vaguely aware it's there, but you never think about what it's worth until you need it." Don't start counting your pension checks yet, though.

Odd as it may sound, your pension is probably also your riskiest asset. This has nothing to do with market fluctuations (in a pension, your employer bears those risks, not you) and everything to do with the typical plan's complicated, back-loaded design. Anything that interrupts your service with your current employer, from job-hopping to early retirement (voluntary or involuntary), can have a devastating effect on your pension's growth path. So can any corporate action that affects your plan, such as a merger that folds your plan into an acquirer's benefit package or a conversion of your old pension into any other kind of retirement plan. True, a pension doesn't require as much hands-on attention as, say, a 401(k).

Relics of a more paternalistic era in employee relations, pensions are designed to reward long, loyal service; to earn one, you don't have to do much more than hold on to your job. But that doesn't mean you can afford to ignore your pension. It's quite possible, for example, to blow benefits that are almost within your grasp through some rash or uninformed move (like, say, storming in to your boss and quitting the day before you qualify for early retirement).

"The best advice is to make the effort to understand your plan," says Andy Stratton, a principal at the benefits consulting firm Buck Consultants. "You may discover it's worth more than you thought." (Or could be soon.) Better yet, you'll learn what you can do to keep it on track. In the most common form of the traditional pension, the size of your eventual benefit depends on your age at retirement, how much you earn, how long you work at your company, and the benefit formula built into the plan. A typical formula calculates the size of your benefit by multiplying a percentage (1% to 2%, say) of your final pay - or more precisely, of the average of your last three to five years' pay - by the number of years you worked for the firm.

Regardless of when you actually leave work, you can't start collecting that benefit until you reach the plan's standard retirement age, typically 60 to 65, unless you qualify for early retirement. That's usually decided by some combination of age and years of service. You might be in line for early retirement at the tender age of 50 if you're a longtime employee.

To see the practical effect of this design, look at the chart at right, which depicts the buildup of pension assets for a typical longtime employee, now 50 years old and pulling down a $100,000 income. (While pensions are almost always calculated as a monthly annuity, the graph converts that stream of lifetime payments into a lump sum for the sake of comparison.) For most of his career, the lump-sum value of his pension struggles up toward the five-figure mark like an underpowered biplane. Then, once he qualifies for early retirement, it blasts off like an F-16. Why?

Part of the reason is simply the time value of money: at early retirement you've gone overnight from not being able to claim your reward for another five to ten years to being able to lay your hands on it immediately. Another reason is the multiplier effect of the pension formula - as you put in your years and get raises, your pension is based on an ever-higher percentage of an ever-higher salary. But what really kicks in the afterburners is the fact that most companies subsidize pensions for early retirees. In other words, to help you afford to leave before age 65, your employer probably credits you with a larger benefit than you'd deserve if actuarial assumptions were strictly applied.

Actuaries call this transition point - the point at which your pension benefits take off the "cliff." If you're almost at that point in your career with your company, it's worth sticking around for. Just showing up to work the morning you qualify for early retirement could boost the lump-sum value of your pension by 100% or more of a year's salary. In the hypothetical plan depicted in the graph, the lump-sum value of the pension spurts from a quarter of a million dollars at age 54 to just under half a million at age 55. If the employee were to put in another three years from that point, the value of his pension would be almost triple the lump-sum value of the pension just before early retirement at a 28.7% compound annual rate of return.

A couple of things can get in the way of this pleasant scenario, however. First of all, you can blow the whole scheme by leaving your job in the middle of your pension's meteoric accumulation phase or (even worse) right before the phase begins. So get a copy of your pension's summary plan description from your plan's administrator, and find out what the early retirement rules are. (Or just ask the administrator to explain them.) Don't squander your pension out of ignorance.

This is not to say that you should hold on to a dead-end job solely to let your pension accrue. However, if you do decide it's time to move on, know what you're forgoing in pension benefits and make sure you're fairly paid for it. "If one of my clients is changing jobs, I'll figure out the present value of his pension, along with options and bonuses he otherwise could expect to get," says Paul Westbrook, a Ridgewood, NJ, retirement planner. "Then, in negotiations with his new employer he can say, 'Look at everything you're asking me to give up for you.'

"Another reason to get familiar with your plan is that it will help you recognize the effect that changes imposed by your employer can have on your pension's growth. Remember, the employer owns the pension. As long as the company doesn't disturb the benefits you've already earned, it is completely within its rights to "amend" the plan in ways that will lower benefits you might earn in the future - just as it is free to freeze your wages or reduce your health benefits. Scrooge-like amendments do happen.

In 1991, for example, Thiokol (now Cordant Technologies) raised the normal retirement age in its pension formula from 65 to 67. Your company may also try to switch you from the traditional final-pay pension model to what's called a cash-balance pension, a plan that blends features of traditional pensions and 401(k)s. In a cash-balance plan, the company makes annual contributions to an account in your name, so that you get periodic statements. Employers like the greater predictability that cash-balance plans offer, and employees, especially younger ones, like the fact that benefits grow faster in the early stages of a career than they do with traditional plans. But if you're at or near early retirement in a traditional pension, your company does you no favor by converting to a cash-balance plan. The latter's steady growth simply can't match the traditional pension's soaring benefit growth at this stage.

So if your plan converts to a cash balance plan and you have a choice of retaining the old plan, figure out where you are in your traditional plan's growth curve and consider standing pat. More frequently than they'd like to admit, companies can also shortchange pensioners purely by accident. Benefit formulas tend to be complicated to begin with and are subject to more than their share of absurdly tangled tax rules. Not surprisingly, companies do goof in calculating benefits.

Allen Engerman, president of the National Center for Retirement Benefits (NCRB) in Northbrook, Ill., says roughly a third of the payouts that pensioners hire his firm to review are in error. (One caveat about that figure: NCRB is a for-profit firm that helps employees check the accuracy of retirement benefits they receive, in return for contingency fees of up to half the money the firm recovers for its clients; obviously it's not in the business of underestimating the incidence of pension errors.) Continental Airlines, GTE, MCI, and Tyson Foods, to name a few, have all had to make good on honest errors in recent years. It may be particularly wise to check your employer's math if your pension plan undergoes any fundamental change, such as converting to a cash-balance pension (without giving you a choice of staying with your final pay plan) or any other type of retirement plan. You want to make sure you get full credit for the benefits you've already earned.

"Anytime there's a plan merger, a plan termination, or a conversion from one kind of defined-benefit plan to another, a host of potential problems confront employees," says Jeffrey Lewis, an Oakland attorney specializing in pension cases. Obviously, you won't be able check for errors yourself. You'll need to bring in an experienced actuary (figure on $100 to $200 an hour) or a contingency firm like NCRB. (Its toll-free number is 800-666-1000.) But at least there is one error you won't make anymore: You won't underestimate the value of keeping an eye on your pension."

<Note from JobFairy.com: With the recent downturns in the market, the collapse of Enron and the ongoing drastic slide in the share price of Qwest stock, it never pays to own significant amounts of your company's stock. When I first began tracking the employment market, I felt a little uneasy recommending a job-hopping strategy, as a pension payoff could be such a lucrative end to a long-term employment situation. But generally, you made so much more money upfront through job-hopping, without strings, that I kept to that stance. (With the exception of considerably older or union employees.) There is a time value to money as well, and I figured that it's better to get more money working for you the earlier you can, which is the advantage to the job-hopping strategy - continuously higher pay. Now, with Enron's employees' pensions in tatters (not to mention Qwest's retirees), I do not recommend the stay-until-retirement algorithm unless you are a government employee of some flavor (civilian or military). I recommend setting up one's own 401K-type plan, contributing a monthly sum to it (dollar-cost averaging), making sure it's suitably diversified for your age and earnings bracket, and making sure it is independent of your company's administration. If you do get stock options or other equity benefits, hold onto them only if you would have purchased them independently of your employment with the company in question. If these products are not something you would have had in your portfolio otherwise, cash them out as soon as possible and put the money to work towards your own retirement plans. Short the stocks if you have to! (Talk to a professional, registered investment representative in order to do this - don't try this at home! You really have to know what you're doing, and it always pays to create a financial strategy with a licensed financial planner.) Don't feel guilty about unloading loser stocks. Don't listen to your company's executives when they send out e-mails about how "stable" the company is or what a "good value" the shares are, or that a recovery in price is just around the corner (and search for rumors about your company at http://www.fuckedcompany.com so you can confirm or deny any previous confirmations or denials) . Chances are they're just pacifying you into holding onto the stock long enough so that they can cash out their positions!! Remember, pay yourself first, and that means taking care of your own retirement needs yourself without relying on the company to be there for you when you're older. Ask those who were at Enron or Qwest or WorldCom or Andersen or...>

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