By Doug Carey
Last November American Airlines filed for bankruptcy protection. Many of American’s employees are in a defined-benefit pension plan, which means American Airlines promised them a certain amount of money each year in retirement, regardless of what the markets do. But promises such as this are fleeting, as can be seen by the infighting going on now between employees of the airline and executives.
Two months ago Kodak filed for bankruptcy protection as well. Thousands of retirees and employees assumed they would get their full pension benefits from Kodak.
When it comes to private pension plans, the Pension Benefit Guarantee Corporation (a government agency) covers most people. It covers up to $55,000 per year for those over the age of 65. But it does not cover health benefits and many employees and retirees that worked for American Airlines or Kodak will never see these health benefits and now have to fend for themselves.
What about these risks to social security? The government has already projected that the social security trust fund will not be able to pay out full benefits starting in 2036. It is likely that benefits will be cut, especially for those deemed “not in need” by the federal government. So just how much of an impact does a cut in social security benefits have on a retirement plan?
To determine just how a couple in retirement might be affected by cuts in their social security, I ran some scenarios in the retirement planning application I use. I modeled a plan using a couple that has just retired at age 65. They currently have a combined $30,000 in social security payments per year, as well as $15,000 in pension payments. They plan on spending $40,000 per year in retirement. Given this, they will run out of money when they are 120 years old, which pretty much means they should not ever run out of money.
Let’s look at the results below:
|% Change in Social Security Payments||Age of First Shortfall in Retirement|
Things start looking quite a bit worse when social security payments are cut. If benefits are reduced by 20%, they would see nine years lopped off of their funding in retirement.
So what can one do to prepare for such a situation? It is best to assume that not all of the social security benefits promised will be there if you are below the age of 50. To be safe, those who are under age 50 should assume they will see at least 15% of their benefits cut. Those who are expecting health benefits from a private pension plan should also be wary. If your company declares bankruptcy, you will very likely see your health plan eliminated or severely reduced.
In terms of preparing for such cuts, I have always recommended saving more money today and cutting expenses while in retirement. But before any of this, it is very important to get a handle on when your funds might run out in retirement. Planning today will make things much better for you when you’re ready to retire.