Defined benefit pension -- please help!

[Merdox]

Noble Mustachians,

My dad is absolutely clueless about money and I'm trying to make sure he's not getting screwed, so I would deeply appreciate your expertise. He's a small business owner and has a defined benefit pension plan managed by a pension/financial services company. He's turning 67 and will likely have to retire in 2020 (when the lease ends). He made the mistake of never really saving in the past, so he's been trying to catch up in recent years. His current dollar value in the pension plan is about $450,000, and I believe his monthly calculated benefit right now is around $2,800 (the employees have negligible benefits at around $80 monthly benefits). Other than his house and store, he has no other assets. I spoke to his investment officer recently, and I'd love your objective feedback. The portfolio summary he sent me shows a 0.54 expense ratio, and the fee schedule of the company is 1.5% for up to 499K and 1% for 500K to 999K.

The defined benefit pension plan is new to me, but my understanding is it would be used to buy a life annuity. My concerns are 1. the long-term costs and 2. making sure my mom is taken care of, as she's 8 years younger than him and my understanding is joint annuities pay much less, so my dad would probably take a single annuity.

How does the transition work when the pension plan is used to buy an annuity at retirement? Will this company continue involvement after that (and continue collecting fees) or is it passed off entirely to the annuity seller?

Like a proper Mustachian, I'm personally all in low cost investments that I manage myself (with Vanguard) and my dad using financial services with high costs makes me very nervous. I'm not totally sold on annuities yet, but I understand that it may make sense for someone like my dad who is close to retirement and playing catch up. Feel free to share your thoughts.

Generally, is this just a bad investment plan? Does he need to continue with this company? Are the costs unreasonably high? Is there even a way to back out and switch gears this far in? I assume not because of the tax benefits for a pension plan, but I would love some insight from your far superior financial brains. As always, thank you in advance!

[Merdox]

Come on, guys. Surely there's a pension expert among the hordes of brilliant financial minds in this forum.

Right now I'm thinking about having my dad put half his pension contributions this year into starting a Vanguard brokerage fund (not unlike mine) so he has some low cost, liquid retirement investments. Good idea? Or do you think he should just double down on his pension plan for the tax benefits despite the service fees and expense ratios? I'm not sure if I should just back off and let him continue with this financial adviser or have him change courses.

[dandarc]

You might research / ask White Coat Investor - I've seen some stuff on Defined Benefit Pension Plans there before.

In general though, they are expensive, and WCI advises them as the last tax-advantaged bucket to fill, for very high-income folks.  These are pretty exotic vehicles for a small business.

The one upside to a defined benefit plan is you can put way more into it - something like $200K / year.  Which is probably what your dad is looking for.  Also looks like he might have been swayed by the "fairness" requirements in a 401K - he'd have to put in 3% for all of his employees to safe-harbor and max one out for himself.  If he's making enough money, he could do both a 401K and a defined benefit plan.

[Merdox]

Thanks. Yeah, he's been dumping decent amounts into it yearly (which is why he started with this), roughly in the 30K-60K range. But given that he's this far in, do you think it makes sense to continue or to back peddle somehow? Is there even a clean way to do that? I'm guessing no because of the tax hit.

[beltim]

Generally, is this just a bad investment plan? Does he need to continue with this company? Are the costs unreasonably high? Is there even a way to back out and switch gears this far in? I assume not because of the tax benefits for a pension plan, but I would love some insight from your far superior financial brains. As always, thank you in advance!

There's really not enough information in what you've given us to say whether this is good or bad.  It's high fees relative to a Vanguard index fund for an individual investor, sure (although that's not a fair comparison, since this plan also administers benefits for your dad's employees).  But what are the returns?

I know a lot about pension plans in general, but I have no experience with a small business plan like this.  Is the money simply invested in mutual funds which are liquidated upon retirement to buy an annuity?  Is he currently invested in a guaranteed annuity?  In the first case, he's taking all of the stock market risk, while in the second case, the company administering the pension plan is.  There are other possibilities as well for what the money may be invested in.  We need that information before we can make any judgement at all.

[Merdox]

Generally, is this just a bad investment plan? Does he need to continue with this company? Are the costs unreasonably high? Is there even a way to back out and switch gears this far in? I assume not because of the tax benefits for a pension plan, but I would love some insight from your far superior financial brains. As always, thank you in advance!

We need that information before we can make any judgement at all.

Thanks very much for narrowing the issues. I had already sent an email to the investment advisor about exactly that (how the plan will be used to purchase an annuity). I will report back. You guys are the best.

[MDM]

He's a small business owner and has a defined benefit pension plan managed by a pension/financial services company.

As beltim said, more information is needed.

If your dad were an employee, getting the Summary Plan Description for the pension would be a good course.  Similarly, if he as the owner negotiated the agreement, then he/you should get the details of the contract he signed.

Is he also eligible for Social Security?  Your mom?  Do they know about different claiming strategies and which would be best for them?

Of course the bigger question is, "will they have enough?"  And that depends in part on how much "enough" is for them.  Probably worth some time with a retirement calculator looking at both expected expenses and income.  Good luck!

[mikesinWV]

One thing you said that worries me is that you are concerned about making sure your mother is taken care of but you are looking at a single annuity.  Think carefully about this.  What if something happened to your father early into his retirement, your mother would receive nothing. 

[pbkmaine]

Annuities can be a good idea for people who are bad with money. But you want to purchase as low cost an annuity as possible, and it needs to be joint and survivor for your mom. Probably 75% joint and survivor. I think Vanguard can handle your dad's DB plan. Call them. They can also help you to invest it without all the fees. When it comes time to purchase an annuity, shop the insurance companies. Look for the highest ratings from the ratings agencies like Moody's and AM Best.