For me, it’s simple.

When my father passed away in 2005, my mother had advanced dementia and needed to move to a memory care facility. For those of you who have paid for such services, you know what skilled residential care costs — easily exceeding what it costs to attend a private university.

As she needed more care, I recall writing checks for more than $7000 a month. That was almost 20 years ago. Today, that eye-popping number is the median cost for residential memory care, according to the National Council on Aging. Harvard is a bargain compared to Happy Trails Adult Care Home.

While my wife and I would have (happily) paid for my mother’s care, my father’s teacher pension helped helped keep my mother safe, secure, and cared for after he died.

These are among the many reasons that I hug my pension. Let’s explore some basics about how pensions work and why you should hug your pension too.

Welcome to Pensions 101

Pensions are an essential leg of your financial independence. and as an educator, you are among the lucky Americans to have one!

The goal of this post will be to grow your pension IQ so that you can research and better understand your own pension plan and options.

While this post get into some necessary detail, this is not an encyclopedia article on pensions — more like crib notes. Once your read this post, you can keep building your pension confidence by reading Why Pensions Are Your Last (Almost) Free Lunch and How To Hack Your Pension.

Let’s start with three reasons why your pension is retirement GOLD!

1. Guaranteed lifetime income

Pensions are old-fashioned in a good way. They provide guaranteed retirement income for your lifetime, and if you choose it, for your partner. I’ve already shared the challenges my educator parents faced in retirement. While my father could have made other choices to plan for his retirement, he made one really good decision when he began receiving his pension benefits.

To his credit, he included my mother as a beneficiary for his pension. While it reduced his benefit, that benefit continued after he died and helped offset the cost of my mother’s care. While the cost of her care eventually exceeded his pension and Social Security benefits, this guaranteed income was essential to her survival and care. This was also the case for a close friend whose mother, also a teacher, also suffered with dementia after her husband’s death. Her pension paid for her care and needs as her family supported her. 

There are financial writers and bloggers who are less bullish on pensions than I am. But there are also many more who envy those of us who have pensions. Many financial advisors seek to replicate the guaranteed income of pension (and make money) through products like annuities. Those who argue against pensions usually base their argument on two assumptions:

1. The pension fund itself may go under and/or
2. You can do better with your money by investing it yourself.

While many private pensions have ceased to exist and some state pensions are underfunded, those that remain have been stabilized. And despite the economic shocks of the Great Recession and the Pandemic, these programs have come through largely unscathed. While future financial shocks are likely to occur again, my own investments are likely to fare worse in a crisis than the expert management of the public pension programs. 

This gets to the second argument, which amounts to a bet that you can take your money out of the retirement program and do better than the wonks whose job and legal responsibility is to ensure you get a guaranteed benefit each month.

I’ll take the guaranteed lifetime money, please.

2. Pensions are a simple bargain ‘annuity’

In recent years, financial writers have warmed up to annuities as a solution for ensuring lifelong income in retirement. While annuities have been around for years (and quite popular in educator circles), they have a history of high costs and confusing and sometimes deceptive marketing.

In its most basic form, an annuity is much like a life insurance policy in which you exchange a sum of money for guaranteed payments over time. There are an infinite number of variations in this basic formula, but essentially it’s a bet between you and the annuity provider — you fork over a chunk of cash for a lifetime of payments. If you live really long, you win. If you don’t, they do. 

Because most non-educators don’t have pensions, annuities have become more popular as a way to guarantee income in retirement. But annuities can be profoundly confusing and the annuity marketplace takes advantage of this confusion. Just Google ‘best retirement annuities’ and you’ll see what I mean. 

For educators with pensions, you are already ahead of the game. Your pension is like a hassle-free annuity. When you qualify for your pension at retirement, you will have future guaranteed income for life.

3. Pensions ensure stable cash flow

One of the biggest financial changes that occurs in retirement is that your income changes overnight. After receiving paychecks for decades, your steady work-based income either stops or decreases, depending on whether you continue working in some capacity after retirement.

Retirees must shift from passively earning money through their employment to actively managing their retirement investments and income flows. In the last century, this was far less complicated bacause many retired workers simply began receiving income from their traditional pensions and Social Security. This was the case for my dad, although this income stream turned out to be insufficient.

In modern retirement, you have to replace employment income with other sources and manage these investments and assets far more than you did before you retired. These options include a variety of options depending on your circumstances.

• Social Security benefits
• Personal savings
• Annuity payments
• Distributions from sales of investments
• Dividends or interest from investments
• Rents or proceeds from real estate
• Pensions

For most American adults, Social Security is the only ‘guaranteed’ retirement income source outside of personal retirement savings and investments. In Why Pensions Are Your Last (Almost) Free Lunch, I explain how and why educators are some of the last workers who have access to and can benefit from retirement pensions.

Pensions can provide a steady and solid income foundation in retirement, much like your former paycheck. While the amount will be smaller than when you were working, it will nevertheless be locked in for life.

But wait! When you add Social Security benefits, you will also receive lifetime income from the U.S. Government. Combined with your pension, you now have two stable, steady, and secure streams of income coming to your bank account every month.

Contributions and distributions

Understanding pensions, not to mention other investments, involves two very distinct and unique functions and phases of saving for the future.

In the first phase, you (and likely your employer) make regular contributions to the pension program over multiple years or decades. This first phase is about building value and assets for your eventual retirement.

In the second phase, you begin taking distributions from your pension, also over multiple years or decades after you qualify for retirement benefits.

In order to understand pensions, it helps to explore each of these phases on their own. Let’s begin by understanding more about contributions to your pension and some of the options that you might have.

Putting money into the pension

Defined benefits are fine indeed

Defined benefit plans are ‘classic’ pensions in which contributions from an employer and/or employee are collected over time and invested in order to provide future retirement benefits for qualified participants. In the last century, this was pretty much the only kind of pension that existed. Social Security is a type of defined benefit plan.

Unlike the one-size-fits-all pension programs that Baby Boomers enjoyed, modern pensions are far more complicated. In order to ensure they remain solvent and able to provide benefits, your educator pension has evolved. While pension programs will vary across states and systems, the following are likely features of your retirement plan

Blend of defined benefit and defined contribution

While most pension plans offer some type of guaranteed defined benefit, they are also likely to include a defined contribution program in which you, as a member, elect to invest a portion of your paycheck into a variable fund or program. Some old(er) educators (like me) may have pensions which are only have a defined benefit component.

Defined benefit = guaranteed monthly income
+
Defined contribution = variable investments

Much like investing in mutual funds or individual retirement accounts, the defined contribution component of your pension requires you define how much you want to contribute and where you want the money invested.

Set it and (almost) forget it

Time and patience is necessary for the pension to become valuable. For the defined benefit portion, the following areas are what determines your eventual benefit.

• Months and years of qualifying educational employment
• Average salary in a specific period of time
• Multiplier based on your program and date of retirement

For the defined contribution portion, the key consistent investment into your selected funds.

The good news is that both of these components are largely ‘set it and forget it,’ meaning that once you start working in a covered educational position, you’ll begin accruing service credit and adding value to your retirement account.

And once you specify the percentage or amount of your defined contribution, this will automatically be deducted from your paycheck each month until you initiate any changes.

Getting money out of the pension

Depending on your pension program, there are defined criteria for when you can begin receiving benefits. Since most educator pension include both defined benefits and defined contribution components, let’s look at each of these separately.

Define my benefits!

As shared above, your defined benefits are calculated based on your years of service, average compensation, and a specific multiplier. Without getting into the weeds, the longer you work and the more you make translates into a larger benefit.

If you work in a qualified educational position for certain number of years, you become ‘vested’ in the pension program. This means that you qualify for some level of defined benefits when you reach retirement age.

Each retirement program has a different ‘full retirement age’ when you qualify for and can receive benefits. While you may be able to claim benefits earlier than this age, they will be reduced. In some programs, you can delay receiving benefits in order to receive a higher amount.

When you apply to receive your defined retirement benefits, you can select to either receive a regular benefit in which you will only receive payments while you are alive or some type of beneficiary arrangement to continue benefits after you die.

Raise me the defined contributions

Since most educators these days also have made defined contribution investments to complement their guaranteed defined benefits, you will also need to make some decisions about if, how, and when you’d like to take distributions from these accounts.

In some cases, you will need to begin taking money from these accounts at the same time you begin receiving defined pension benefits. Some programs may allow you to defer distributions until a later time.

In some cases, the distributions from the defined contribution investments may be included in your pension check. But since there are many additional options for how and when you sell assets or receive interest or dividends, this income will likely be separate from your monthly pension payment.

Of course, all distributions are subject to IRS guidelines and rules specific to tax-advantaged accounts. In many cases, any distributions from such accounts before you are 59 1/2 years old will incur a penalty for early withdrawal.

Last thoughts

Before you take the money and run, make sure you read Why Pensions Are Your Last (Almost) Free Lunch. In that post, I offer some strong reasons to consider holding onto your old-fashioned pension.

You. Can. Do. This.

Now

1. Identify your pension program and create an online account to access information about your pension plan.
2. Download the guide to your specific pension program and read it when you’re trying to fall asleep.

Next

1. While it’s not quite the same as winning the lottery, imagine what you’d do if you became an FIE (Financially Independent Educator).
   • Would you remain doing what you do now or do something different either in education or outside education?
2. If you haven’t already, calculate your net worth to begin assessing your state of financial independence.