Government Pension: Does It Have a Bond-Like Impact on the Portfolio?

Next up is Steven, and he has a really good question because pensions, of course, have declined over the last 40 to 50 years. However, there are still a lot of government employees who have pensions, and some private sector employees do too. He asked, “Can I treat my government pension as a bond in my retirement portfolio and be more aggressive with other retirement vehicles? The pension will replace 100% of the income needed in retirement, so how should he think about his pension?”

Yeah, this is really interesting, and I don’t love the way that the question gets worded because we get asked this all the time: “Can I consider my pension a bond?” Well, it’s not exactly right. When you think about portfolio construction, that’s not a one-for-one. So, I think you have to remove that thinking. But, can I or might it be okay, or is it permissible for me to have a slightly higher risk tolerance, have a slightly more aggressive portfolio because I have a pension in the background? I think that’s probably a more appropriate way to approach this, especially if you have a pension that’s backed by the government, by the full faith and credit of the government. It’s a little bit different than a pension that’s backed by a corporation that may not be as well-funded or as secure.

Stephen, I wouldn’t say, “Okay, if I need a 60/40, but my fixed income is going to be that.” I wouldn’t construct my portfolio that way. What I would think about is, “Okay, I’ve got my liquid portfolio, the dollars that I’m building and saving today. If I were normally going to be a 60/40, perhaps it’s okay for me to be a 70/30 at this stage in life because I know I have this pension in the background.” I wouldn’t think about it as a one-for-one portfolio replacement. I would think about what sort of risk capacity can my situation allow because I have this guaranteed income source in the background. Agree? Disagree?

I love that you reframe that because it does allow you to focus more on the long-term legacy of the money. That’s where I’ve run into situations exactly like this where somebody has a pension that covers 100% of their living expenses, and they’re living their best life. It’s just one of those things where they say, “What do I do with this now?” That’s something we talk about as financial planners. But one of the things that it does typically allow for, if you can think legacy or go beyond your life, is that you typically can then go a little more rive because you’ve got the basics covered.

Now, before I give you the all-clear to load it up and start taking on additional risk, I do want to caution you. When I hear a pension can cover 100% of your expenses, that means either you’re living a very modest life or you have a very large pension. If you have a very large pension, there is one more step of homework you need to do. Go to the Pension Benefit Guaranty Corporation website. I think it’s pbgc.gov. Essentially, just like you have FDIC insurance, the government has set up a pool for pension funds to have insurance for coverages just in case your pension is not fully funded or there are issues with solvency, liquidity for the company making this promise, or the government making this promise. There’s a cap on how much they’ll guarantee. So, if you have a high pension, there’s a chance that you might not get all of it. So, if you have a very large pension, go to the Pension Benefit Guaranty Corporation and realize your pension is substantially over their guaranteed pension. Maybe take that into account on the aggressive meter on how far you’re going to go because I wouldn’t assume that money is always safe. Very likely, it will work out and be great, but that’s another risk that you do need to be very aware of.

Did he say if he was government or private? Because he said it was a government pension. Okay, that makes it a lot safer. It’s still something an exercise I would do, but I just know for those who are watching this highlight when it comes out who may work for a private corporation that has pensions as well, think about Delta. I mean, we worked with a lot of Delta pilots, and there was a season where a lot of these folks were getting six-figure pensions. But then Delta, in a very sly way, kind of shed that responsibility as a strategic move, and it changed a lot of people’s futures. So, be very aware of that. The only other thing I would throw out there is that we know that personal finance is like 80% behavioral. So, what you don’t want to do is put yourself in a really aggressive portfolio because you think you can, because you have the pension, and then all of a sudden, we see the fourth quarter of 2018, or we see COVID, or we see the entire calendar year of 2022. Because you have a very aggressive portfolio, it leads you down the path of making a very poor decision, like going to cash or selling at the world’s worst time. Have a portfolio that matches not only your risk capacity—how much can I handle—how much should I handle because of that pension, but also your risk tolerance. How much can I emotionally handle without making a bad decision? Because a really well-constructed portfolio will satisfy both of those two pieces. For more information, check out our free resources.