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Source: Is it Worth the Money to Hire a Financial Advisor? The Balance, 2021
Starting to save as early as possible matters. Time on your side means compounding can have significant impacts on your future savings. And, once you’ve started, continuing to increase and maximize your 401k plan contributions is key to retirement planning.
Caterpillar Pension Plan - Overview
Eligibility
When leaving Caterpillar with a vested benefit under the Traditional Plan, you must understand how your age and the time you separate from service will impact the timing and type of your benefit. If you are a PEP participant with a vested benefit, you are eligible to receive your pension any time after you leave the company.
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Early Retirement Special Note:
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If you elect early retirement after meeting one of the age and service requirements listed above, your pension under the Final Earnings Formula will be reduced 4% for each year (or 1/3% each month) that payments start before age 62.
Pension Plan Calculation
Final Average Monthly Earnings (FAME)
Your Final Average Monthly Earnings is the average of the highest five years of earnings out of your last ten years with Caterpillar as an eligible employee and a participant in the plan. The “years” used in the calculation end with the last 12 months before you retire or otherwise terminate employment and work backwards in 12-month increments from the
date that you retire or otherwise terminate employment.
Final Earnings Formula
The Final Earnings Formula produces a lifetime monthly pension equal to the excess of a percentage (generally 1.5%) of your Final Average Monthly Earnings multiplied by your Years of Service as an Eligible Employee and a Participant in the plan (up to 35 years) over your Credited Service Formula benefit.
Credited Service Formula
The Credited Service Formula produces a lifetime monthly pension, payable at your Normal Retirement Date, equal to your
Credited Service earned while an eligible full-time employee and a participant in the plan, multiplied by the basic pension rate
and supplemental pension rate:
- *The basic pension rate is $43.35 if you retire on or after January 1, 2010. The basic pension rate may be adjusted by
Caterpillar from time to time.
*The supplemental pension rate is determined by a table listed within your Summary Plan Description (SPD), and based on the class in which you were a member for the longest period of time within the two-year period ending with your retirement or termination date.
Example #1:
The following is an example of how the Credited Service Formula and Final Earnings Formula combine to determine your Traditional benefit.
Pension Plan Distribution Options
Lump-Sum vs. Annuity
Retirees who are eligible for a pension can typically choose between ongoing annuity payments or a lump sum payout. Choosing an annuity effectively means that you receive income payments for life, which may be appealing if you're worried about outliving your assets. Your annuity will continue as long as the pension plan stays solvent, providing steady, reliable income regardless of how long you live in retirement.
The major downside of choosing to receive a monthly pension is that benefits are often reduced following the early or untimely passing of the retiree and/or joint annuitant. In some cases, the pension ends altogether upon death. Additionally, unlike with Social Security, company pensions rarely contain a cost of living allowance (COLA). As a result, recieving a fixed dollar amount as a monthly pension payments means that sum will lose purchasing power during the course of your retirement.
In contrast, selecing a lump sum payment provides you with the equivalent present value of your monthly pension income stream all at once. If you roll that money over into an IRA and invest it, the idea is that you could potentially achieve a higher rate of growth over time to generate the cash flow needed to take systematic withdrawals throughout your retirement years in your city, your state. Additionally, if a balance remains upon your death, it can go to your surviving spouse or heirs.
However, if you fail to invest the funds for sufficient growth, there’s a danger that the money could run out altogether and you may regret not having held onto the pension’s “income for life” guarantee.
Ultimately, the risk assessment that should be done to determine whether to take guaranteed lifetime payments or the lump sum that your Caterpillar pension offers depends on what kind of return you would need to generate to make your lump sum replicate your annuity payments. For instance, if a modest annual return (like 1% or 2%) would create the same cash flow as your monthly pension payments, there is less risk that you will outlive the lump sum. However, if the equivalent cash flow requires a higher and riskier rate of return, there's a greater risk that those returns won’t manifest and you could run out of money.
The decision you make matters. If you'd like some guidance, reach out to an advisor from The Retirement Group.
Interest Rates and Life Expectancy
Current interest rates, as well as your life expectancy at retirement, have a large impact on lump sum payouts of defined benefit pension plans.
Rising interest rates have an inverse relationship to pension lump sum values. The reverse is also true: declining or lower interest rates will typically increase pension lump sum values. Interest rates are important for determining your lump sum option within the pension plan.
The Retirement Group believes all Caterpillar employees in your city, your state should obtain a detailed RetireKit Cash Flow Analysis comparing their lump sum value to their monthly annuity distribution options, before making their pension elections.
As enticing as a lump sum may seem, the monthly annuity for all or a portion of the pension may still make better sense, especially in a high interest rate environment.
Each person’s situation is different, and a complimentary Cash Flow Analysis from The Retirement Group will show you how your pension choices stack up and play out over the course of your retirement years, which could last two, three, or even four or more decades.
By knowing where you stand, you can make a more prudent decision regarding the optimal time to retire, and which pension distribution option best meets your needs.
Over half of plan participants admit they don’t have the time, interest, or knowledge needed to manage their 401k portfolio. But the benefits of getting help go beyond convenience. A Charles Schwab study found that those plan participants who get help with their investments tend to have portfolios that perform better: The annual performance gap between those who get help and those who do not is 3.32% net of fees. This means a 45-year-old participant could see a 79% boost in wealth by age 65 simply by working with an advisor. That’s a pretty big difference.
Getting help can be the key to better 401k results across the board in your city your state for those around retirement age years old. According to the study, those using independent professional advice:
- Improved savings rates – 70% of participants who used 401k advice increased their contributions.
- Increased diversification – Participants who managed their own portfolios invested in an average of just under four asset classes, while participants in advice-based portfolios invested in a minimum of eight asset classes.
- Increased likelihood of staying the course – Getting advice increased the chances of participants staying true to their investment objectives, making them less reactive during volatile market conditions and more likely to remain in their original 401k investments during a downturn.
Don’t try to do it alone. Get help with your Caterpillar 401k plan investments. Your nest egg will thank you.
Net Unrealized Appreciation (NUA)
When you qualify for a distribution from your employer-sponsored retirement plan, you have three options:
- Roll over your qualified plan to an IRA and continue deferring taxes.
- Take a distribution and pay ordinary income tax on the full amount.
- Take advantage of NUA and reap the benefits of a more favorable tax structure on gains.
How does Net Unrealized Appreciation work?
First, employees must be eligible for a distribution from their qualified company-sponsored plan. Generally, this means reaching retirement or age 59 1⁄2. Second, NUA only applies to company stock that has been offered as part of your 401k plan. In other words, if you have Caterpillar stock that has appreciated over time, the NUA strategy may benefit you.
To leverage NUA, you would start by taking a lump sum distribution from your 401k plan, distributing all assets from the plan within a one-year period. The portion of the plan that is made up of highly appreciated company stock is transferred to a taxable brokerage account. The remaining balance can then be rolled into an IRA for further tax deferral.
The tax benefit comes when you transfer the company stock from a tax-deferred account to a taxable account. At this time, by making a NUA election, you can reduce taxes owing on your stock's appreciation, paying long-term capital gains rates based on the cost basis of your stock. The appreciated value of the Caterpillar stock above its basis is not taxed at the higher ordinary income tax rate, which could be as high as 37%, but at the lower long-term capital gains rate of 0%, 15%, or 20%. This could mean a potential savings of 20% or more.
If you are in your city, your state, and approaching retirement age, you may be interested in learning more about NUA with a complimentary one-to-one session with a financial advisor from The Retirement Group.
IRA Withdrawal
Your retirement assets are likely spread across a variety of accounts, such as IRAs, 401ks, taxable accounts, and others. 
So, what is the most efficient way to take your retirement income after leaving Caterpillar in your city, your state?
You may want to consider meeting your income needs in retirement by first drawing down taxable accounts rather than tax-deferred accounts. This may help your Caterpillar retirement assets last longer as they continue to potentially grow tax deferred.
You will also need to plan to take the required minimum distributions (RMDs) from any company-sponsored retirement plans and traditional or rollover IRA accounts. For thoes born between 1951 and 1959, RMDs begin at age 73. Current legislation allows account owners to delay taking their first RMD until April 1 following the later of the calendar year they reach age 73 or, in a workplace retirement plan, retire.
Two flexible distribution options for your IRA
When you need to draw on your IRA for income or to take your RMDs, you have a few choices. Regardless of what you choose, IRA distributions are subject to income taxes and may be subject to penalties and other conditions if you’re under 59½.
- Partial withdrawals: Withdraw any amount from your IRA at any time. If you’re 73 or over, you’ll have to take at least enough from one or more IRAs to meet your annual RMD.
- Systematic withdrawal plans: Structure regular, automatic withdrawals from your IRA by choosing the amount and frequency to meet your income needs after retiring from Caterpillar. If you’re under 59½, you may be subject to a 10% early withdrawal penalty (unless your withdrawal plan meets Code Section 72(t) rules).
Your tax advisor can help you understand distribution options, determine RMD requirements, calculate RMDs, and set up a systematic withdrawal plan.
Additionally, if you or your eligible dependent don’t enroll in Medicare Parts A and B, your provider can bill you for the amounts that are not paid by Medicare or your Caterpillar medical plan, making your out-of-pocket expenses significantly higher.
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