Do Pensions Run Out of Money? Rules and Risks

For generations, pensions have been regarded as the gold standard of retirement security, offering guaranteed income you can count on for life. However, funding gaps, longer life expectancies and economic volatility have put pressure on many pension plans. It begs the question: do pensions run out of money? Understanding the rules, risks and options for pensions is key to ensuring your retirement income is both reliable and sustainable.

Pensions are designed to provide retirees with steady income for life. However, that does not mean every plan is guaranteed to stay solvent.

A pension runs out of money when the fund’s assets fall short of its obligations to current and future retirees. This typically occurs when contributions from employers and investment returns are not sufficient to cover promised benefits. Over time, this gap can widen, especially if investment performance is weak or if more retirees live longer than the plan anticipated.

Another major factor is how well the pension is managed. Some pension funds invest conservatively to preserve capital, while others take on more risk to chase higher returns. If risky investments do not pay off, the fund may face serious shortfalls. Additionally, underfunding can steadily erode a pension’s financial health. This is when employers or governments do not put in enough money year after year

Economic downturns also put pressure on pensions. During recessions, assets in the fund may lose value just as more retirees begin to draw benefits. This double hit makes it harder for the pension to recover. This is particularly the case if contributions from employers shrink in tough economic times. In extreme cases, pension plans may reduce payouts or freeze benefits. They may also turn to government backstops, such as the Pension Benefit Guaranty Corporation (PBGC), for support.

Ultimately, whether a pension runs out of money depends on a mix of investment performance, contribution levels and longevity trends among retirees. While many pensions remain stable, others face challenges that make them less secure.

Understanding these risks can help you better plan your retirement strategy. Consider whether additional savings or professional guidance from a financial advisor might be necessary to help finalize your strategy.

Projecting the lifespan of a pension fund starts with comparing the money flowing in against the obligations going out. On one side are the assets: employer contributions, employee contributions and investment returns. On the other side are the liabilities. These are the total benefits promised to current workers and those who will retire in the future. A fund that consistently pays out more than it takes in is on track to deplete its reserves over time.

Actuaries use detailed models to estimate how long a fund can last under current conditions. These calculations rely on assumptions about investment performance, interest rates, wage growth and life expectancy. For example, if retirees live longer than expected or if investment returns lag, liabilities grow while assets shrink. This shortens the fund’s projected lifespan.

One common measure is the funded ratio, which compares the plan’s assets to its obligations. A ratio of 100% means the plan has exactly enough to cover all future benefits. If that ratio is significantly lower, the plan may only have enough money to continue paying benefits for a limited number of years. Stress testing under different economic scenarios helps highlight the fund’s vulnerability to downturns or unexpected demographic shifts.

By analyzing these factors, pension managers and regulators can forecast how many years a fund is expected to remain solvent. While these are projections rather than guarantees, they provide a valuable way for participants to understand the health of their plan. This way, you can better determine whether there is a risk of running out of money without reforms or additional funding.

When a pension fund allows for drawdown, retirees have some flexibility in how and when they access their money. Instead of receiving a fixed monthly benefit for life, drawdown plans let you take income directly from your pension pot, keeping the rest invested. This flexibility can be attractive to many investors. However, this also introduces risk, as the fund’s sustainability depends on market performance and the amount of your annual withdrawals.

A common approach is to take a fixed percentage of the fund annually, which helps preserve balance if investments perform well. Others may opt for a variable strategy, adjusting withdrawals up or down, according to market conditions or personal spending needs. The key is balancing your income requirements with the long-term viability of the fund so it does not run out too early.

Managing risk is central to a smart drawdown strategy. Keeping withdrawals modest can give your pension more time to grow. Many experts suggest around 4% per year as a starting point. Diversifying investments within the pension can also reduce volatility and improve the chances that your money lasts through retirement. At the same time, it is wise to keep a portion of cash available to cover immediate expenses without having to sell investments during a market downturn.

Because drawdown decisions have lasting implications, it often makes sense to seek professional guidance. A financial advisor can help tailor a plan that balances your income needs, investment goals and risk tolerance. With the right approach, pension drawdown can offer both flexibility and security, giving retirees more control over their future retirement income.

These are some common ways to supplement your pension benefits.

• Individual retirement accounts (IRAs): Contributing to a traditional or Roth IRA can help you grow retirement savings alongside your pension. These accounts offer tax advantages, and Roth IRAs in particular allow for tax-free withdrawals in retirement, helping to ease your overall tax burden.
• Employer-sponsored retirement plans (401(k), 403(b)): If your employer offers a defined contribution plan, regular contributions can significantly boost your retirement funds. Many employers match contributions up to a certain percentage, essentially offering free money that can compound over time.
• Social Security benefits: Most retirees are eligible for Social Security benefits, providing a guaranteed monthly payment based on your earnings history. The longer you wait to claim—up to age 70—the larger your benefit will be, making timing an important part of your strategy.
• Annuities: Annuities can provide a steady income stream similar to a pension, with options for lifetime payments. They can be especially useful for those concerned about outliving their savings. Still, it is critical to ensure you fully understand the associated fees and contract terms before purchasing.
• Personal savings and investments: Beyond formal retirement accounts, other sources of income can all supplement your pension income. These may include taxable brokerage accounts, real estate or even part-time business ventures. These options provide flexibility but also carry varying degrees of risk and management responsibility.

Supplementing your pension with one or more of these options can create a more resilient retirement plan. By diversifying your income streams, you can better weather market fluctuations, unexpected expenses or changes in pension benefits. This will help ensure a more comfortable and secure retirement in your future.

Pensions remain a valuable source of retirement security, but they are not immune to financial pressures or funding challenges. Understanding how and why a pension fund might run out of money, as well as the options available for drawdown and supplemental income, can help you prepare for both the strengths and limitations of these plans. The more informed you are about your pension’s health and your broader retirement strategy, the better equipped you will be to safeguard your future.

• A financial advisor has the expertise to help you choose a retirement number to save as well as to help you manage your investments so you can get there. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• Are you struggling with how much you need to save for retirement? Before working with a financial advisor, consider using a retirement calculator to help you estimate how much you’ll need.

Photo credit: ©iStock.com/BrianAJackson, ©iStock.com/JLco – Julia Amaral, ©iStock.com/SARINYAPINNGAM