The Vanishing Safety Net
For many workers, the promise of a monthly pension check in retirement is a thing of the past.
By Melynda Dovel Wilcox
May 31, 2006
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Pension checks may one day be relegated to museum exhibits along with buggy whips, telegrams and other artifacts of days gone by. The number of employers offering so-called defined-benefit plans peaked in the mid 1980s, when pensions covered one out of three private-sector workers in the U.S. By the end of 2003, pension coverage had slipped to less than one in five.
In recent years, most of the hand-wringing over pensions has been directed at corporations -- mainly in the steel, airline and auto-parts industries -- that went bankrupt and turned their pension obligations over to the Pension Benefit Guaranty Corp., the federal agency that insures private pensions. As recently as 2001, the PBGC estimated that it had more than enough assets on hand to cover its expected liabilities. But that is no longer the case. Currently, it has about $23 billion less than it needs if it has to take over several vulnerable plans at the same time. While affected retirees will continue to receive benefits from the PBGC, in some cases the payments they receive will be smaller than if employers had continued to operate the pension plans.
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And within the past year, even well-funded pension plans sponsored by healthy, profitable companies have taken a T. rex-size step closer to extinction. Some of the biggest names in corporate America -- many known for offering the richest benefits -- have backed away from making any further pension promises to employees. General Motors, IBM, Lockheed Martin, Motorola, Sprint Nextel and Verizon are among those that have "frozen" their plans. Earlier this year, GM offered cash buyouts to workers with less than 30 years of service in exchange for giving up promised pensions and retiree health benefits. More announcements are expected to follow. (Learn when it makes sense to accept a buyout offer.) Ten years from now, employers will still be paying out benefits to retirees, but few active employees will be accruing them.
Reasons behind the trend
Companies are getting out of the pension business for a variety of reasons. The sluggish stock market has kept pension-fund assets from growing to expected levels, forcing companies to contribute more. At the same time, low interest rates require employers to set aside more money to pay future benefit obligations. For example, an immediate lifetime annuity paying $1,000 a month to a 65-year-old man cost roughly $110,000 in 2000, according to the Employee Benefit Research Institute. In 2005, the same monthly benefit cost about $145,000.
Looking ahead, tougher pension accounting rules from the Financial Accounting Standards Board and legislation pending in Congress have the potential to make defined-benefit plans even more unpredictable and costly to maintain.
Some firms are shutting down healthy pension plans because of cost-cutting pressure from global competition. Effectively, companies are saying that "it's more important that you have a job than a rich defined-benefit plan," explains Martha Priddy Patterson, of Deloitte Consulting's Human Capital Group. At the same time, the cost of employee health care is rising so fast that it is squeezing out pension benefits.
Finally, many employers believe that their employees don't understand, and therefore don't appreciate, pension plans, particularly if they don't expect to remain with their current employer long enough to accrue a meaningful benefit. By freezing or terminating a pension plan, employers are sending a not-so-subtle message, says Karen Holden, a professor of public affairs and consumer science at the University of Wisconsin: "Your retirement is your responsibility, not the company's responsibility. It's up to you to build up an adequate nest egg."
Frozen in place
Most companies that are altering their pension plans are either implementing a "soft freeze" or a "hard freeze." A soft freeze is what IBM put into place in early 2005 when it closed the plan to all new hires. Existing employees continued to accrue benefits.
In January 2006, IBM turned down the temperature another notch, moving from a soft freeze to a hard freeze. As of 2008, there will be no further benefit accruals in the pension plan, but all benefits earned as of that date will be preserved. IBM's 125,000 current retirees, former employees with vested benefits and employees who retire prior to 2008 will not be affected.
Freezing a pension plan does not relieve a company from making future contributions, but it does mean that its pension liability will gradually melt away. It still has to pay premiums to the PBGC, and benefits are still insured if the company subsequently goes under.
"The good news about a pension freeze is that you haven't lost anything that you've already earned," says Steve Metz, of PricewaterhouseCoopers HR Services. A typical pension plan is designed so the value of benefits grows slowly when you're young and ramps up dramatically as you approach retirement age. A frozen pension is not a big deal for young workers who aren't vested yet or who are accruing benefits at a very low level. It's also not a tragedy for someone who is 64 and has already earned 90% of his or her pension accrual. The biggest losers are those mid-career workers in their fifties with many years of service.