The Latest Blow: Shrinking Pensions

Some new retirees may get smaller payouts as employers struggle to fund pension plans.

For years, Ken Hollis watched as his father, a skilled machinist at a tool-and-die shop on the east side of Detroit, worked long hours six or seven days a week, only to struggle to make ends meet in retirement. Determined not to repeat his father's experience, Hollis, an engineer in Clarkston, Mich., about 40 miles northwest of Detroit, says he deliberately chose a career path that would provide him with a guaranteed pension.

So when Hollis finished college in the mid 1970s, he accepted a job with the division of General Motors that made auto parts and worked there for 23 years. When the division was spun off as Delphi Corp., Hollis says that workers were told their pensions would carry over to their new employer. Having committed more than two decades to the company already, he decided to stick it out and worked for Delphi for nine more years.

Although Delphi filed for bankruptcy in 2005, Hollis thought his benefits would be protected. And even when he was forced into early retirement nearly two years ago, at age 54, as a result of the downturn in the automotive industry, he didn't worry. He should have.

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Early last year, Delphi announced that it was terminating health- and life-insurance benefits for retirees. Then, GM filed for bankruptcy, jettisoned the pension plan it managed for Delphi white-collar retirees, and turned the plan over to the Pension Benefit Guaranty Corp., the federal agency that insures private-sector defined-benefit pensions.If a company's pension plan becomes underfunded and the company cannot make up the shortfall, the PBGC takes over and continues to pay retirement benefits up to the limits set by law, which are adjusted each year. In mid February, Hollis was notified that his monthly pension payment would shrink by 38%, or by more than $1,100 a month.

For plans that are taken over by the PBGC in 2010, the benefit cap for workers who retire at age 65 is $54,000 a year. Those who retire at younger ages, such as Hollis, get even less. "I worked according to the rules," Hollis says. "Now that the game is over, they've changed the rules."

A growing trend

Hollis is not alone. For many of the roughly 15% of private-sector workers covered by defined-benefit plans, the so-called guaranteed pension is no longer guaranteed. Because of the 2007-09 stock-market collapse and the inability of some recession-scarred companies to sufficiently fund their pension plans, the PBGC took over 129 plans last year. That's a 74% jump from the year before, when the agency assumed 74 plans.

And 2010 is shaping up to be even worse. Through the first six months of the agency's current fiscal year, the PBGC took over 85 plans, putting it on pace to break last year's tally. The PBGC has taken over so many plans with looming obligations to future retirees that its own deficit approached $22 billion last year.

Deep freeze

But the PBGC numbers, which cover only pension plans that went bust, don't tell the whole story. Even companies that aren't filing for bankruptcy -- including some of the best-known names in corporate America, such as Kimberly-Clark, the maker of Kleenex, and 3M, which manufactures Post-it notes -- have trimmed their pension obligations for current employees or new hires.

More than 100 major companies have shut their pension plans to new workers, frozen benefit accruals for current employees, or terminated their pension plans altogether since 2006, according to a running tally compiled by the Pension Rights Center. The group, based in Washington, D.C., can help you if you're having trouble collecting your pension.

Furthermore, a recent survey by Hewitt Associates showed that 9% of defined-benefit plans are likely to shut out new workers this year. Another 9% expect to freeze their plans, barring some or all current workers from accumulating future pension benefits (although they would keep the benefits they already earned).

There's usually a lag between the bottoming of the economy and the pinch on corporations. As a result, predicts former PBGC director Bradley Belt, many more employees will see their pension plans taken over by the PBGC in future years, possibly squeezing their benefits.

What's the take-away for the average American worker? If you are counting on your traditional pension to cover your expenses in retirement, you may need a backup plan. Some retirees, like Hollis, are getting hit with a one-two punch: a smaller-than-expected pension check and the unanticipated expense of health insurance because their retiree health plans were eliminated.

The onus is on employees of a certain age to fill in the gaps created by employer cutbacks. They are more likely to be affected by pension cutbacks than most younger workers, who were never covered by defined-benefit plans in the first place. If you're 50 or older, you can take advantage of catch-up contributions that allow you to stash up to $22,000 in your 401(k) or similar employer-based retirement plan in 2010 -- $5,500 more than younger workers.

PBGC protections

If the PBGC takes over your pension plan, the amount of pain you feel may depend on how much of a benefit you were expecting and whether you retire early. Although the majority of retirees receive their full pension benefits, 16% of workers whose plans were assumed by the agency between 1990 and 2005 saw their pension payments reduced. On average, such employees lost 28% of their expected benefits. The higher your salary and the longer you've been in the workforce, the more likely you are to take a cut.

The outcome also depends on your industry. A PBGC study showed that workers in the steel and airline industries, which have powerful unions and magnanimous benefits, tended to be harder hit by the payment caps than those in other industries. The auto industry could be the next PBGC ward if government efforts to rescue General Motors and Chrysler falter, according to a new report by the Government Accountability Office.

The wreckage piling on top of workers is only partially the result of the recent economic downturn. For years, some companies failed to squirrel away enough cash to pay the obligations they promised to current and future retirees. Those low contribution levels were further compounded when the stock market tanked, shriveling pension funds heavily dependent on investment returns.

This year, corporate pension plans will have enough cash in their accounts to cover only 92% of their obligations, on average, down from 111% in 2009, according to Mercer, the workplace-consulting giant. Even more worrisome is that more than one-third of the plans Mercer surveyed have funding ratios below 80% -- a crucial level that can trigger restrictions on lump-sum payouts to new retirees. To get their plans back on track, Mercer estimates that companies will have to contribute 400% more cash this year than they did in 2009.

The burden on firms is so great that industry trade associations are asking Congress for temporary funding relief, arguing that taking a "time out" on their obligation to fund their plans will save jobs and prevent additional benefit cuts. New pension laws took effect in 2008 that require companies to meet tougher funding requirements -- particularly bad timing as they were trying to cope with the sluggish economy. "Obligations for defined-benefit plans soared at a time when the economy was weakest," says Lynn Dudley, senior vice-president of policy at the American Benefits Council, the national trade association that represents businesses with pension plans.

Payout restrictions

Your plan's funding level could affect your payout choices. If your plan offers a lump-sum payment option and it is less than 80% funded this year, you will be allowed to take only half of the benefit as a lump sum. The balance will be paid in monthly installments or as a deferred lump sum when the plan is at least 80% funded again. If your benefit is worth less than $5,000, however, you may still take your benefit as a lump sum.

Depending on how underfunded their plans were, some companies faced an April 1 deadline for certifying their funding status; for others, the deadline is October 1. Mercer estimates that 9% of plans had restrictions on lump-sum payments in 2009. Unless companies bump up their pension contributions, that figure will jump to about one-third of plans this year, says Mercer.

If you are planning to retire with a lump sum in 2010 (and your company wasn't restricted in April), submit your paperwork well before the October 1 deadline. "If your plan is close to the edge, make sure you get paid your lump sum by early to mid summer," says Ethan Kra, Mercer's chief retirement actuary. Once a plan is deemed to be under 80% funded, payout restrictions kick in immediately. So if you wait until the fall to get your check, you could miss out.

The worst-case scenario: a company's pension plan drops below 60% funded, barring new retirees from receiving any lump sum (until the plan regains its footing) if the value of their pension benefits exceeds $5,000. The good news is Mercer expects just 1% of plans to fall into that category in 2010.

Associate Editor, Kiplinger's Personal Finance