Plan B for a Frozen Pension
When bankruptcy buffets a pension plan, benefits usually take a hit.
Adrian Hale was watching the American Airlines bankruptcy unfold with a sense of dread. Hale, 75, a retired vice-president of engineering, had already suffered a 25% hit to his retirement income because the company slashed a supplemental retirement program when it filed for bankruptcy protection in November.
American recently struck a deal that should save most of its pensions from termination, easing Hale's worries. Up to that point, he was hearing conflicting stories about what might happen if a bankruptcy judge allowed the airline to transfer its pension obligations to the Pension Benefit Guaranty Corp., the government agency that guarantees traditional pensions. "One story was that they'd calculate my maximum benefit based on my current age. The other said benefits were based on my age when I retired," says Hale. "If that were true, I would have taken one heck of a hit."
Hale's story illustrates the complexities baked into the pension insurance system. Even if Hale's pension had been terminated, his benefits from the PBGC would have been based on his current age, so the hit he already took would have been his last. Many workers in terminated pension plans fare worse. Indeed, American Airlines estimated that about 10% of its 128,000 current employees would have suffered some sort of pension loss had its plans been terminated. And it's possible that the pensions of the airline's pilots will still be transferred to the PBGC.
Like the Federal Deposit Insurance Corp., which stands behind bank deposits in the event of a failure, the Pension Benefit Guaranty Corp. ensures that troubled pensions keep their promises to retirees. It does that by assessing fees on existing pension plans to finance benefit payments for beneficiaries of failed plans. Through this system, the agency insures 44 million Americans in 27,500 traditional pension plans and currently pays monthly benefits to some 829,000 individuals. Last year alone, the agency took over 134 plans, covering 57,000 workers.
Frozen benefits. Current American Airlines employees still a few years away from retirement are likely to suffer even without a PBGC takeover, because it's likely that American will freeze its pension plan through the bankruptcy process. Patrick Hancock, a 55-year-old flight attendant, for instance, would never have been affected by the PBGC limits because his pension benefit is not rich enough to trigger the caps. But he's facing a huge loss because he'll no longer accrue benefits, and the amount of money he and other workers can expect at retirement is likely to be drastically reduced.
Hancock was planning to retire in five years, at age 60. He was expecting a $2,500 monthly pension, but he'll get roughly $1,800 a month because he won't earn those pivotal final years of accrued benefits. Now he's trying to save like crazy in a 401(k) plan. Though he's already near the annual contribution limit of $17,000 in 2012, he's able to take advantage of "catch-up" contributions that allow participants over the age of 50 to save $5,500 extra.
But realistically, even if he saves every dime he can and gets an unusually high investment return, the result of five years of saving can't possibly be enough to make up a $700 monthly shortfall for the rest of his life. "I relied on the company's promises and representations," he says. "I'm going to be hurt because they're not going to keep their promises."
If he were younger and further from retirement, he'd have a better chance of saving enough to fill the gap. Compound investment returns would have more time to work their magic.
Getting a haircut. Pensions are complex, and the insurance program that backs them is, too. If your plan is terminated and taken over by the PBGC, you could face a cut in benefits. Not all promises made by your employer are covered, and limits often apply to the ones that are.
For starters, the PBGC has a maximum amount it insures. Like FDIC limits, PBGC limits are set -- and occasionally adjusted -- by Congress. For plans that terminate in 2012, the maximum benefit is $55,841 ($4,653 per month). But PBGC benefits can be affected by three different caps: the maximum-benefit cap, based on the plan's termination date; an age-at-retirement cap; and, for those who retired years before the plan terminated, an age-at-termination cap.
For instance, PBGC maximum benefits were adjusted for 2012, but the "termination date" cap that affects any given plan is based on when the company files for bankruptcy protection. That means American Airlines workers would have been affected by the limits in effect in November 2011. Thus, an American Airlines worker who retires in 2012 at age 65 would be eligible for the 2011 maximum benefit of $54,000 annually ($4,500 per month) rather than the 2012 maximum of $55,841.
However, pension benefit caps are figured on a sliding scale that rises (and falls) with your age at retirement. So if a worker retired at age 59 rather than 65, his maximum benefit would be $34,063 ($2,839 per month) in 2012. If he was 69 when he retired, his maximum benefit would soar to $83,203 ($6,934 per month).
What if you retired early, but years before your plan terminated? Then you're subject to the cap that corresponds to your age in the year of the plan's termination -- not the age you were when you actually retired. So if you are 75 years old when your pension terminates but you retired at age 59, your benefits are determined by the cap for 75-year-olds. Someone who is age 55 at the time of a pension termination but is already retired would be subject to the maximum benefit for 55-year-olds, which is far more restrictive: $25,128 annually, or $2,094 per month.
More limits. The PBGC covers only "qualified" plans that are available to all workers. Supplemental plans that are often offered to highly paid employees are not insured through the agency -- and are often at risk in a bankruptcy.
The PBGC generally follows the rules in effect when a plan is terminated, including paying enhanced benefits to early retirees when called for in the plan documents. But there's an exception for plan enhancements that were made within five years of the plan's termination date. These benefits must vest over a five-year period and may be only partially covered, depending on when enhancements were made.