Hot Topics : Why Pension Plans Are Becoming Extinct
Lately, we have been hearing the news of Delta and United
filing bankruptcy and terminating their pension plans. In addition,
IBM and Alcoa are
moving away from pension plans to 401(k) plans. The news will continue
to be bleak, as other companies are considering moving away
from their pension plans as well. So, why are companies moving
away from these plans? First,
pension plans is usually referencing a defined benefit pension
plan where
employees earn a fixed benefit for life when they
retiree (i.e., $xxx per month). This differs from a 401(k) plan
where the employer provides employees an annual a benefit while working
based on a % of pay (usually through matching
their employee's 401(k) contributions). The
reason why Delta and United got rid of their pension plans is due to
bankruptcy, yet the question is why are healthy companies getting rid
of their plans? One
may accuse companies of doing this to reduce costs. Headlines are
usually about how much money these companies will save, however
this may be misleading which I will explain later. One of the
main drivers is really about controlling risks. And, employees
need to be aware of this because companies are controlling their risks
by
diverting the risks to the
employees
and retirees.
Why are these risks are being transferred to employees?
Pension plans became popular in the 60's and 70's when
employees were working for a corporation for most of their careers. To
reward these employees, companies gave lifetime monthly pension benefits
to its employees. Starting in the 80's and continuing in the 90's,
the trend switched to move away from these pension plans to 401(k)
plans for
several reasons:
- Employees no longer worked their whole careers for one employer and
wanted more portable benefits that 401(k) plans provide
- Many employees did not appreciate the real value
that these plans provide because receiving $x,xxx per month in retirement
did not have the
same tangible value
of receiving $x,xxx
per year in a 401(k) plan because $x,xxx paid in retirement
seems so far away
- Congress and IRS put an extra layer of regulatory burden on pension
plans which made pension plans more complex and costlier to administer
Yet, the final two nails in the pension coffin appear to be:
- The stock market downturn from 2000 to 2002 created large
investment losses for many pension plans that either had to
be made up by
higher than expected investment returns to offset these
losses (which has not happened) or by the company contributing
money
to offset these investment losses
Companies like United and Delta that suffered from a prolong
business downturn could not survive in an environment of loosing
money and needing
to make large pension contributions to make up for the investment
losses from 2000 to 2002. Thus when they terminated their
plans, PBGC (Pension Benefit Guarantee Company)
was left to pay out these pension benefits
using the company's pension plan assets which were underfunded by several billion dollars
due to investment losses from 2000 to 2002.
- Pending legislation aimed at saving the PBGC by shortening the
time
period that companies have to contribute money (to make up for
investment losses) will drive many companies to drop their plans
In the end, a pension plan will have a hard time surviving in
this economic environment. Businesses need to have
flexibility to meet the needs of the market and fend of competition
from newer
leaner competitors. With
this pending legislation, a company with a pension plan will lose flexibility
because the time period they need to make contributions for the market losses
will decrease from 5 to 10 years to 3 to 5 years. This means
that during an economic downturn, a company not only needs to have
cash to meet payroll but also to find cash to make a much larger contribution
to its pension
plan to make up for investment losses in its pension plans. This
will make it difficult and if not impossible to compete with
a competitor that
does not have a similar pension plan burden. Therefore,
companies are looking for greater stability in their cash
flow needs that 401(k) plans provide.
So what should I do if I am in a pension plan?
- Do not panic - Even if a company drops its pension
plan, they can not decrease the benefit that you have already accrued. So
if you are older and near retirement, the benefit you have accrued
can not be taken away. If you are younger, you have time
to increase your 401(k) plan to make up the difference. In
addition, in case your company goes bankrupt, most pension plans are
covered by the PBGC which
guarantees to pay out lifetime benefits up to $3,971 per month at age
65 (for plans terminating in 2006). For many employees, this
means that their benefits will be fully protected. Those
that may lose some of their benefits (those who are on the news) are
higher income individuals such
as the
United
and
Delta pilots. Note, when you hear of rank-and-file employees
losing their benefits, this is future benefits that could have been
accrued if they continued to work to retirement. Yet, as we all
know, there is no guarantees of future employment, let alone future
benefits.
- Do not blame the company - Many companies take
this step as a part of the ultimate survival of the company (even
if they are not in trouble currently). Companies
are trying to fend of competition from smaller firms that may provide
smaller
benefit
packages. So, the question is, would you want to ensure your future
benefits at the risk of losing your job? I
have been in meeting with several companies when they are making
these decisions. Many are not trying to find ways to pull a fast
one on their employees, rather they tend to go out of their way (if
they can economically)
to find ways for their current employees
(in particular those who are most affected) to be protected as much as
possible from such
a change (e.g. continue to provide benefit accruals for several years). Remember,
blame will only hold you back in the past rather than taking charge
of your
financial
future.
- Figure out what you need for retirement -
As companies are moving the responsibility of retirement benefits to
its employees, employees need to take responsibility for knowing what
they need to to be able to retire. Even if you can
not save right now, figure out what you need to save in the future
to meet
your retirement needs.
- Do not wait for your company or Social Security to change,
act now - The writing is on the wall that we can not depend
on receiving as much from our government or our companies for
retirement, so get a head start on your retirement security
by factoring in a cut
back in future benefits
from
both your company and Social Security. You can wait to act.
Yet, it will only make it harder if and when these changes
do occur.
As a side note, why do company's save millions when they
change their pension plans? There are several reasons why this
can be so. Many would initially believe that it is because
employees benefits are reduced. Yet, this is not necessarily so. Due
to accounting rules, many company's have accrued on their financial books
larger pension benefits than what actually has been accrued (due to projecting
salaries to retirement). When companies freeze their plans, they
reflect that benefits accrued to date are less than what is actually
on their financial books for accounting purposes. So,
they need to reduce this accounting number and it shows
up as a reduction of costs for accounting purposes. Yet, in reality
the employees accrued benefits have not changed. The money
saved may be just an accounting issue. The Financial Accounting
Standards (FAS) wants to accrue the ultimate benefit over a specified
number of years and usually does not correlate to what an employee's
actual benefit is at a given point of time.
It, also does not mean that the average employee will receive
less of a benefit at
retirement
compared to
what he would
have
received if the prior plan continued. So, it is improper to jump
to the conclusion that a change in pension benefits is done just to
save money at the expense of its employees. |
