By Liz Weston, MSN Money
If a defined benefit pension is part of your retirement plan, there’s good news and bad news. Find out what you need to know to protect yourself.
The big attraction of traditional pensions is their promise of security. They’re designed to provide to a steady stream of checks in retirement to last the rest of your life. Unlike a 401k or other workplace contribution plan, what you get from a defined benefit pension doesn’t depend on how much or how well you invest.
“Even during a downturn, (retirees receiving pensions) know how much they’re getting on a monthly basis,” said Karen Friedman, the executive vice president and policy director of the Pension Rights Center. “They know how much they can spend.”
Increasingly, though, that promise of security is being broken. Lousy investment returns, changing company policies and taxpayer concerns about public retirement benefits are putting many pensions at risk. Consider:
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• Nearly 80% of the private pension plans covered by the Pension Benefit Guaranty Corp., or PBGC, are underfunded, to the tune of $740 billion. The news is even worse among the nation’s largest companies. Only 18 defined benefit pension plans offered by companies in Standard & Poor’s 500 benchmark are fully funded.
• More than 1,400 companies shut down their pension plans in fiscal year 2011, compared with 1,200 in 2009, according to the PBGC. An additional 152 plans failed, meaning they were terminated without enough money to pay promised benefits and were taken over by the PBGC. The PBGC itself, which is funded by employer-paid insurance premiums, is running a $26 billion deficit.
• Public pension funds are underfunded by at least $1 trillion, according to a report by the State Budget Crisis Task Force. To close the gap, 35 states have reduced pension benefits for their employees, and half have increased worker contributions to their plans, according to a report released in March by the U.S. Government Accountability Office. Three states — Georgia, Michigan and Utah — have implemented hybrid plans that include defined contribution plans, similar to 401k’s, that shift some investment risk to workers.
• Even fully funded retirement plans aren’t exempt. General Motors, once considered the model for running a solid pension plan, shocked its salaried retirees by announcing it was offloading their pensions to Prudential Financial. About 42,000 retirees had to make the difficult decision whether to take a lump-sum settlement or trust Prudential to send them monthly checks.
“These are the folks who thought they were totally protected, and then the company lays this on them,” Friedman said. GM’s move may give other companies the “green light” to consider similar actions, she said.
Traditional pensions are on the wane, but plenty of people still have them. Private plans cover nearly 44 million people, according to the PBGC, and public plans cover about 23 million (15 million active members and 8 million annuity recipients), according to the Census Bureau.
If you’re one of them, here’s what you need to know:
Everything changes. That’s the bad news and the good news. Plans can be frozen, shut down or altered, changing how much you can expect in retirement. But investment climates change as well. “Pension funding is very cyclical,” Friedman said. “What’s underfunded now could be adequately funded in a couple of years. It’s not a cause for panic.”
Friedman does recommend reviewing the annual benefit and funding statements your plan sends so you can gauge its health. Anything below 80% funding is cause for concern. Although you can’t do much to correct an underfunded plan, you can let the company know you want the benefits you’ve been promised.
“Make it clear to your employer that you value your pension,” said Rebecca Davis, the Pension Rights Center’s legal director.
The private plan benefits you’ve already earned are protected (pretty much). Companies with private plans can change the rate at which you earn future benefits, including ratcheting that down to zero if the plan is frozen or terminated. But companies typically can’t mess with benefits you’ve already earned. Federal law protects “vested” benefits — those that you’ve earned after working for a certain number of years. The plan may require you to work five years before you’re 100% vested, for example, or it may offer gradual vesting, so that you would be 20% vested after two years, 40% at four years and 100% at seven years.
If your plan fails, however, there’s a risk for higher-paid workers. If the plan is underfunded when it’s terminated and the company can’t cough up the needed cash, the PBGC usually steps in, and the amount it can pay retirees is capped based on age. For a 65-year-old, the cap is $4,653 a month, or just under $56,000 a year; for someone who’s 55, the cap is $2,094 a month or about $25,000. Since the median private pension benefit was less than $8,000 in 2008, that means most workers will get everything they’ve earned, but some longtime employees with high earnings can take big hits.
Already-earned public plan benefits are usually protected, too. The PBGC protects only private sector plans, but state constitutions or other laws typically guard the benefits already earned by public sector workers. That’s why most states that have trimmed benefits have done so only for new hires, although some have also done so for retirees and current workers. Many state and local governments have required workers to increase their contributions as well. (Unlike most private plans, which are employer-funded, public plans typically involve both employer and employee contributions). The Center for State and Local Government Excellence has an interactive map of changes governments have negotiated in public plans.
Older workers face particular risks. Most pensions are designed to give extra weight to your pay in your final years of work. If your plan is frozen or terminated while you’re in midcareer, you typically lose the significant boost that higher earnings in your 50s and 60s could have given your benefit.
You need to save. It should be clear by now that relying solely on pension promises is risky. If your company also has a defined contribution plan, such as a 401k or 403b, you should be putting in enough to get the full match, if there is one. Even if there isn’t a match, your contributions typically offer a tax break. If you can’t contribute to a plan at work, consider putting money into an IRA or Roth IRA.
Keep track of your plan. Your worries aren’t over if you leave your job. The Pension Rights Center says it regularly hears from people who have lost track of a plan after a previous employer closed or merged. Others wind up having to prove they’re owed benefits. The center recommends retaining records of your employment history (such as your W-2 forms), getting a copy of the plan’s most recent summary plan description before you leave and making sure the company and the plan have up-to-date contact information for you.
For more, read the center’s “Tips for Keeping Track of Your Pension.” If you’re having problems with a pension or 401k, you may be able to get free legal advice from the U.S. Administration on Aging Pension Counseling and Information Program, which serves residents in 30 states.