Updated: May 3, 2013 12:14PM
Originally published: November 21, 2002
If you’re counting on a pension check, you’d better do a quick checkup.
Pension funds make a simple promise: a check a month for life. There are variations, of course. You can take smaller monthly checks and cover your spouse’s lifetime as well. But you have no discretion over how the money inside the plan is invested, or the amount you will receive each month. Those kinds of pension plans are called “defined benefit” plans.
That’s just the opposite of 401(k) plans, where the ultimate payout depends on the amount you contribute and how your investments grow inside the funds you choose. That’s why 401(k) plans are called “defined contribution” plans.
Pension plans have always been viewed by participants as more of a sure thing, while 401(k) plans (and 403(b) plans for non-profits or 457 plans for government employees) are variable, and thus riskier, at least in terms of the ultimate payout.
But if you look at corporate earnings reports these days, you’ll find there’s new risk in the staid pension retirement plans. Every year companies use some of their earnings to make a pension plan contribution. The amount of the annual contribution depends on actuarial formulas, but ultimately it’s based on a projection of future payouts versus expectations of investment results.
When the investments inside the plan are doing well, the required contribution is lower, or nonexistent, as it was in the 1990s.
But lately those investment results have been horrible, and interest rates continue to fall. Corporate actuaries are sharpening their forecasts and requiring companies to ante up more out of earnings for pension contributions.
Ameritech Corp. parent SBC Communications warned that next year, earnings will be reduced by $1 billion to $2 billion. Yes, that’s a “b,” because of additional required contributions to its pension plan and retiree medical expenses. Credit Suisse First Boston reports that 360 of the 500 companies in the Standard & Poor’s 500 index are underfunded, to the tune of $243 billion.
For some companies, those required contributions will not only dent their earnings but could force them to the brink of insolvency if lower stock prices continue. That should make retirees and today’s workers think about what happens to their promised pension benefits if a company goes bankrupt.
Yes, there are some government guarantees for pension benefits. But just like the guarantees behind bank deposits, there are limits. The Pension Benefit Guaranty Corp., which is funded by contributions from solvent company pension funds, stands behind corporate pension fund payouts. And ultimately, the taxpayer stands behind that government-backed guarantee fund.
But the agency covers only a maximum annual payout of $42,954 for a 65-year-old worker retiring this year. (The amount of coverage depends on the year of retirement and the age at which the worker retired.) But many retirees were counting on far more than $3,600 a month in pension benefits.
And what about the guarantee fund itself? It currently has a surplus of about $4.8 billion--cut in half in the last year. The agency was paying the pensions--or at least part of the promised pensions, up to its limits--of 268,000 retirees at the end of fiscal 2001. But, according to a study in the Christian Science Monitor, that number has now probably risen to nearly 400,000 retirees.
That leaves more than 34,000 pension funds, with millions of retirees, depending on the dwindling guarantee fund in case of company bankruptcy filings. And who will be footing the bill? Look in the mirror.
Companies recognize the growing problem, and many have switched to defined-contribution plans. This week, Delta Air Lines said it will switch, and participants will be given a “cash value” that can be rolled into a new defined-contribution plan.
The future of your pension is worth a second thought, and some action to make yourself less dependent on that promised check. That means saving more. Take advantage of the new higher limits on IRAs--$3,500 a year if you’re over age 50. I never heard anyone complain about having saved too much money for retirement. And that’s The Savage Truth.
Terry Savage is a registered investment adviser and is on the board of directors of McDonald’s Corp. She appears weekly on WMAQ-Channel 5’s 4:30 p.m. newscast.