Updated: May 3, 2013 12:14PM
Originally published: September 16, 2004
How would you feel if you were just a few years away from retirement, and your company took away a good part of your promised pension benefits? That’s potentially what’s in store for thousands of airline employees, as their companies head into bankruptcy court or struggle to emerge from bankruptcy.
But don’t think this problem of pension underfunding is limited to those who work for failing companies.
The same problem of underfunding is facing your pension: your promised Social Security benefit check. The only difference between the airlines and the Social Security system is that the government can print the money to cover the check! But the issue of retirement security is one that faces all of us, especially if you’re counting on a pension promise.
A pension used to be a sacred promise that a company made to its employees: the promise of a check a month for life, with the amount based on years of service and income level during working years. Every year the company set aside money to be invested inside its pension plan so it could one day make those promised payments. This type of pension is called a “defined benefit” plan.
Defining the contribution
In the early 1980s, a new type of retirement plan was conceived, one that put the burden of saving and investing directly on employees. It was called a 40l(k) plan, or 403(b) for non-profit organizations. Since the amount of the retirement benefit would be ultimately determined by the amount saved and the investment results, this type of plan is called a “defined contribution” plan. You define how much you’ll put in, and the results at retirement are up to you.
There’s no problem with a defined contribution, 40l(k) plan, as long as you have the discipline to save, and if you keep making smart investment choices. The problems that you see in the headlines is occurring in the defined benefit pension plans of a very few companies that simply don’t have the financial resources to keep their long-term promises.
This problem should not have arisen, because the companies used actuaries to determine how much money to put into their pension funds every year in order to pay future, promised benefits. But the decline in stock prices over the past four years has decreased the value of pension-fund reserves and increased the amount companies must contribute today to make up the shortfall. The decline in interest rates has also meant companies must contribute more now to be invested for future payments.
Plans that don’t receive current contributions are considered underfunded. That’s typically not a worrisome problem, because over time, the markets will return to their traditional growth rates, and the investments will make up for the previous lean years. And that’s all figured into the contribution requirements each year.
The big problem arises when a company cannot continue to make at least some level of contribution to its pension funds because it simply doesn’t have the money to do so. And that’s what’s happening throughout the airline industry. When a company files for bankruptcy, it’s up to the bankruptcy court to force management to find the money to fund their pensions.
If a bankrupt company can’t make the required current payments into its pension fund, a quasi-government agency called the Pension Benefit Guaranty Corp. takes over the plan. This agency isn’t funded by taxpayer dollars, but instead gets its money from insurance premiums paid by all employers that sponsor pension plans. When the PBGC takes over, it is responsible for the pension payments.
Here’s the catch: The PBGC pays a maximum annual benefit of $44,386 at age 65.
While that may seem like a lot of money, it may be half of what higher paid airline employees, such as pilots, were promised by their contracts. With those pension promises likely to go up in smoke, pilots feel betrayed by their bosses. In fact, they probably feel a lot like the Enron employees, whose bosses destroyed the value of the company stock in their 401(k) retirement plans.
Social Security’s problem
And here’s something to think about: It’s a lot like you are likely to feel when your promised Social Security benefits are either cut or paid for in dollars made less valuable by the inflation effect of the government printing enough money to pay those promised benefits. And that’s The Savage Truth.
Terry Savage is a registered investment adviser, and appears weekly on WMAQ-Channel 5’s 4:30 p.m. newscast. Distributed by Creators Syndicate.