November 15, 2013
By Robert Powell
If you are among the few who still have a traditional defined-benefit pension plan we wish you luck. In the coming months your employer—as part of an effort to “de-risk” the plan—is likely going to offer you a lump-sum payout, an annuity, or freeze the plan.
A growing number of U.S. employers, who are benefiting from rising interest rates and improved equity performance, are taking steps to de-risk their defined-benefit pension plans, according to a survey by Towers Watson and Institutional Investor Forums.
In fact, three out of four employers responding to the survey either have implemented, are planning to, or are considering developing what’s called a formal “journey” plan to de-risk their defined-benefit plan. A journey plan, according to Towers Watson/Institutional Investor Forums, details actions a plan sponsor will take to de-risk its pension plan once certain trigger points have been reached. [EXPAND Read more]
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“Pension plan sponsors remain under tremendous pressure to reduce the financial liabilities of their DB plans,” Michael Archer, leader of the client solutions group for retirement, North America at Towers Watson, said in a release.
And many see lump-sum payments and annuity purchases as the as the most viable option to lower their defined-benefit burdens. The reason is quite simple. Defined-benefit plans must match their assets with their liabilities, the pensions owed to current and former employers. And any unfunded liabilities—the difference between what they have and what they owe—must be made up with additional contributions to the plan, or by investing the pension more aggressively, or by transferring their pension obligation to the employee.
And the benefits to the company that de-risks their pension plan are many, according to Towers Watson/Institutional Investor Forums. By de-risking the plan, employers can improve their financial statements, increase their cash flow, and reduce the cost of operating the defined-benefit plan.
If your plan gets frozen
Companies, according to experts, are also freezing the benefits for their defined-benefit plans as way of de-risking. In fact, 40% of defined-benefit pension plan sponsors in the Fortune 1000 had at least one frozen plan by 2011, according to a recent paper on the subject, Cost Shifting and the Freezing of Corporate Pension Plans. Some of the most recent and newsworthy of these freezes include Ford Motor Co. F -0.18% , the Archdiocese of Philadelphia, Diebold DBD +0.30% , and Goodyear GT +0.09% .
So what might you consider if you are among those whose defined-benefit plan is frozen?
When a company freezes its pension plan, some or all of the employees covered by the plan, stop earning some or all the benefits from the point of the freeze moving forward, according to the Pension Rights Center.
In essence, your defined benefit is essentially locked in when your employer freezes your plan. And that means, among other things, that you’ll have to make up the difference between what you might have received from your defined-benefit plan with income from other sources, such as your personal savings. If you were planning on getting $1,000 per month, given your projected years of service and projected final pay, but it’s now $800, you’ll have to make up the $200 difference somehow, someway if you want to maintain your desired standard of living.
Revisit your plan
When a pension plan is frozen, it becomes more urgent to either update the past retirement planning or do it for the first time, according to Alan Glickstein, a senior retirement consultant with Towers Watson.
While benefits accrued at the time of the freeze are not reduced and employers often add additional 401(k) benefits when a pension is frozen, it is likely that the picture now looks worse than before, he said.
“And even if the overall picture is supportive of the desired retirement goals, the balance has now shifted more heavily toward resources that are subject to market risk both before and after retirement,” said Glickstein. “Moreover, it can be especially challenging to project 401(k) account balances given the market volatility since the recession and the historically low level of interest rates.”
Save, save, save
In other words, according to Norman Ehrentreich, a pension expert with Ehrentreich LDI Consulting & Research, it’s likely that you will need to increase your savings when your pension plan is frozen.
“Workers whose defined-benefit plans are hard frozen should increase their savings rate for two reasons,” he said. “First, it is reasonable to assume some efficiency losses in their self-directed retirement accounts compared with a defined-benefit plan through higher fees. More important, though, is their sudden loss of the longevity insurance inherent in a defined-benefit plan. The contribution dollars of employees were meant to last until the average life expectancy of the covered insurance pool. Now, employees have a 50% chance of running out of retirement funds before death. Lowering that probability means increasing the savings rate, possibly by a lot more than older workers can actually afford.”
Count your blessings
The next thing to do is to count your blessings. “Remember that you are still lucky, as you will be getting some sort of pension benefit,” said Christine Russell of Christine Russell Retirement Consulting. “Many folks today have no pension at all.”
Another expert is of the same opinion. “Participants in frozen plans will still receive a benefit. Any pension benefit they’ve earned for past work isn’t going away, it just means they won’t be earning more benefits in the future,” said Nathan Zahm, an analyst in Vanguard’s Investment Strategy Group who specializes in pensions.
Review your annual benefit statements and payout options
Besides that, experts also say that you should ask for your annual benefit statement. “If you do not ask, you may not get,” said Nick Paleveda, an adjunct professor in the Graduate Tax Program at Northeastern University and the CEO of National Pension Partners. The employer is required by law to furnish a statement known as the 204(h) notice, he said.
Others agree with the advice. “Review your annual benefit statement to see how much you will be eligible for in retirement,” said Russell. “Even a small monthly amount can take some of the pressure off their monthly cash flow needs in retirement.”
In addition, Russell recommends that you look at your summary plan document or what’s called the SPD and speak with your human resource and ask whether they can take a lump-sum payment at retirement and invest it themselves. “This might be a good option if the company providing the pension is having financial difficulties and may have too little money saved in the pension to pay a lifetime benefit,” she said. “It pays to be prepared for either option: retaining the monthly benefit as paid by the company, or taking the lump sum and investing it themselves.”
Russell also suggests that you become familiar with the different periodic payment options available as a pension, such as a straight lifetime payment, or a joint and survivor payment. “This way when you get to retirement and want to create a monthly payment, you will know their options and what will work best for your monthly budget needs,” said Russell.
Delay Social Security
Delaying the start of Social Security benefits until age 70 is another tactic to consider when your defined-benefit plan is frozen. By delaying until age 70, you essentially purchases an inflation-adjusted annuity that continues for life and in some cases maximizes your household’s lifetime benefit. Also consider using a Social Security claiming strategy after reaching “full retirement age” that maximize your household’ benefits.
The good news, according to Glickstein, is that there are many resources available—from the government, the employer and elsewhere—to help guide workers who are trying to take stock of what they have and might project to have at retirement.
“It is important, he said, to consider multiple scenarios with respect to issues such as future employment (most workers end up retiring earlier than they planned), future investment return, and life expectancy.
Will your frozen plan be terminated?
Another thing to consider is the possibility that your frozen pension plan might be terminated. “Some participants in frozen plans may find that their plan is being terminated,” said Zahm. “With the recent run-up in the equity markets and rising interest rates, many frozen pension plans are significantly better funded today, which means that there’s less of a gap between the assets in the plan and what it would cost to terminate the plan.”
As a result, he said some sponsors may decide to just go ahead and terminate the plan. “Generally in a plan termination, participants who have not already retired will be offered the opportunity to take a lump sum today or receive an annuity from an insurer,” said Zahm. “If they elect the annuity, their benefit checks will come from an insurer rather than the employer.”
Of note, Zahm said protection should be a consideration. “When your pension plan is run by your employer, the protection of your benefit, should your employer fail, comes from the Pension Benefit Guarantee Corp., but after the plan is terminated and the benefits are received from an insurer, then your benefit is protected under insurance guarantees provided by your state,” he said.
Don’t wait till it’s too late
Of course, trying to get a handle on your retirement benefits isn’t all that different for workers covered by a non-frozen pension plan or those who have never been in one, according to Glickstein.
The big take-away is that you need to do it sooner rather than later, when you are midcareer rather late-career. “It is also important for those in the middle to do this—those far enough along in their working life to have some reasonable ideas about the next phase and some resources accumulated but not so close to retirement that there is little to do to alter the course,” said Glickstein. [/EXPAND]