I am one year and five months away from being fully vested in my agency’s pension plan. As I mentioned previously when I discussed what happens to your pension when a company goes bankrupt [1], I contribute 6.45% per paycheck and my employer matches this contribution. Another nice option for staying with my employer for an extended period of time is that Health insurance is offered as part of the pension after ten years (I am working on five years). However, I noticed on my last pension statement that there is an asterisk beside the health care plan information. In smaller font, it basically states that health insurance being offered to pensioners is at the discretion of the employer and could be changed at any time. When one is looking for certainty in their retirement planning, this obviously is not something they wish to hear.
More uncertainty in retirement planning has been introduced with a new law that passed this year concerning pensions. On July 6, 2012, President Obama signed into law the Surface Transportation Bill. Despite its title, this bill has potential consequences for pensioners as they retire and look to retire in the future.
Details of the New Pension Law
This bill extends low interest rates on student loans, as well as renews several transportation projects. So what does it have to do with pensions? It was partly paid for by changing pension laws. $19 billion is being raised by increasing the amount of money companies must contribute to the pension asset fund [2]. The other part is a little more interesting. Pension fund contributions by companies are tax deductible. So this law allows companies to calculate their pension fund earnings by assuming the interest rate will be near the average of the past 25 years, rather than the past two years when interest rates have been extremely low. This means they will have to contribute less to pension fund plans, which means they will receive less tax deductions.
Companies Changing Payout
I read an article in the Wall Street Journal that highlights a growing trend in the pension world. Companies are beginning to offer lump sum payouts to pensioners in the hopes that they will accept the lump sum instead of the monthly paychecks. This is obviously cheaper for a company, as well as a good option when as of June 30th this year the Milliman Pension Funding Index showed that 100 U.S. public companies had a funding deficit of $415 billion to their pensions (WSJ, July 12, 2012). Two companies (General Motors and Ford Motor) gave a group of retirees until July 20th to decide if they wanted a payout ranging from $300,000-$500,000, or if they want the steady paycheck. That is a large sum of money! And while this is only two companies, the thought is that many other companies are watching and waiting to see what type of response they receive. In other words, many more companies may attempt this in the future in order to terminate the pension program and distribute their assets.
My Thoughts on these Changes for the Pension
Raising the amount employers must contribute to the pension asset fund is probably a good move. In 2011 alone the Pension Benefits Guaranty Corporation [3] (a US Government Agency) had to bailout 152 plans. However, it sounds like the money is being raised for one thing (to guarantee pension funds) and will be used for another (the transportation projects and lower student loan interest). I think that probably happens a lot…And in the second case where companies need to contribute less towards their pensions, I wonder how that will bode for future pension fund recipients (like me, hopefully)? It is essentially assuming that market rates will be what they once were. While the market has a good overall history, what happens if the market finds a new normal and the rate of returns never fully achieve what they used to be capable of? This would mean that companies may be slowly bankrupting their own pension funds. I think only time will tell on whether or not this was a good idea.
As far as the change in payout, I think so long as you are disciplined in spending money, then this is an okay option for you. However, how many Americans are disciplined in spending money? Will they get out the excel sheet and online calculations to figure out just how much of the lump sum they can withdraw each month so as not to outlive their bank account? Will some invest the money without regard to risk and age and lose part of it? Or will this lump sum feel like winning the lottery to others resulting in house renovations, new cars and other large (and offset) purchases?
Decline of the Pension
Pensions are a dying breed. We’ve heard in the news time and time again of government agencies and companies alike being saddled by their pension obligations from previous decades. I feel for the people who were promised a certain amount of pension upon retirement. They used this information during their retirement planning without necessarily considering future economic times, because who really knows what the future may hold? At the same time, it seems that some pension benefits are just not sustainable [4].
According to the Employee Benefit Research Institute, only 15% of Americans who work in the private sector participate in pension plans. This is mostly because companies have shifted from defined benefit plans like pensions to defined contribution plans like 401(K)s [5]. Defined benefit plans like the one at my company promises an employee a certain amount of money each month in retirement typically based upon number of service years, salary in the final years of service, and age. This means that regardless of market conditions over the years, the same amount of money will still go to the employee in retirement (so most of the investment risk is on the employer). With defined contribution plans, the employee takes on most of the investment risk as their payout in retirement is based on market conditions. The employee also tends to contribute much more into defined contribution plans than in defined benefit plans. Â Once again, I think only time will tell if this shift of investment risk and contribution obligations onto the employee was a good or bad idea.