Pension Funding Deficit Reaches 50-Year High -- Should You Be Worried?
The market swoon in last month didn't just hurt your portfolio, it also clobbered corporate pensions. The total deficit of U.S. pension liabilities increased by $134 billion to $512 billion as of September 30, according to worldwide HR consulting firm Mercer. The reported deficit compares pension liabilities to assets in pension trusts for defined benefit retirement plans sponsored by S&P 1500 companies. The increase in the deficit results from a combination of stock market declines and decreases in yields on high-quality corporate bonds during the month. (Pension liabilities rise when interest rates fall, due to reduced expectations for future investment earnings).
In aggregate, the funded ratio (assets divided by liabilities) for these plans is now at 72 percent, down from 81 percent at year-end 2010. Mercer believes that the funding deficit, in aggregate dollar terms, is at an all-time high since the end of World War II.
While the news sound dire, this information only affects you if you participate in a defined benefit retirement plan, whether it's a traditional pension plan that pays a monthly retirement income or a cash balance retirement plan that typically sets up a retirement account for you. If you only participate in a defined contribution retirement plan, such as a 401(k), then there's no direct impact on you -- not counting any possible drop in your 401(k) account caused by the stock market decline.
The immediate consequences for a defined benefit plan depend on the actual funded status of the plan at the end of its plan year, which is typically December 31. The following consequences apply to the defined benefit plans of businesses and nonprofit organizations (but not to the pension plans of federal, state and local government employees):
- If your plan's funded status falls below 80 percent at plan's year-end you may receive a notice by September 2012 indicating that certain optional forms of payment, such as lump sums, are restricted. Lump sum payments are common with cash balance defined benefit plans, less common with traditional pension plans. If these restrictions apply, there's a chance you might only be able to receive a portion of your total benefit as a lump sum with the rest payable as a lifetime monthly income. Any such restriction would not apply until you are notified by your employer.
- If your plan's funded status falls below 60 percent, then the plan is prohibited from allowing additional benefit accruals until the plan's funded status recovers above this level.
Next page: What Should You Do?
What Should You Do?
"Nothing" is the most likely answer, particularly if you're well below the age at which you might normally retire. As mentioned previously, many plan sponsors contribute enough money to avoid benefit restrictions; if that happens, it's business as usual for the plan.
If you're close to retirement and are eligible to take a lump sum payment from your plan, you might be tempted to retire now before you lose the chance to take a lump sum. Think again: In most cases, a monthly retirement income is a better option if you want to avoid outliving your financial resources. Even if a plan is restricted from paying lump sums, it can still pay monthly retirement incomes.
Should you be worried that you'll lose benefits that you've earned? In most cases, no. Federal law requires employers to make sufficient contributions to be on track to fully fund the plan; most employers will kick in more money to the pension trust next year due to the increased funding deficits.
Three conditions must be in place for you to lose any benefits you've earned:
- Your employer must go bankrupt.
- The plan's assets aren't sufficient to fund benefits for all participants in the plan. (It's important to know that if your employer goes bankrupt, creditors can't touch the assets in the pension plan trust.)
- Your earned benefit is higher than the amounts guaranteed by the Pension Benefit Guaranty Corporation (PBGC), which is like the FDIC for pensions. In this case, you would only lose the portion of your benefit that exceeds the PBGC guarantee.
Possible bad news would be if this last round of funding deficits causes your employer to throw in the towel and freeze its plan, as many employers have done in prior years. When an employer freezes a plan, you won't earn any additional benefits. About the only thing you can do to prevent this outcome is to tell your employer how much you value the pension plan; if enough of your co-workers chime in, your employer might think twice about freezing the plan. Often employers think their employees don't value the pension plan and won't complain if they freeze it.
You may come to appreciate the value of your plan more as you approach your retirement age. You'll receive a guaranteed monthly income regardless of how long you live or how the stock market performs. That's an enormous help in a world full of financial uncertainty.
While none of this is good news, you can reduce your anxiety by learning about your plan's situation and about the rules that affect your retirement. Take responsibility to gather this information yourself, instead of simply listening to -- and believing -- the people who pass along fearful rumors or the headlines from the evening news.
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