Your Pension Just Got a Lot Riskier

One of the biggest problems that corporate America and the millions of employees who work in it face is figuring out how to provide for workers' retirement. Recently, pension plans have attracted increasing amounts of attention as companies look for solutions to deal with the worsening challenge of how to earn enough to meet pension commitments in an environment of poor investment returns. That challenge threatens not just workers' retirement prospects but also the financial survival of dozens of huge companies that have to provide for workers.

The federal government recently came to the rescue for corporate pensions, letting companies kick the can further down the road. Later in this article, I'll give you all the details. But first, let's take a look at the scope of the problem and why it's become such a contentious issue recently.

The problem with pensions
If you've ever tried to plan for your own retirement, then you can understand the position that corporate pensions are in. Pension plans own huge pools of investment assets, thanks to ongoing contributions from the companies that run them. But they have to balance the needs of thousands of current and former workers, some of whom receive income payments from the plans now, and others of whom may not need benefits for 30 years or more. As a result, they have to own investments that will both grow and produce income -- not something that has been easy to accomplish in recent years.

At the same time, though, pension plans have obvious financial implications for the companies that run them. Companies have to reduce earnings when they make contributions to pension plans, and because analysts and investors penalize companies when they miss earnings estimates, there's a big incentive to fund pension plans with less than enough money to pay the expected amount of future pension benefits.

One solution that major pension plans at General Motors (NYSE: GM  ) and Ford (NYSE: F  ) have tried is to reduce future benefits by offering lump-sum buyouts of pension obligations to their retirees or workers. In essence, by paying money up front, GM and Ford would avoid having to figure out how to earn a high enough return in their pension funds to pay benefits down the road.

A bandage with no stick
But for companies that don't have the cash on hand to make such huge lump-sum payments, the federal government appears poised to help out. As Barron's reported over the weekend, the federal transportation bill that became law over the weekend included provisions that would allow companies to use higher interest rates to discount future obligations. That will cut the amount that those companies have to contribute to pension plans to be considered fully funded.

Yet this purported solution has two major flaws. The smaller one is that the impact of the move will be temporary. Because of the complicated way in which the new calculations incorporate both a two-year average and 25-year average of corporate bond rates, the impact of the provisions becomes smaller each year.

More important, though, using higher rates increases the likelihood that companies won't be able to deliver on the assumption underlying them: that investment returns will actually meet that target. That's certainly been a problem with public pensions, where discount rates of 7.5% to 8.5% are common despite the fact that their portfolios typically need to be fairly bond-heavy to accommodate current income needs.

The near-term effect
What stock investors need to know, though, is that lower pension obligations could goose up earnings in the short run for companies with struggling pensions. That's good news for Alcoa (NYSE: AA  ) , SUPERVALU (NYSE: SVU  ) , and other companies that have severely underfunded plans that need attention. Moreover, after having taken a big hit to earnings after a voluntary pension contribution earlier this year, Boeing (NYSE: BA  ) could get a lot of relief. The company reported that even a quarter-percentage-point increase in discount rates could cut liabilities by $1.7 billion, which would have huge implications for contributions going forward.

Unfortunately, these new rules do nothing to address the true question of how companies will come up with enough money to support their workers in retirement. Without companies stepping up to the plate to live up to their obligations -- or at least giving workers a chance to make their own decision about one-time buyouts -- the worst for workers is yet to come.

What all this means is that it's up to you to figure out how to save for your own retirement. Let us show you the way with the Motley Fool's special report on investing for retirement. Inside, you'll find smart long-term plays that have served investors well. Just click here and start reading your free copy right now.

Fool contributor Dan Caplinger remembers playing kick-the-can fondly in school. He doesn't own shares of the companies mentioned in this article. You can follow him on Twitter @DanCaplinger. The Motley Fool owns shares of SUPERVALU and Ford. Motley Fool newsletter services have recommended buying shares of Ford and General Motors, as well as creating a synthetic long position on Ford and buying calls on SUPERVALU. Try any of our Foolish newsletter services free for 30 days

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy won't leave you out in the cold.


Read/Post Comments (5) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 02, 2012, at 2:14 PM, rav55 wrote:

    I am astonished that Americans risk their Pensions by allowing them to be invested in the Stock Market. If every pension plan payment both from employees and employers were paid into Social Security, then Social Security could probably pay every retiree somewhere between $3000 and $5000 per month. That is a very respectable pension benefit. Basically the problem get solved like this.

    Bump Social Security FICA tax by 100%. Increase the payment benefit by 150%.

    Social Security Benefits are TAX FREE.

    Increase the FICA Tax ceiling to $250,000.

    Allow all retirees NOT collecting from another pension plan (IRA or 401K) to work and collect Social Security without penalty. Of course FICA Taxes will still be withheld from wages. Only wages will be taxed NOT the Social Security BENEFIT. The benefit is TAX FREE.

    Social Security would become the wealth of the nation. The cash value of the fund would be staggering. The fund could still provide loans to the the Treasury as it is doing now for futher growth.

    We would all have security and a pretty fair pension.

  • Report this Comment On July 02, 2012, at 2:31 PM, mdk0611 wrote:

    Wow! Social Security benefits are tax free? I'll stop there.

  • Report this Comment On July 02, 2012, at 7:06 PM, GETRICHSLOW2 wrote:

    I have a better idea. Why don't every WORKING

  • Report this Comment On July 02, 2012, at 7:09 PM, GETRICHSLOW2 wrote:

    OOPS! Why don't every WORKING American just surrender their paycheck each week to the government. We will through it all in a big pile and mix it up. Then, every American(deadbeats included) gets an equal share of the kitty. Shazaam! All of our problems are solved.

  • Report this Comment On July 02, 2012, at 7:09 PM, GETRICHSLOW2 wrote:

    OOPS! Why don't every WORKING American just surrender their paycheck each week to the government. We will through it all in a big pile and mix it up. Then, every American(deadbeats included) gets an equal share of the kitty. Shazaam! All of our problems are solved.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1930745, ~/Articles/ArticleHandler.aspx, 12/22/2014 1:25:53 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement