The Problem With Your Pension

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With our baby boomer-in-chief turning 60 earlier this summer and the baby boom generation marking that same milestone this year, we're providing a number of articles that might be useful to this noteworthy generation. This article was originally published on Jan. 12, 2006.

According to Standard & Poor's, in aggregate, the companies that make up the S&P 500 would have to set aside $40 billion this year to catch up and fully fund their pension plans. That means the 300 or so companies in the S&P 500 that offer pension plans would need to contribute an average of $130 million-plus to bring their pensions into compliance with their statutory funding statuses.

The problem is that pensions do not allow companies to shrink because the obligation to retirees continually increases. Thus the news earlier this year of Ford's (NYSE: F) pension woes and IBM's (NYSE: IBM) decision to eliminate its pension plan after 2008 in favor of a 401(k) plan. All told, the Pension Benefit Guaranty Corporation (PBGC) projects that 75% of all pension plans that it guarantees are underfunded by a total of $95 billion. That the number is so high suggests one thing: It's not just the unhealthy companies that have pension problems.

A look at some big companies shows shocking deficits in their pensions. In 2003 I wrote that GM (NYSE: GM) actually needed to sell some $13 billion in stock to shore up its pensions, and lo and behold, it still remains in arrears. But problems at GM aren't likely to be a big shock -- many market wags predict the behemoth will file bankruptcy. More surprising might be the pension shortfalls at some companies performing quite well.

($ in Billions)
	Proj. Pension Obligation	Pension Assets	Deficit
General Motors	110.0	105.2	4.8
ExxonMobil (NYSE: XOM)	30.5	19.3	11.2
Pfizer (NYSE: PFE)	15.0	11.6	3.4
Altria (NYSE: MO)	18.2	16.5	1.7
Dupont (NYSE: DD)	22.9	19.8	3.1

*Data provided by Capital IQ.

Fortunately, the PBGC provides backup insurance in case pension funds go belly up. Unfortunately, the PBGC is effectively insolvent itself.

There's one last big element. The Financial Accounting Standards Board (FASB) recently approved a project that will clean up some of the accounting mess in pensions. The overhaul may require companies to place their pension costs on their balance sheets. Many more companies are going to respond to this by doing what IBM has done -- replacing their pension programs with 401(k)s.

What does all of this mean? Well, effectively, companies are going to come under more pressure to bring some predictability to their retirement benefit costs, which is very difficult to do with pensions. So even companies that have the ability to fully fund a defined-benefit program are more and more likely to convert to defined contribution. For the companies listed above, with current pension deficits, the pressure will be even greater.

This means at some point in the near future, even if your company currently offers a pension, in some form or another it may be switched over to a 401(k). And you'll not only contribute to the funding for your own retirement, but you'll also have to choose where to invest those funds. Naturally, as Fools, we'd be pretty excited about this, but most people have no idea how to invest.

Two simple words
Fortunately, there is a solution. You might not have heard about it if you're not an experienced investor. It's a way to take the decision-making out of investing -- a perfect solution for someone who has neither the time nor inclination to manage a portfolio. It's called an index fund -- highly diverse baskets of the largest companies in the country. These vehicles roughly match the performance of the stock market, which over time has proved quite satisfactory to people who made the decision early on to buy an index fund and get on with their lives. Average may not sound great, but in the past 20 years, that would have turned a starting investment of $1,000 into more than $10,500. What's more, average actually beats the performance of most mutual funds over that time.

As the Baby Boomers reach retirement age, certain health-care and financial stocks are poised for growth. Our top analysts share their best stock picks in this special report: The Big Boom: Explosive Opportunities in Biotech and Health Stocks.

Fool sector head Joey Khattab updated this article, which was originally written by Bill Mann. Joey does not own shares of the companies mentioned. Pfizer is a Motley Fool Inside Value recommendation. This message is sponsored by the Fool's disclosure policy.