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The rise of the 401(k) plan has spelled the end of employer-sponsored pensions for many workers. But don't count out pensions just yet.

Employers across the country have fled from traditional pension plans, which require them to set aside enough money to pay out monthly benefits for workers throughout their retired lives. By setting up defined contribution plans like 401(k)s for their employees, employers have essentially shifted the burden of adequately saving and investing onto their workers.

Recently, however, a third alternative has regained popularity in the retirement benefits world. So-called hybrid pension plans combine some of the favorable elements of 401(k) plans and traditional pensions in a way that helps employers and workers alike.

Mixing it up
Hybrid plans -- which include cash-balance and pension-equity plans -- borrow certain traits from both traditional pensions and 401(k) plans. Like pensions, hybrid plans use formulas based on salary and length of employment to determine the total benefit owed to each employee. Rather than paying a set monthly pension, however, hybrid plans typically calculate a lump-sum amount that the worker will receive at retirement. If the worker wants guaranteed monthly income, converting to an annuity is often an option.

From the employer's perspective, hybrid plans work much like regular pension plans during an employee's career -- the employer sets aside certain amounts of money to cover the expected lump-sum benefit. However, making one payment, rather than a monthly allotment for life, makes the hybrid plan's cash flow much more predictable for the employer. Also, the lump-sum calculation eliminates longevity risk for the employer; it's up to employees to manage their money so that they won't run out early.

Converting and age discrimination
During the 1990s, many employers converted their traditional pension plans to hybrid-type plans. Here are just a few:

Company

Year Converted

Aetna (NYSE: AET  )

1999

American Express (NYSE: AXP  )

1995

AT&T (NYSE: T  )

1998

Citigroup (NYSE: C  )

1996

Goodyear (NYSE: GT  )

1998

Source: Christian Science Monitor, Center for Retirement Research.

Because these conversions reduced the pension benefits of many workers -- especially older workers -- some companies faced age-discrimination lawsuits alleging illegal benefit cuts.

Now, however, employers like IBM (NYSE: IBM  ) and PNC Financial (NYSE: PNC  ) have started to win these lawsuits. This favorable resolution has made hybrid plans more attractive for businesses looking for an alternative to 401(k) plans.

Pros and cons
From an employee standpoint, hybrid plans have several attractive features. Perhaps most importantly, contributions to hybrid plans are made entirely by employers, so they represent free money for employees. Although many hybrid plans have vesting requirements similar to 401(k) plans, they don't require employee participation. If an employer also offers a 401(k), hybrid plans can give employees an extra benefit toward their retirement.

In addition, hybrid plans are somewhat more portable than traditional pensions. Many traditional pensions skewed benefits toward longtime workers, making it more difficult for those who changed jobs during their careers to keep up. Hybrid plans typically allow a departing worker to roll over accrued benefits into an IRA.

Unfortunately for employees, whether a company offers a traditional pension or uses a hybrid plan, your lack of control over that money makes it difficult to incorporate it into your financial plan for retirement. In contrast, the complete control you have over your 401(k) account balance makes planning much simpler.

If hybrid plans do become more popular among employers, a new generation of workers may enjoy some supplemental income beyond what they set aside on their own. Yet with all the uncertainty over retirement payouts, both from Social Security and private employers, you're still better off treating a company pension as an unexpected bonus, rather than relying on it for your necessities.

For more on retirement, read about:

To get helpful pointers on saving more for retirement -- pension or not, you know you need to! -- check out the Fool's Rule Your Retirement newsletter service. You'll find lots of info to invest smarter, save more, and be better prepared for your golden years. It's all yours for the taking with a 30-day free trial.  

Fool contributor Dan Caplinger isn't expecting any pension at all. He doesn't own shares of the companies mentioned in this article. The Fool owns shares of American Express, which is also a Motley Fool Inside Value pick. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy will take care of you.


Read/Post Comments (1) | Recommend This Article (1)

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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 August 19, 2008, at 2:53 PM, DrFerry wrote:

    Hybrid plans can be very good when managed correctly. They provide a near constant percentage each year and should build nicely over time. The downfall of these plans is often the conversion from traditional pension plans to the cash balance account side. This usually leads to a wear away of benefits because for older employees, little or no money is contributed to their accounts for as much as 10 years. This is the timeframe where traditional pensions increase the precentage contributed, hence the lawsuits. Keeping older employees on a traditional plan and starting new or younger employees on hybrid plans would eliminate the issue.

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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