Decades ago, nearly every employee could look forward to retiring on a pension. Today pensions are far less common: according to the Employee Benefit Research Institute (EBRI), only 13% of all employees were participants in a pension plan by 2013. If you happen to be one of the lucky few who still has access to a pension, it's important to be aware of how healthy said pension is before you decide to count on it for your retirement income.
Why pensions are disappearing
Few employers offer pensions these days because they're very expensive for the business to maintain. When it offers a pension, a business is promising its retired employees that they will receive a certain sum per month for the rest of their lives. Of course, that means the business has to have the money to pay the promised benefits and to keep doing so every month for decades. Having that much cash available can be extremely difficult for a business, and as a result many pensions are seriously underfunded compared to their liabilities.
Part of the funding problem stems from the fact that in order to have enough money, companies don't just stick their pension funds in a savings account: they invest that money in hopes of getting better earnings. After all, the higher the return they can get on invested pension funds, the less capital they're required to put up in the first place. Unfortunately, if the pension manager makes a few bad investment choices, those funds can be seriously depleted by the losses. That puts even more strain on the employer's ability to provide the cash it needs to meet its pension obligations.
How to tell if a pension is underfunded
By law, employers who offer pensions are required to send pension participants a funding notice every year that gives detailed information on how well-funded the pension is. If the pension's assets are at least 80% of its liabilities, it's in good shape. If the percentage of assets is any smaller than that, the pension is underfunded and could be in danger.
The good news is that if your pension is underfunded, that doesn't necessarily mean it's about to fail. If your company is in good overall financial shape, it should be able to meet those liabilities and keep the pension going. However, if the pension is underfunded and the company is struggling, you need to worry.
If financial troubles reach the point where your employer no longer feels capable of funding its pension, it may place a freeze on the pension. A pension freeze means that benefit accumulation for some or all employees will be halted. The benefits that employees have already earned will remain, but affected employees will not be able to accumulate higher benefits. A soft freeze typically affects only certain employees, for example new hires, and/or it may allow for some types of benefit accumulation to continue. A hard freeze puts a stop to all benefit accumulation. Hard freezes often lead to the company's phasing out the pension and switching to a 401(k) or similar defined contribution plan instead.
Since a pension freeze doesn't affect the benefits you've already earned, at least you'll know that money is safe. Or is it? Companies can terminate pensions entirely under certain conditions, such as a bankruptcy. In that case, the Pension Benefit Guarantee Corporation (PBGC) will step in and pay the pension benefits to retirees, assuming that particular pension is insured (you can check for your own pension on the PBGC website). However, it won't necessarily pay the full benefit; PBGC guarantees are capped based on the benefit amount, the year the PBGC takes over the pension, and an employee's retirement age. You can look at the PBGC's Maximum Monthly Guarantee Tables online to get an idea of the highest benefit you could potentially receive from them (but be aware that these tables list maximum benefits, and your own benefits may be considerably lower based on the aforementioned factors).
All in all, pensions simply aren't the ironclad guarantee they once were. If you are covered by an employer pension, consider opening an IRA and making regular contributions just in case your own pension goes the way of so many others.
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