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Skating on a frozen pension

By Barbara Whelehan · Bankrate.com
Friday, October 1, 2010
Posted: 2 pm ET

Fortune 1000 companies continue to freeze their pensions at a steady pace in this uncertain economy, according to a recent Towers Watson study. By freezing pensions, companies are effectively putting their defined benefit plans on ice by either closing off benefits only to new hires (known as a soft freeze), or halting all future benefits for existing employees (called a hard freeze).

If companies are in serious financial trouble, they may terminate their plans. In extreme cases, like when a business goes bankrupt and the plan is in default, the Pension Benefit Guaranty Corporation steps in to make the plan participants whole -- to an extent.

Plan freezes have become more commonplace in recent years. In 2004, only 45 Fortune 1000 companies had one or more frozen defined benefit plans in place, but now, 208 companies have at least one frozen plan. Fortune 1000 companies are America's largest companies based on revenues, so these companies are in a good position to offer great benefits to their employees. In fact, more than half of these behemoths still do offer a defined benefit plan, and 378 offer only plans that are not frozen. But, in general, the vast majority of companies don't offer DB plans.

Defined benefit plans base pension amounts on a formula that takes into consideration an employee's salary and tenure. The longer the tenure and the higher the salary, the better the benefit. These plans became a  popular way for companies to foster loyalty among workers. The motive had nothing to do with a sense of moral duty; it was a way to avoid high turnover.

Times have changed. It's no longer financially viable for most companies to offer these expensive plans. They're not required by law to offer or maintain one.

And workers are not inclined to stick with one employer for 10, 20 or 30 years just for the reward of a pension check. It's a heavy price to pay, particularly if job satisfaction is low. Portable pensions in the form of 401(k) and 403(b) plans make more sense for a mobile work force. The trade-off: Workers are wholly responsible for their retirement planning.

If your pension freezes over

If you're a prospective employee in the interviewing process with a company that has a frozen plan, too bad. You can't attempt to get in the plan as a negotiating tool in the hiring process, says Nevin Adams, editor-in-chief of Plansponsor.com. "There's no one-off negotiating, no matter how 'special' you are," he says.

If you are an employee with a vested interest in a plan that's going on ice, you'll get a statement at least once a year letting you know its value. Companies that are intent on getting out of the pension business won't add any money to it no matter how big your raises get or how many more years you devote to the firm. But you won't lose what you've already earned.

Some companies convert their plan to a cash-balance or an account-based plan to which they may apply an annual credit (5 percent is common, says Adams). That's free money (and subject to change), but the employer is paying out much less than it otherwise would in a DB plan. In addition, the funds are generally invested in an account earning interest at market rates.

When can you get the money? "The options will vary, but normally, the employer will simply tell (employees) what is going to happen to their vested account, and what the rules will be going forward. They would be entitled to their vested benefit at the time the plan allows."

The plan may allow for a lump sum or annuitized distribution. I asked Adams whether getting an annuity through an employer would be a better deal than taking the lump sum and buying an annuity on the open market. "It's tough to generalize on things like annuities, but generally one would expect to find better pricing with an 'institutional' buy," he says.

But shop around to make sure.

The decision about whether to take a lump sum or a monthly annuity check is complicated, but most people take the former, says Adams. "I would suggest that you look at how comfortable you (or your adviser) are making those kinds of long-term decisions. Consider how many years you have until retirement, what your other sources of retirement income are, and what kind of monthly benefit the annuity will provide and for what term."

In other words, your employer is not going to decide your pension amount. The fate of your retirement is in your hands.

Have you had to deal with a pension freeze? Share your experience.

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10 Comments
Barbara Whelehan
November 24, 2010 at 11:39 am

Clifford, I wrote to Nevin Adams of Plansponsor.com about your question. He said that if your "retirement fund" is a defined benefit pension plan, then any interest that accrues goes into the general pension fund, which will be used to fulfill the promises made to pension plan recipients. The set amount that you were promised is being funded by the pension fund's returns. Says Adams: "The individual gets the benefit promised, they don't have an 'account' per se (as they do with a defined contribution plan)."

Thanks for writing.

Clifford
November 24, 2010 at 11:26 am

Barbara,

I have a retirement fund that was frozen 2 years ago. I am fully vested after 26 years and the amount of retirement income has been fixed to a set amount never to change. My question is what happens to any interest that accrues on that money? It would be a sizeable annual amount. Does the employee have ownership of his/her accrued interest, or does the employer (in this case of approx 2500 accounts) reap the profits?

Thanks

Barbara Whelehan
October 19, 2010 at 10:53 am

Hi, Mark. I ran your comment by Nevin Adams, the editor-in-chief of Plansponsor.com and an authority on the subject of pensions. He said, "It's hard to precisely answer a question like this without actually seeing the plan document. But yes, it's entirely possible that the final number could be different, based on the payment formula and interest rates at the time."

Barbara Whelehan
October 15, 2010 at 8:25 am

Hi Mark -- I don't know the answer to your question, and I am not in the office today, but I will look into this next week and reply when I have an answer for you. Thanks for writing.

Mark Frankel
October 14, 2010 at 4:52 pm

Pension was frozen 7 years ago. We get an annual estimate of what our pension payout will be and every year it's the same. However, I was told that the actual payout will depend on the year you retire. Is this based on some type of formula that takes into account inflation or interest rates at the time? Could the actual payout deviate wildly from the companies estimate that I have been receiving?

Jack
October 11, 2010 at 6:05 pm

Shantique,

Go talk to a professional.

The $5k threshold is when they won't auto roll to an IRA. If you are over that I don't see why you can't take a lump sum to your IRA. Barbara is correct that it does depend on the plan but it just struck me when they told you about the $5K rule and prehaps they are confusing it with auto roll.

I need to calrify about the PBGC. The PBGC protects you if a company "goes under" and is still paying the PBGC premiums. It doesn't protect you if there is theft of the money or the plan is out of compliance. Theft is covered under an ERISA bond but of course if the company steals the money I doubt they are paying for the bond. Also, PBGC maximums are a bit more complicated than just a number cap. PBGC actually has rules about how they view how much a person could get. For example, United Airlines was forced by the PBGC to step in to the mechanics pension and the mechanics pensions were cut not because of the cap but because PBGC had tougher qualification standards than United. (Probably why United had trouble with the plan.) Anyway, United based a pension off of age, rank, salary, tenure, etc. while PBGC only bases it on tenure and salary so it was a haircut accross the board. Additionally, PBGC tends to pay only anout 80% benefits because they couldn't stay in business otherwise.

Barbara Whelehan
October 04, 2010 at 10:25 am

Hi Shantique. Thanks for writing. Unfortunately, the plan determines when you can get your hands on the money. But fortunately, it's protected. In extreme cases, such as if a pension plan defaults, the Pension Benefit Guaranty Corporation will step in to protect plan benefits. The PBGC is a federal insurance program funded mostly by defined benefit plan sponsors, not taxpayer money. Right now in general the maximum amount it guarantees is $4,500 per month, or $54,000 a year.

Barbara Whelehan
October 04, 2010 at 10:03 am

Thanks for your clarifications. Regarding your first point, it's true that senior executives get all kinds of perks that are unavailable to the rank and file. This blog post was intended for the latter. As for the second point, I was talking about benefits as perceived by the worker, but you're right, the funding has to be there to provide for those benefits. So I didn't state that very clearly. As for your third point, I'm glad you brought that up because in essence, the conversion to a cash-balance plan stiffs workers -- particularly older ones with many years in the company.

Shantique
October 04, 2010 at 8:19 am

Reading this article got me thinking. I worked for a company for over 10 years from the time I was 16. I was lucky to have been working when companies still gave pensions. I have since moved on, I had rolled over my 401K to an IRA, but because the pension value was over $5000 I was forced to leave it at the former employer. I get a statement telling me I'll get $211/ month when I retire (about 40 some odd years away). Being that I am unable to remove this money and roll it to an IRA, is this at risk? Is it possible that I will never see these benefits, or are people that were in these things guaranteed to receive this defined benefit in the future? What rights do I have to retreive this money so I can invest it myself and protect it?

Tough Love
October 01, 2010 at 11:43 pm

Barbara,

A few clarifications seem in order..

(1)You said ... If you're a prospective employee in the interviewing process with a company that has a frozen plan, too bad. You can't attempt to get in the plan as a negotiating tool in the hiring process, says Nevin Adams, editor-in-chief of Plansponsor.com. "There's no one-off negotiating, no matter how 'special' you are," he says."

That's only partially true. While they can't let you in the IRS "qualified" Plan, they can give you the exact same (or even better) benefits as the qualified Plan, but on a non-qualified basis. Although not a common practice, it does happen occasionally when a highly desired Senior executive is "special enough".

(2) You said ... Companies that are intent on getting out of the pension business won't add any money to it no matter how big your raises get or how many more years you devote to the firm.

That's incorrect. Your "benefits" won't increase, but even if frozen, as the employee gets closer to retirement, the frozen "benefit" requires additional money to fund it, and this incremental funding is required by law/regulation. Of course, if the Plan's investments do extraordinarily well, smaller or (in rarer circumstances) no additional funding may be necessary.

(3) You said ..."Some companies convert their plan to a cash-balance or an account-based plan to which they may apply an annual credit (5 percent is common, says Adams). That's free money (and subject to change), but the employer is paying out much less than it otherwise would in a DB plan. In addition, the funds are generally invested in an account earning interest at market rates."

No big deal, but a for clarification, BOTH the pre-conversion Plan (often called a Traditional DB Plan) and the "Cash Balance" Plan are DB (Defined Benefit) Plans. It's just that the latter functions (from the employees' perspective) much more like a 401K Plan which is not a DB Plan, but a Defined Contribution Plan. Your statement that the Cash Balance costs less is just about always true, and although employers dislike admitting it, the savings is most often the primary reason for the conversion.