(Photo from Flickr user Simon Cunningham used under Creative Commons license)
Pensions are hard to come by these days. And if you are one of the lucky few still receiving one, chances are your future benefits are being cut or eliminated.
As of last year, the share of Fortune 500 companies still offering traditional pensions to new hires was down to 7 percent. compared to about 50 percent in 1998, according to a report released earlier this year by professional services firm Towers Watson. A much more common type of defined-benefit plan — offered by 17 percent of large employers — is the hybrid pension, which is a combination of a 401(k) plan and a cash-balance plan. (Many workers are likely to find themselves with a hybrid plan after an employer decides to freeze a traditional pension, retirement experts say.)
Companies give many reasons for cutting pension benefits. Sometimes, the employer is struggling to fund the pension after a tough run in the stock market or because of low interest rates. Other times, companies freeze pensions even when a plan is in good shape if they’re looking for ways to reduce their operating expenses and contain future costs– although the majority of private-sector workers with traditional pension plans are not in frozen plans. according to the Bureau of Labor Statistics.
“This is the day and age of risk being transferred from the employer to the employee in terms of retirement,” says Wendy Weaver a financial planner with FBB Capital Partners in Bethesda.
When pension cuts happen, workers are left to redo the math of their retirement planning. Companies that freeze pensions are essentially cutting a worker’s future compensation. “This is a huge change in their life,” Weaver says. With the loss of income, the next question usually is: What can be done to close that gap?
One place to start is to make a list of your anticipated sources of income in retirement, says Alan Glickstein, a senior retirement consultant at Towers Watson. In addition to the pension, that may include a savings plan like a 401(k) or an Individual Retirement Account. People should factor in Social Security and consider any income that would be coming from a spouse, he says.
Once the streams of income are figured out, workers should determine what they can do to get the most out of each one.
Evaluate the pension. Employers are required to give workers written notification quantifying the projected cuts when they make significant changes to a pension plan. Those notices may provide a daunting figure — the difference between what a person can earn with the current plan and what they would have received under the old plan. Some workers, particular those who are younger, may find that they’ll receive more under the cash-balance plan or through a 401(k) match than they would have under a traditional pension, especially younger workers who were likely to change jobs before earning the maximum benefit through the pension or before becoming vested in the plan. But that will vary for each person. The important thing, Weaver says, is to get an understanding of what the pension will pay out under current terms so that you can figure out what kind of shortfall you might face in retirement. “There is still a silver lining, if you will, in that you have a pension,” she says.
Consider the cash-balance plan. After freezing pensions, many companies introduce a cash-balance plan. This is how they work: Employers need to set aside a credit each year that amounts to a certain percentage of a worker’s earnings. And they will pay a conservative interest credit. That rate, set by the employer,
cannot exceed the “market rate of return,” which is capped at 5 percent this year, according to rules set by the Internal Revenue Service.
Because these funds cannot be invested the way 401(k) assets can be, the cash may not grow as much as savings that are controlled by the employee — but they also don’t carry as much risk, says Norman Stein, a law professor at Drexel University. Companies need to pay the pre-determined interest credit each year, even if the assets used to pay cash-balance plans had a higher return that year, he says. For example, if plan assets returned 5 percent but the company agreed on a 3 percent interest credit, the company only has to pay the 3 percent credit. If the plan assets return less than 3 percent, employers may have to contribute more to the plan to honor the promised 3 percent credit.
As with a traditional pension, retirees can typically take a cash-balance plan as a lump sum or they can use the money to buy an annuity, Stein says. When the time comes, some workers may want to consult an adviser about which option is best, he says. (Pension benefits may not be available until retirement age but some workers may be able to rollover a cash-balance plan into a 401(k) or IRA when they change jobs.)
Increase your savings. Most employers providing a pension also offer access to a 401(k) savings plan as a supplement, but when a pension is frozen or eliminated, the 401(k) may become the primary retirement savings tool. “The importance of the decisions you make on the 401(k) side are now magnified,” Glickstein says, adding that it might be a good time for people to make sure their savings are not invested too conservatively.
Workers should contribute enough to the plans to max out any matching contributions offered by the employer, but they shouldn’t stop there, Stein says. IRS rules allow employees to contribute up to $17,500 a year into a 401(k), not including employer contributions. Those 50 and up can make additional catch-up contributions of up to $5,500 a year.
Calculate Social Security. If you haven’t calculated how much you’re likely to get in Social Security benefits when you retire, now would be a good time to do that, Glickstein says. The Social Security Administration has a retirement estimator that helps workers figure out how much they might receive based on their earnings. Calculating that now can also help workers decide how much more they need to save and if they should put off collecting retirement benefits.
Social Security retirement payments will be smaller for people who start collecting before full retirement age and they will grow by 8 percent for each year that workers wait beyond retirement age until they reach 70. People do not have to work until age 70 to take advantage of the bigger benefit, Weaver says, adding that some people may start to draw on their pensions or savings in the meantime.
Readjust your retirement expectations. There are a lot of what-ifs involved in these situations. What if the person would have left the employer before qualifying for the full pension anyway? What if a market crash or other crisis would have forced the company to cut the pension at another time? Those unknowns aside, affected employees should focus on what’s in their control, Glickstein says.
“You can adjust when you’re going to retire. You can adjust your expectations about the standard of living you’re going to have in retirement,” he says, “and you can adjust the level of savings between now and then.”