How Safe Is Your Pension Plan?

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S&P Indices recently released a report which revealed that underfunded pensions (fancy speak for pensions that won’t be there when you retire) reached a record level of almost half a trillion dollars. This despite stock prices (in which these funds invest) reaching record highs.

Their final recommendation? “Younger workers may want to start to save and plan early on, allowing early investments to eventually compound.”

Translation to plain English: “You’re on your own, baby!”

 

The Root Of The Problem

Medical science says the average life expectancy has jumped from just 65 years before 1950 to 78 years.

How could something so good be so bad? Pension plans were not designed for this.

Pension plans haven’t been around all that long. A hundred years ago, nobody had one. In the early days, when men worked and women stayed at home, the thought was to provide widows with a means of living when their husbands passed away. In fact, they were called widow funds before they became pension funds.

The low general life expectancy meant that pensions didn’t have to last all that long and only needed to provide for one person. Therefore, the amount employers set aside wasn’t all that much, relatively speaking.

But several things happened, as they usually do:

1. Companies got used to funding a relatively low amount for pensions. And, as everyone knows, once something gets set as a benchmark, it’s hard to change.

2. Life expectancy increased. The low funding levels (which were sufficient in the beginning) became inadequate. This happened very gradually, and so it went unnoticed until recently. When people finally wake up to a problem like this, it becomes difficult to fix.

3. Healthcare costs skyrocketed with increased life expectancy. Some cynics say the elderly are being kept alive longer to keep the drug companies and medical community in business. Whether that’s an overstatement or not, the medical component of OPEB (Other Post-Employment Benefits) has increased much faster than any comparable benefits.

4. The US has an unusual demographic aberration known as Baby Boomers. Baby Boomers are a huge group of people who, when they worked, formed a large employee base to contribute to pension funds. These Boomers are now retiring, shrinking the amount of contributions to pension funds and significantly increasing the withdrawals from the system. This graphic from Calculated Risk shows the bulge visually.

5. In the ‘80s, corporate America underwent a radical transformation as corporate raiders, funded by junk bonds, bought out large corporations, split them up and sold off the pieces. (Creating the term “downsizing” in the process.) These raiders pillaged their victims’ pension funds to help pay for their buying sprees. Even corporations that escaped the clutches of the raiders were forced to trim their pension funding levels — exactly when the increased life expectancy and higher medical costs hit.

 

Pension Plan Types

There are four basic types of retirement plans, in descending order of attractiveness to you as an employee:

1. Company pension plans (funded).

2. Company pension plans (unfunded).

3. 401(k) plans with matching.

4. 401(k) plans with no matching.

If your job offers a company pension, they probably never told you whether it was funded or unfunded. What’s the difference? A funded pension plan involves your company paying over the monthly premium to a pension fund, which then invests that money on your behalf.

An unfunded pension plan has no such requirement. In essence, your employer is saying, “Oh, don’t worry. Just trust us. When the day comes, we’ll have enough money to pay you a good pension.”

Up till now, that hasn’t been a big issue for most. But state and local governments are increasingly unable to fund those promises. That’s scary if it’s your pension we’re talking about. The City of Detroit recently declared bankruptcy, in large part because the city is shrinking and can’t afford to pay the pensions it promised the previous generation of workers.

Despite what people are saying in the press, the problem is not that governments (or companies) are shrinking. It’s that they didn’t fund their pension plans.

If you work for an employer whose pension plan is unfunded, you are at risk. They may be able to fulfill their promise — but in our economy, where growth no longer can be taken for granted, their ability to deliver on their promise can no longer be guaranteed.

 

What You Can Do to Protect Your Pension

 

1. Do Your Research

Get the full skinny from your HR department. Ask them who the pension plan administrator is (every employer has at least one employee designated to oversee the retirement thing, whatever they call it). Make an appointment and go talk to that person face to face, if possible. Find out specifically if your pension plan is funded and, if so, who manages the fund.

You may run into ignorance. Not all pension administrators understand the difference between funded and unfunded plans, because most of their time is spent managing the deductions, interfacing with Payroll and dealing with retirees. If that’s the case, it’s time to…

 

2. Get Involved

Many employers have a committee, panel or other group to represent employees to the plan administrators. If yours does, find out how to get on that board — this is your future livelihood.

More often than not, they’ll be only too grateful to have someone interested enough to spend a little time on the issue. They’ll probably welcome you with open arms and buy you lunch.

 

3. Explore Your Options

If your company’s pension plan is unfunded, take a long look at your employer. Find out what their long-term prospects are — not from anyone in the organization, but from outside analysts.

If your job is in government, track population and income growth in your branch’s jurisdiction. If, as in Detroit, those numbers are declining, that’s a red flag (possibly for your own employment, too). However, if your county or state are growing in numbers and income, you’re probably at less risk.

If you work for a company, Motley Fool is a good starting point. They have thousands of people who critically look at every public company and its prospects. Within your company, you’re not likely to find objective opinions; either people think the leaders are Dilbertian morons, or they believe their company will take over the world. The best opinions on your company’s future are likely to come from the outside.

 

4. Do It Yourself

In the end, the only reliable source of provision is going to be yourself. (Click here to tweet this thought.) (If you were counting on Social Security, well, that’s the biggest unfunded pension plan of them all.)

You have two available options: a 401(k) plan and an IRA. Of the two, a 401(k) plan allows you to set aside the most money, but it also takes the most from you in fees.

A good general strategy is to:

1. Max out on your IRA contributions (either regular or Roth).

2. Contribute enough to your 401(k) to take advantage of employer matching.

3. Contribute to your 401(k) until you reach the maximum.

 

Will this crimp your current lifestyle? Yep. But it’s either that or clearing tables at McDonald’s when you were supposed to retire.

William Cowie blogs about managing your financial future at Bite the Bullet Investing. Get his free Investing Basics series at http://bitethebulletinvesting.com/join_bbi/

 

 

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