How to Fight a Draining Pension Fund
If you have a company-sponsored pension plan, you might be alarmed at some recent news: pension funding levels are at their lowest since World War II.
Consider some numbers. The aggregate deficit in pension plans sponsored by S&P 1500 companies increased by $134 billion as of Sept.30, bringing the total deficit to $512 billion, up from $378 billion as of Aug.31. The current deficit corresponds to an aggregated funding ratio of 72% compared to a 79% funded ratio on Aug. 31. The previous low point for funding was 71% on Aug. 31, 2010, but the deficit at that point capped at $507 billion.
These depressing figures are likely to impact new hires and those currently working at companies with pension plans more than those who are soon to retire or already have.
Not yet a fire drill
But not all hope is lost, says Jonathan Barry, a partner with Mercer’s Retirement Risk and Finance Group. Companies do have to “fund back,” and they have a number of tools at their disposal to do so.
A recent Mercer report says funded status swings are not as unexpected as one might think. Plan sponsors should be prepared for continued volatility going forward, especially through the end of the year. The report cites several potential tools at sponsor’s disposal to ride out the storm.
For example, a company can freeze its plan so that employees will not accrue pension benefits from that point, or simply close it, in which case new hires going forward would not be eligible for participation in the plan.
Companies can also allocate more of their portfolios to fixed income.
Another strategy involves plan sponsors executing on a lump sum transfer strategy. Former employees and retirees can take the money and roll the sum over to their own IRA.
A liability transfer strategy allows a company to buy annuities from other companies, and much like with reinsurance, transfer risk to other parties.
Firms can also defer funding and spread the gap out over several years, a strategy many companies have taken since the financial crisis of 2008. But that’s a temporary stopgap, not a permanent cure.
Cash solutions and worries
“We’ll see a lot of cash going into these [pension] plans to close the gap,” says Barry. “Sponsors with a fair amount of cash on the sidelines will face no strain, but for others the deficit can be quite painful.”
Worst case scenario is bankruptcy, the most disastrous outcome for companies and employees alike.
In that case, the Pension Benefit Guaranty Corporation (PBGC) will cover the majority of an employee’s loss, though for companies with a funded ratio of lower than 80%, PBCG’s rescue outcome may be less palatable.
Still, Barry suggests employees--those in mid-career, pre-retirees or young people just starting out--view the current climate as an opportunity to take stock. Whether your company offers a pension or not, “you have a significant responsibility to plan for your retirement. You can’t wait until you’re 64 1/2 to fix it,” he warned.
Don’t assume retirement happens; you need to plan
Here’s how Barry and Ray Meadows, a registered investment advisor and president of San Francisco-based Berkeley Investment Advisors, suggest you take the reins:
Recognize the power of compounding. When you start to save early you will have the benefit of many years to accumulate retirement savings.
Open your monthly statements. Some people don’t open their statements because they assume the market will bounce back. Don’t be one of them, open your statements and keep them.
Continually assess where you are. When necessary, make a course correction.
Understand Your Plan. Whether your plan is defined benefit (DB) or defined contribution (DC), understand what your guaranteed monthly payment will be in retirement and determine how this aligns with what you really need to live on. Your company website typically has interactive tools and charts to help you.
Take a close look at your pension contract. If the benefits don’t match up with what you need or want your retirement income to be, step up your contributions in other areas like a 401(k), even if your company also has a pension plan. People tend to underestimate what they need in retirement.
Set up your own personal savings plan and invest in safer U.S. assets like higher yield bonds. If you still want to invest in equities, choose foreign equities. He also likes Roths but says IRAs are also useful.
Meadows eschews the lump sum transfer option instead of a guaranteed monthly option. You’d have to be a “financial superstar” to achieve consistently high returns on your own. Says Barry, “Gaining investment control means you take on more risk.”
Accept the fact that either because of your personal situation or the economy, you may have to consider working longer, to age 70 or beyond. “That’s not necessarily a bad thing,” says Barry. “But what will you do if you can’t?”