How's your pension these days? Are you worried about its health? If so, you're not the only one.
Private and public pensions are on shaky ground, even though both are guaranteed -- the former by their sponsoring corporations, with the Pension Benefit Guaranty Corporation, or PBGC, as a backup. Public or government pensions are effectively guaranteed by taxpayers.
The funded status of pension plans can change erratically, even over short periods of time. For example, pension plans sponsored by Standard & Poor's Composite 1500 companies lost $191 billion in the first six trading days of August 2011 alone, according to Mercer, a global benefits consulting firm. Their funded ratio fell from 83% at the end of July to 73% by market close on Aug. 8. Then it rebounded to 79% by the end of August. That's down from a peak of 88%, measured at the end of April.
These pension plans were hit by increasing liabilities and falling assets, with the most significant impact coming from a rally in long corporate bonds, says Peter Austin, executive director of BNY Mellon Pension Services.
"Falling interest rates had a severe impact on the funded status of the typical corporate plan," Austin says. "As a result of the rate decline, corporate plans gave up all of the gains they had achieved in 2011."
So should you be really worried? The answer is almost certainly yes -- and no.
Precious Few Pensions
First of all, if you have an old-fashioned defined benefit pension, consider yourself lucky. Only about 20% of workers do, according to the U.S. Department of Labor.
You can take comfort in the Pension Protection Act of 2006, which requires companies that have underfunded pension plans to pay higher premiums to the PBGC. The PBGC also forces companies that terminate their pension plans to put more money in the plans. And it requires companies to analyze their pension plans' obligations more accurately, closing loopholes that previously allowed some companies to skip payments when times were tough.
"I think the Pension Protection Act really does provide a very sound framework for the management of plans and results in overall better health of the U.S. corporate pension market," says Austin. "It's a pretty darn good law that has gotten the attention of every plan sponsor."
The new rules also make it more attractive for companies to offer employees a lump sum, Austin says. Lump sums require a lot of upfront cash. Under older rules, an employer that chose to offer a lump sum had to stick with the decision. Under the new rule, firms can offer a window of lump-sum opportunity -- and then close it.
Historically, Austin says, half of all employees will choose the lump sum and half will stick with an annuity, which removes some pressure from the corporation's assets.
If you decide in favor of the company annuity plan, the PBGC offers you a guarantee that the money will be there as long as you are around to draw upon it. For 2011, the maximum benefit for those retiring at age 65 is $54,000 per year. You can count on being made whole even if the company you worked for goes belly up.
What About Public Pensions?
Last year the Pew Center on the States stated there was a $1 trillion gap at the end of 2008 between the amount states set aside to pay for their workers' retirement benefits and its actual price tag. Other organizations said the Pew estimate was conservative, and that the gap was much wider. Still others say it's not as bad as it seems.
"Public pensions are in good shape, given the economic downturn," says Elizabeth Kellar, president and CEO of the Center for State and Local Government Excellence. Her organization calculates government pensions are 78% funded.
"There's a gap between promises and assets, but if you look at it historically, there's no cause to be particularly alarmed. It's a relatively small shortfall and governments are making changes that will shore up funding," she says.
There are some exceptions, she says. While 42 states have made adjustments to their pension plans to make them more fiscally sound, others, such as Illinois, aren't trying hard enough and remain significantly underfunded. The municipalities within those states tend to be those that also are having trouble. The city of Chicago's pension plan, for instance, is only 50% funded, Kellar says.
"If governing bodies don't have fiscal discipline and if they take liberties, employees are going to have problems," she says.
Options for Workers in the Private Sector
Here are some possible options if you are worried about getting your money from a private pension when the time comes.
Study up. The Pension Protection Act requires that your company provide you with information about the financial status of your pension. The statement should show you the extent to which your plan's assets cover its liabilities. A funding rate of 80% or higher is a good sign. If the funding rate is below that, you may have reason to be concerned.
Take the early out. If the company you work for is in a financially unstable condition and offers you an early retirement option, consider taking them up on it, extracting your pension and finding other employment and investment options.
Consider taking the lump sum. If your company pension is really in shaky condition, ask about taking a lump-sum distribution. But if you get it, invest cautiously. These days, taking the lump sum can mean you won't be able to generate nearly as much return as you expected your company pension to provide.
Options for government workersIf you have a public pension, Edward A. Zurndorfer, a financial adviser in Silver Spring, Md., who specializes in offering retirement advice to federal and other public employees, makes the following suggestions.
Understand your current plan. Don't take co-workers' interpretations as gospel. Get help from your union attorney or someone who is qualified to explain how your government employee pension is likely to affect you and mesh with other plans for which you may qualify, including Social Security.
Try to avoid quitting early. Workers who quit well before 65 or 66 are the most vulnerable to cuts and low or no cost-of-living adjustments. If you can, keep working until your full retirement age.
Qualify for Social Security. You can do this by working under it for at least 10 years or 40 quarters. Federal employees who were hired before 1983, as well as state or local workers who are not paying Social Security, may be affected by the federal Windfall Elimination Provision, or WEP, which reduces the Social Security benefit that can be earned elsewhere. Its sister provision -- Government Pension Offset, or GPO -- affects spouses of those under WEP.
WEP and GPO will reduce the Social Security benefit, but they won't eliminate it entirely. The closer you get to having worked 30 years earning what the government terms a "substantial" wage (defined in 2010 and 2011 as at least $19,800) the less WEP affects you. So if you're employed outside of the federal system, make it a goal to rack up as close to 120 quarters as you can.
Zurndorfer, who is 60 and a retired federal employee, has run an accounting business on the side for many years. He says he's planning to work seven more years so he can rack up 25 years under Social Security earning a substantial wage. This will increase his benefit by 50%, compared to what he would have received after 20 years in the system.