Things have changed since Grandpa retired with his gold watch. The old-fashioned pension plan he was awarded for years of loyalty to his employer is going the way of the IBM Selectric typewriter.
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More and more employers are freezing traditional pension plans, also known as defined benefit plans. Employees caught up in pension realignments aren't being thrown entirely to the wolves -- they do have some protections from the Employee Retirement Income Security Act of 1974, or ERISA. In extreme cases, the Pension Benefit Guaranty Corp., or PBGC, steps in. But generally, workers have little choice when a company opts to freeze a pension plan.
Here's what you need to know if your pension plan is set to ice over.
Soft Freeze or Hard?
There's more than one way to freeze a pension, and a company freeze may not affect every employee the same. A soft freeze might only apply to new hires or certain types of employees; it may also signify the end of benefit accumulation based on years of service, but could provide for additional pension benefits based on pay.
Hard freezes dictate that workers stop earning future benefits under the defined benefit plan altogether, but no freeze can take away what a worker has already earned. Earned benefits must be left intact, while future benefits can take the shape of a defined contribution plan, such as a 401(k) or 403(b).
Experts say there's not much an employee can do about either type of pension freeze unless the employer violates the law.
"If the employer doesn't follow proper procedure, then the freeze isn't legal," says ERISA attorney Ary Rosenbaum. In order to pass legal muster, companies must comply with a bevy of provisions, including ERISA, the Pension Protection Act of 2006 and complicated Internal Revenue Service regulations.
Rosenbaum says pension freezes aren't going away; many private companies, including unions, are phasing out defined benefit plans. "You're rarely going to find an employer offering you a defined pension plan anymore," Rosenbaum says.
It's a frosty trend local and state governments are also exploring. While many states and municipalities are addressing severe pension liabilities, officials in places such as Washington state and North Carolina, with fairly healthy pension plans, are attempting to stave off anticipated or real funding shortfalls by implementing certain reforms or exploring defined contribution plans.
A Shift of Risk
When a pension plan is frozen, employers often opt for defined contribution plans, such as the 401(k), 403(b) or 457 plan. The good news is that these plans are portable: The employee can take his or her retirement funds along when changing jobs.
The drawback is that workers are responsible for managing them. As hundreds of thousands have discovered, investments can pay off big, but also tank spectacularly, leaving participants with little or nothing to show for years of work.
Transitioning over from a defined benefit plan to a defined contribution plan requires some homework because your bottom line will change when it's time to start collecting benefits. The amount you receive from your pension is based on a formula that takes into account years of service and compensation. When your plan changes, so will the payout you can expect to receive from your pension plan.
You should familiarize yourself with the plan's changes, then determine about how much you'll receive when you start drawing your pension. (Your company's human resources office should be able to assist you with this.) Once you have that figure, crunch the numbers and see how much you'll fall short of earlier expectations. That will give you a savings goal.
Does your employer match contributions? If so, you should maximize that opportunity by contributing at least the amount to get the full match. But you might also want to consider alternative savings plans to supplement your 401(k) contributions, especially if the investment options are limited.
If Your Pension is Terminated
In the worst-case scenario, a company can terminate your pension. That doesn't happen often, but if it does, you have some protection. Your employer must either pay your money out in a lump sum or purchase an annuity. If the company's gone belly-up financially, as Harlem's North General Hospital did recently, the PBGC can and will step in.
Fortunately, terminations are not as common as pension freezes. Ronald Stair of Creative Plan Designs works with companies to realign their pension plans. He says he's helped 74 firms put their plans into a freeze, but that even if a company freezes its plan, all is not lost.
"The advantage to a freeze is that the company can thaw it at any time, even if it's a partial thaw. Sometimes (companies) just need to let the dust settle, and a freeze helps them get to the end of the year," says Stair.