Never Mind Social Security: Are Your Retirement Pensions at Risk, Too?

As America grows old, it is faced with a new threat – that of retirement poverty. Americans are not saving enough for retirement. In an attempt to combat this new threat of retirement poverty, in August 2006 President Bush signed into law the Pension Protection Act. This act was passed to ensure that companies’ pension plans had enough funds to pay their retired employees and requires companies to maintain a higher funded status to cover their liabilities.

The act targets employers who fail to set aside enough reserves to cover current and future pension obligations by defining plans less than 70% funded as “at risk.” To discourage employers from changing plans to meet their funding level rather than changing funding to meet plan needs, it prohibits plans less than 80% funded from increasing benefits, adding new benefits, changing the benefit accrual rate, or changing the vesting rate. Plans that are underfunded must notify their participants.

Critics argue that this act has accelerated the closure of defined benefit plans by companies. Many companies, especially in the beleaguered industries such as airlines, have closed down defined benefit pension plans and offer new employees defined contribution plans. A defined benefit plan is a plan which bases the pension at retirement on the member’s length of service and, usually, his or her average salary at retirement. A defined contribution plan is a plan which bases the pension at retirement on the accumulations in the member’s account at that date. These accumulations are made up of the member’s contributions plus interest and the employer’s contributions on the member’s behalf plus interest.

Companies say that they have closed down the defined benefit plans to decrease volatility. These plans invest about 60% of their assets in equity markets. They are required to maintain a consistent funding level and make up any deficit within seven years. They must value assets on a market to market basis. This adds more volatility to the balance sheet.

The closing down of defined benefit plans is not good for the economy, especially in its present state. Defined benefit plans are an important source of capital as they invest in venture capital. Closing them down could have a crippling affect on the economy – shortage of capital means no new business which in turn means fewer new jobs. The defined contributions plans which have replaced these defined benefit plans do not invest in venture capital.

From an employee’s point of view, the defined benefit plan is much more beneficial than the defined contribution plan. The new plans do not build up enough money. According to the data from Employee Benefit Research Institute based on 2006 figures, an employee after investing for 30 years in a defined contribution plan and retiring in his 60s would receive about $6,450 every year if he lives till he is 90, whereas $100 in a defined benefit plan would earn about $200 more over a 30 year period than the same amount invested in a defined contribution plan.

One way to combat this problem, which could very soon snowball into a major crisis, is to allow pension plans to take a longer view on assets and liabilities to remove short term volatility.

2 comments to Never Mind Social Security: Are Your Retirement Pensions at Risk, Too?

  • [...] Correct Never Mind Social Security: Are Your Retirement Pensions at Risk, Too? August 8, 2008 by [...]

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