When "Safer" Pensions Aren't So Safe

Even old-fashioned defined-benefit plans need your scrutiny

Traditional pension plans? How 1970s can you get? For the past two decades, the idea of company-funded retirement plans that gave workers no investment choices seemed dowdy and paternalistic. These "defined-benefit" pensions--so called because they resulted in a fixed benefit, usually in monthly checks, at retirement--were eclipsed by "defined contribution" rivals such as 401(k) and profit-sharing plans.

Then the bear struck. Suddenly, old-fashioned pensions--where employers, not workers, shoulder the risks of down markets--started to gain new appeal. But look closely: Traditional pensions have their problems, too. And if your plan is in trouble, you may have even less warning than you'd get if your 401(k) started to sink.

In the third year of down markets, the average pension fund has lost 12%--leaving it some 30% poorer than it would have been with normal 9% annual returns. And many companies--among them General Motors (GM ), United Technologies (UTX ), and US Airways (U )--are facing huge shortfalls that must be made up in the next few years. For some companies, "the cash demands to restore pension funding could be enough to bring down the company--and the pension along with it," warns Ethan Kra, chief retirement actuary for Mercer Human Resources Consulting.

Before you panic, though, keep in mind that traditional pensions offer many safeguards. Defined-benefit plans are run by professional managers who are subject to stricter standards--including a rule that no more than 10% of pension assets can be in the employer's stock--than are individuals investing their own 401(k)s. And the federal government polices traditional pensions more closely than defined-contributions plans. If the worst happens, Washington will take over a traditional plan and insure its benefits, though not at a level that guarantees full coverage for highly paid executives.

Traditional plans lag badly in one area: disclosure. Investors in 401(k)s get quarterly statements and may even go online for daily updates. Traditional pension participants get sketchy annual reports that are almost a year out of date. And those reports may not tell you the most vital data: whether plan assets are enough to cover current and future benefits for you and your co-workers.

So what should you do to check out the health of your pension? Start with that Summary Annual Report, a very brief statement that employers or administrators of plans with more than 100 participants are required to distribute each year. (Smaller plans send out SARs every three years.) If your company operates on a Dec. 31 fiscal year, your 2001 SAR should be arriving in late October or November.

The key statement on the SAR is under the heading Minimum Funding Standards. It should attest that professional, independent actuaries have certified that the plan's funding is sufficient to cover benefits that participants have already earned. You'll find more data on assets in the Basic Financial Statement, including how much the plan made or, more likely, lost on its investments. But asset figures are meaningless without the offsetting liabilities--and the SAR isn't required to tell you those.

If you want a fuller picture, you've got to get a copy of the full annual report, filed on Form 5500. Your employer is obligated to give you its 5500 (though it may charge you for copying costs); the SAR should tell you where to make your request. If you anticipate resistance, make your request by certified mail; you can sue and win a $100-a-day fine if the plan doesn't deliver the form within 30 days. You can also get a Form 5500 from the Labor Dept.'s Pension & Welfare Benefits Administration. Find the nearest PWBA office by going to www.dol.gov/pwba or by calling 866-275-7922.

The 5500--six pages, plus several schedules and other documents--contains lots of useful information. The problem is unearthing it. The PWBA's Protect Your Pension guide (available on the Web site) tells where to look for signs of trouble: excessive expenses, investments that could pose conflicts of interest, lists of assets held in the fund, and ways to calculate investment returns. If your own examination leaves you worried, you can contact the federal Administration on Aging's Pension Information & Counseling Project. (Find a list of sites at www.pensionrights.org.) The American Academy of Actuaries has volunteers who will help untangle the knotty calculations--call 202 223-8196 and ask for the Pension Assistance List.

You'll find the company's calculations of its plan obligations--how much it has to pay in benefits--in the 5500. Plans have two ways to figure what they'll owe workers: current obligations, or what the plan must pay to fund all benefits that were earned up until the date of the report, and the much larger potential obligations, which are based on all benefits the plan must pay to current and future workers. If you focus on potential obligations, you may be needlessly alarmed, since a healthy company can count on future contributions to cover potential benefits.

It's the current obligations vs. current assets that determines whether a plan is underfunded. If so, the government's safety net starts to unfurl. If your plan's assets are less than 90% of current liabilities, it must send you a notice of underfunding. The Pension Benefits Guaranty Corp., the federal insurer of defined-benefit pensions, will step in, requiring the employer to make larger, more frequent contributions.

If worse comes to worst, your company will terminate the pension--and PBGC insurance kicks in. The agency wrings what it can out of employers, but failing companies' plans are often in poor shape. In that case, benefits may be cut: PBGC payments are capped at around $3,600 a month, vs. the $5,600 or so that a highly paid employee with 30 years' seniority might expect. "PBGC insurance is for the rank and file, not the top echelons," warns Kevin Wagner, retirement-practice director for Watson Wyatt Worldwide (WW ).

If you're close to retirement and fear for your company's health, ask if you can take your pension benefits as a lump sum. If your employer offers that option, it must pay you the amount it would need to invest at current interest rates to fund your promised benefits. With today's low rates, lump-sum payouts are larger. But taking a lump-sum cashout means you've got to manage the funds, with no guarantee that you won't outlive your money.

Should you worry if your company is facing a funding gap? "The health of your pension basically depends on the health of your company," says Martha Priddy Patterson, director of benefits policy for accountants Deloitte & Touche. If your company is sound, the funding gap is a bigger problem for shareholders--who will take an earnings hit as funds are replenished--than for employees. And when markets turn up again, those gaps will narrow. Nonetheless, you'd be smart to treat the shortfall as a wake-up call--and make sure your traditional pension gets some old-fashioned attention.

By Mike McNamee

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