Last Updated: March 16, 2009
The news about defined benefit plans — traditional pension plans — has not been good of late, with many research firms reporting that funding ratios have dropped to levels not seen in years.
A recent Watson Wyatt analysis of pension disclosures for the 100 largest U.S. pension sponsors found that aggregate funding levels decreased by 30 percentage points, from 109 percent funded at the end of 2007 to 79 percent funded by the end of 2008. Milliman, another research firm, noted that its Milliman 100 Pension Funding Index, which also consists of 100 of the nation's largest defined benefit pension plans, witnessed a decline in the funding ratio from 99.6 percent to 71.7 percent. And, according to Towers Perrin, the funded ratio of the pensions it tracks fell to 60.2 percent in February, a 27 percentage point drop over the trailing six-month period.
The funding ratio represents the degree to which a pension plan can fulfill its obligations to future and current retirees. According to Investopedia.com, "a defined-benefit plan is considered adequately funded if its assets equal or exceed the discounted value of its future liabilities." However, under the Pension Protection Act of 2007, private defined benefit plans that are significantly underfunded must meet special requirements for accelerated funding and disclosing shortfalls to the Pension Benefit Guaranty Corporation (PBGC), according to Investopedia.com. "By 2011, all private defined benefit plans must pursue full (100 percent) funding by amortizing any shortfalls over seven years and increasing plan contributions accordingly." Learn more about funding ratios.
So given the current shortfall and the looking change in the law to be fully funded, what should you do if you work for a firm with a defined benefit plan or are retired from a firm that has such a plan?
For his part, FPA member, Michael Kresh CFP®, of M.D, Kresh Financial Services, notes that most employees enrolled in defined benefit plans are covered by the PBGC. To learn more read FPA's Check if Your Defined Benefit Plan is Safe.
With that backdrop, Kresh noted that "the lack of funding initially is more of a problem to the corporation than to any individual participant." The law does not allow a corporation to take away any benefits that a participant has already accrued, he said. "So what you have already earned is protected. And unlike your 401(k) plan any investment loss is a problem for your employer not you."
However, if the plan is under so much stress, your employer might decide to freeze the plan, Kresh said. Many large companies such as IBM and Verizon have elected to freeze future benefits. "If you discover that you are in that place you need to review your retirement plan," he said. "If your company goes bankrupt, the PBGC will step in and guarantee your pension.This, "could protect most of your pension at normal retirement age. However, if you retired early or planned to do so you could lose a lot of your pension," Kresh said.
Another word of caution for those whose pensions have been taken over by PBGC or might be taken over is that the maximum pension the government is responsible for is $ 54,000 payable at age 65.
"The most important advice that I could give any employee is to pay attention to your company's funding of their plans since that could give you a great insight into the financial soundless of your employer," said Kresh.