First, the bad news: The government agency that insures private-sector pensions and pays out benefits should the plans fail posted a record deficit in the first half of the year. The good news? Even if your employer declares bankruptcy, your retirement benefits are largely protected. Here's what you need to know about your pension and 401(k).
Underfunded pensions. Pension retirement plans are only partially funded at many companies. Pension plan assets declined by 26 percent in 2008, largely because of losses in the stock market, according to a Watson Wyatt analysis of the 100 largest U.S. pension sponsors. Only 14 percent of the pension plans were more than 90 percent funded at the end of 2008, versus 80 percent in 2007. But that doesn't mean companies don't have enough money to pay out promised benefits in the foreseeable future. "The majority of companies don't have big enough losses that they can't make their payments," says Lynn Dudley, senior vice president of the American Benefits Council, a trade group for companies that offer employee benefits. "They do have enough money to pay current benefits." Even when a company goes bankrupt, its pension plan is not necessarily terminated. For example, even though General Motors Corp. has entered Chapter 11 bankruptcy, its two defined benefit pension plans remain in place. Chrysler's pension plans are also continuing under the sponsorship of Fiat Corp., the United Auto Workers, and the U.S. and Canadian governments.
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Government insurance. Most private-sector pension plans are also insured by a government agency—the Pension Benefit Guaranty Corporation—which pays out most benefits if the plans fail. When Circuit City, a now defunct Richmond, Va.-based electronics retailer, went out of business, the PBGC assumed responsibility for its pension plan covering the approximately 21,900 former workers and retirees. Current retirees and beneficiaries continue to receive their monthly benefit checks without interruption, and other participants will receive their pensions when they are eligible to retire. PBGC estimates that Circuit City's retirement plan was 82 percent funded, and PBGC is responsible for about $62 million of Circuit City's estimated $64 million shortfall.
Delay your start date. For retirees who choose the single life annuity payment option beginning at age 65 in 2009, the maximum insured pension amount is $54,000 annually or about $4,500 a month. The guarantee amount is lower if you begin receiving payments from PBGC before age 65 or if your pension includes benefits for a survivor or other beneficiary. "The people who are at most risk of losing benefits are people who retire at younger ages," says Jeffrey Speicher, a spokesman for the PBGC. "If you wish to wait until a later age so that you are not affected by the limits, you certainly can." The guarantee amount is higher if you are over age 65 when you begin receiving benefits. Retirees who begin their payouts at age 45 are insured up to only $13,500 annually, while those who delay payments until age 75 are guaranteed up to $164,160. (Both of these amounts are reduced for retirees who elect survivors benefits.) "You will get a higher pension the longer you wait to take it," says Evan Inglis, chief actuary for Vanguard Strategic Retirement Consulting. The majority of the participants in plans taken over by the agency face no reduction in benefits because of the legal limits on coverage, according to PBGC research. The limits increase each year but apply to the year the company entered bankruptcy or that the pension plan was terminated, even if the employee does not begin collecting benefits until a future year. If the pension was amended within five years of the termination date benefits may not be fully guaranteed.
Underfunded insurance. The PBGC posted a record $33.5 billion deficit for the first half of 2009, which is triple fiscal year 2008's $11 billion shortfall. The PBGC says it has sufficient funds to meet benefit obligations for many years because benefits are paid monthly over the lifetimes of beneficiaries and not as lump sums. "There is very little chance that the PBGCs deficit will lead to employees or retirees getting less than they promised," says Douglas Elliott, a Brookings Institution fellow. The government agency is not currently taxpayer funded, but it receives income largely from insurance premiums paid by companies that sponsor pension plans, assets from pension plans it takes over, and investment returns.
Health insurance. Retiree medical coverage is not insured by the government and is often eliminated by financially struggling companies or during bankruptcy proceedings. "There is basically no protection for retiree health benefits," says Joseph Matthews, an attorney specializing in senior issues and author of Social Security, Medicare & Government Pensions. "You've got to be aware that at any moment you could lose your retiree health benefits." Xerox, for example, announced a cut in medical benefits for some former employees over the age of 65 last year. When asked about the retiree benefit cuts at the company's annual shareholders' meeting in May, recently retired CEO Anne Mulcahy responded, "This was intended to be something that was not going to be a benefit that, you know, was an entitlement forever. It was subject to business conditions. It was subject to management discretion."
401(k) diversification. Employees already own their 401(k) contributions and any employer contributions that have been vested. But the value of company stock in your 401(k) is linked to the health of the company. To protect your retirement security, it's a good idea to diversify beyond company stock. For the most part, employees have already been doing this. Only 9 percent of employees held half or more of their 401(k) plan assets in their employer's stock in 2008, down from 16 percent in 2007 and 27 percent in 2004, according to a Hewitt Associates analysis. Heed the warnings of former Enron employees, some of whom were heavily invested in company stock and saw their retirement savings disintegrate overnight when the company collapsed, and don't put your entire nest egg in one company—even your own.