More Companies Ending Promises for Retirement
More Companies Ending Promises for Retirement
By: Mary Williams. Walsh
Date: January 9, 2006
Source: New York Times
About the Author: Mary Walsh has been a financial reporter with the New York Times since 2000. She has also written for the Los Angeles Times and the Wall Street Journal. She is the recipient of the Overseas Press Club of America citation for excellence in 1995.
For most Americans during the first half of the twentieth century, an ideal career followed a fairly predictable path. Following high school, a person would take a job with a large corporation. He would work there for the next forty years, gradually moving to positions of greater authority and higher pay. At retirement, he would enjoy a festive party at which his coworkers would celebrate his success and present him with an expensive gold wristwatch as a retirement gift. And for the remainder of his life, his former employer would pay him a comfortable monthly wage, along with medical care and other benefits.
The promise of a lifetime pension and a comfortable retirement provided some consolation for workers laboring at repetitive jobs in hot, noisy factories. As the American economy expanded, a rapidly growing marketplace led to soaring profits for large manufacturers, and their rapid growth enabled them to pay their pension obligations to former employees easily. By the 1960s, a majority of American workers were covered by a retirement plan of some sort in which benefits were guaranteed for life.
During this same time span, however, several factors were converging to bring about the death of the traditional pension. First, economic growth slowed, meaning that large industrial companies could no longer depend on reliable earnings growth from which to pay retirees. Second, increasing life spans meant that retired workers lived longer, and consequently received their pensions for far longer than their employers had planned. Finally, as medical science advanced, retiree health-care costs also soared, making each one more expensive to support. In many companies, projections suggested that the traditional pension model was no longer viable, and that runaway retiree costs posed a threat to the business's survival. In response, corporate managers began making wholesale changes to the way in which retirement benefits are paid.
The primary danger of the traditional pension plan lies in its dependence on a series of educated guesses, including how long retirees will live, how much the pension funds can earn in investments, and what future benefits will cost. When these guesses are wrong, as when employees predicted to live to age seventy-five actually reach eighty years old, the company must pay the difference, in this case an additional five years of pension income. Traditional plans are called defined benefit plans, meaning the company promises to pay a defined or set amount of money for as long as the retiree lives. They guarantee benefits while placing the risk of the plan and its predictions entirely on the company.
As corporations began to stagger under their enormous retiree costs, however, they had to limit their risk to avoid the cost overruns of traditional systems. To achieve this goal, most companies began phasing out their defined benefit systems in favor of defined contribution plans. These new plans, including plans such as the 401(k), commit the company to contribute a set amount to an employee retirement account each year and also allow employees to add additional funds from their paychecks. However the company's obligation is limited to the contributions made while the employee is working, meaning that the retiree's actual income from this plan may be higher or lower than expected. More importantly to the company, the firm's liability after the employee retires is zero, thus moving most of the risk for these plans from the company to the employee.
The death knell for the traditional company pension has been tolling for some time now. Companies in ailing industries like steel, airlines and auto parts have thrown themselves into bankruptcy and turned over their ruined pension plans to the federal government.
Now, with the recent announcements of pension freezes by some of the cream of corporate America— Verizon, Lockheed Martin, Motorola and, just last week, IBM—the bell is tolling even louder. Even strong, stable companies with the means to operate a pension plan are facing longer worker lifespans, looming regulatory and accounting changes and, most important, heightened global competition. Some are deciding they either cannot, or will not, keep making the decades-long promises that a pension plan involves.
IBM was once a standard-bearer for corporate America's compact with its workers, paying for medical expenses, country clubs and lavish Christmas parties for the children. It also rewarded long-serving employees with a guaranteed monthly stipend from retirement until death.
Most of those perks have long since been scaled back at IBM and elsewhere, but the pension freeze is the latest sign that today's workers are, to a much greater extent, on their own. Companies now emphasize 401(k) plans, which leave workers responsible for ensuring that they have adequate funds for retirement and expose them to the vagaries of the financial markets.
"IBM has, over the last couple of generations, defined an employer's responsibility to its employees," said Peter Capelli, a professor of management at the Wharton School of Business at the University of Pennsylvania. "It paved the way for this kind of swap of loyalty for security."
Mr. Capelli called the switch from a pension plan to a 401(k) program "the most visible manifestation of the shifting of risk onto employees." He added: "People just have to deal with a lot more risk in their lives, because all these things that used to be more or less assured—a job, health care, a pension—are now variable."
IBM said it is discontinuing its pension plan for competitive reasons, and that it plans to set up an unusually rich 401(k) plan as a replacement. The company is also trying to protect its own financial health and avoid the fate of companies like General Motors that have been burdened by pension costs. Freezing the pension plan can reduce the impact of external forces like interest-rate changes, which have made the plan cost much more than expected.
"It's the prudent, responsible thing to do right now," said J. Randall MacDonald, IBM's senior vice president for human resources. He said the new plan would "far exceed any average benchmark" in its attractiveness.
Pension advocates said they were dismayed that rich and powerful companies like IBM and Verizon would abandon traditional pensions.
"With Verizon, we're talking about a company at the top of its game," said Karen Friedman, director of policy studies for the Pension Rights Center, an advocacy group in Washington. "They have a huge profit. Their CEO has given himself a huge compensation package. And then they're saying, 'In order to compete, sorry, we have to freeze the pensions.' If companies freeze the pensions, what are employees left with?"
Verizon's chief executive, Ivan Seidenberg, said in December that his company's decision to freeze its pension plan for about 50,000 management employees would make the company more competitive, and also "provide employees a transition to a retirement plan more in line with current trends, allowing employees to have greater accountability in managing their own finances and for companies to offer greater portability through personal savings accounts."
In a pension freeze, the company stops the growth of its employees' retirement benefits, which normally build up with each additional year of service. When they retire, the employees will still receive the benefits they earned before the freeze.
Like IBM, Verizon said it would replace its frozen pension plan with a 401(k) plan, also known as a defined-contribution plan. This means the sponsoring employer creates individual savings accounts for workers, withholds money from their paychecks for them to contribute, and sometimes matches some portion of the contributions. But the participating employees are responsible for choosing an investment strategy. Traditional pensions are backed by a government guarantee; defined-contribution plans are not.
Precisely how many companies have frozen their pension plans is not known. Data collected by the government are old and imperfect, and companies do not always publicize the freezes. But the trend appears to be accelerating.
As recently as 2003, most of the plans that had been frozen were small ones, with less than 100 participants, according to the Pension Benefit Guaranty Corporation, which insures traditional pensions. The freezes happened most often in troubled industries like steel and textiles, the guarantor found.
Only a year ago, when IBM decided to close its pension plan to new employees, it said it was "still committed to defined-benefit pensions."
But now the company has given its imprimatur to the exodus from traditional pensions. Its pension fund, the third largest behind General Motors and General Electric, is a pace-setter. Industry surveys suggest that more big, healthy companies will do what IBM did this year and next.
"There's a little bit of a herd mentality," said Syl Schieber, director of research for Watson Wyatt Worldwide, a large consulting firm that surveyed the nation's 1,000 largest companies and reported a sharp increase in the number of pension freezes in 2004 and 2005. The thinking grows out of boardroom relationships, he said, where leaders of large companies compare notes and discuss strategy.
Another factor appears to be impatience with long-running efforts by Congress to tighten the pension rules, Mr. Schieber said. Congress has been struggling for three years with the problem of how to make sure companies measure their pension promises accurately—a key to making sure they set aside enough money to make good. But it is likely to be costly for some companies to reserve enough money to meet the new rules, and they—and some unions—have lobbied hard to keep the existing rules intact, or even to weaken them. So far, consensus has eluded the lawmakers.
"If Congress will not do its job and clarify the regulatory environment, then I think more and more companies will come to the conclusion that, given everything else that they've got to face, this just isn't the way to go," Mr. Schieber said of the traditional pension route.
Defined-benefit pensions proliferated after World War II and reached their peak in the late 1970's, when about 62 percent of all active workers were covered solely by such plans, according to the Employee Benefit Research Institute, a Washington organization financed by companies and unions. A slow, steady erosion then began, and by 1997, only 13 percent of workers had a pension plan as their sole retirement benefit. The percentage has held steady in the years since then. The growth of defined-contribution plans has mirrored the disappearance of pension plans. In 1979, 16 percent of active workers had a defined contribution plan and no pension, but by 2004 the number had grown to 62 percent.
For many workers, the movement away from traditional pensions is going to be difficult. Already there are signs that people are retiring later, or taking other jobs to support themselves in old age. Participation in a pension plan is involuntary, but most 401(k) plans let employees decide whether to contribute any money— or none at all. Research shows that many people fail to put money into their retirement accounts, or invest it poorly once it is there.
Even skillful 401(k) investors can be badly tripped up if the markets tumble just at the time they were planning to retire. Mr. Schieber of Watson Wyatt ran scenarios of what would happen to a hypothetical man who went to work at 25, put 6 percent of his pay into a 401(k) account every year for 40 years, retired at 65, then withdrew his account balance and used it to buy an annuity, a financial product that, like a pension, pays a lifelong monthly stipend.
He found that if the man turned 65 in 2000 he would have enough 401(k) savings to buy an annuity that paid 134 percent of his pre-retirement income. But if he turned 65 in 2003, his 401(k) savings would only buy an annuity rich enough to replace 57 percent of his pre-retirement income.
When a company switches from a pension plan to a 401(k) plan, the transition is hardest on the older workers. That is because they lose their final years in the pension plan—often the years when they would have built up the biggest part of their benefit. They then start from zero in the new retirement plan.
Jack VanDerhei, an actuary who is a fellow at the Employee Benefit Research Institute, offered a hypothetical example. If a man joins a firm at 40, works 15 years, and is making $80,000 a year by age 55, he might expect to have built up a pension worth $16,305 a year by that time, Mr. VanDerhei said. If he keeps on working under the same pension plan, that benefit will have increased to $27,175 a year when he retires at 65.
But if instead when the man turns 55 his company freezes the pension plan and sets up a 401(k) plan, the man will get just the $16,305 a year, plus whatever he is able to amass in the 401(k). It will take both discipline and investment skill to reach the equivalent of the old pension payments in just ten years, Mr. VanDerhei said.
For women, the challenge is even tougher. They have longer life expectancies, so they have to pay more than men if they buy annuities in the open market. It turns out the traditional, pooled pension offered them a perk they did not even know they had.
Despite its security and simplicity, the traditional pension might actually be less practical for many workers today. By 2006, the median length of time in a single job had fallen to only four years, while the traditional forty-year stint at a single employer had virtually vanished. Consequently, many of today's increasingly mobile workers are better served by defined-contribution plans, in which they receive their promised benefits regardless of whether they remain with the same firm or move on. An employee beginning a career today should expect a retirement nest egg consisting of several company retirement plans, as well as an individual retirement account and other instruments. Today's workers confront a dizzying array of choices, including determining how much to save and how to invest those funds. As the employer-funded pension fades into history, a comfortable retirement will increasingly depend on workers' individual choices, particularly their willingness to save, throughout their careers.
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