Pension Participants: Expand Retirement Savings for Future Security

by Monica Steinisch

The traditional defined-benefit pension plan--where an employer or union puts away money on behalf of its workers to provide a guaranteed retirement income--is going the way of the Pony Express. More and more U.S. companies are switching to a defined-contribution plan, such as a 401(k), shifting all the investment risk to the employee.

Still, one in five private sector workers in the U.S. currently is covered by a defined-benefit plan, and for these individuals and their families, reports of companies defaulting on their pension obligations are unsettling. (What pension participant could sleep easy after hearing news of United Airlines' bankruptcy last May and the biggest pension default in history?)

Though pension failure is not the imminent threat to your retirement that some media coverage suggests, recent stories provide an important wake-up call for those who rely solely on their traditional pension to see them through their old age.

Assess the health of your pension plan

If all goes as planned, your pension plan will be around long enough to send you checks throughout your retirement. But it's important to understand what could go wrong and how termination of your company's pension plan might affect you.

According to the Pension Benefit Guaranty Corporation (PBGC), a federal corporation that insures the pensions of more than 44 million plan participants, a pension plan can end for a number of reasons, some of which have nothing to do with financial distress.

For example, an employer voluntarily can end its plan if it wants to switch to a 401(k) or other defined-contribution plan, as long as it has enough money to pay all benefits owed to participants. Under this "standard termination," you would receive either a lump-sum payment of your vested benefits now or lifetime benefits when you retire.

A "distress termination" takes place when an employer is facing financial troubles and its pension plan does not have enough money to pay all the benefits it owes (it is "underfunded"). Underfunding can be the result of lower-than-expected investment returns, an inadequate number of active employees relative to retirees receiving benefits, or "creative" or inappropriate accounting practices.

Regardless of the reason for underfunding, if your terminated plan is a defined-benefit plan insured by the PBGC, you most likely will receive all your vested benefits. Though there is a legal limit on the amount the PBGC can pay, Gary Pastorius, an organization spokesperson, says that nine out of 10 retirees receive everything that has accrued on their behalf.

Though most defined-benefit plans are covered by the PBGC, some are not, such as those offered by church groups, governments, or professional service employers (doctors and lawyers, for example) with fewer than 26 employees. To find out if your plan is insured by PBGC, check your summary plan description (SPD), the comprehensive guide for your pension, which is available from your plan administrator.

So, what is there to be concerned about if you know that your plan is PBGC-insured? Since the PBGC does not guarantee health benefits, you could lose valuable medical coverage that you were counting on. And, if you're at the higher end of the salary spectrum, your benefits may be reduced to fit within the PBGC limits. Furthermore, an unexpected change to a major component of your retirement plan could make it difficult to reach your goals. Regardless of PBGC coverage, it's nice to find out that your pension plan is strong.

According to Know Your Pension, an independent group that provides tools and information to help workers understand and monitor their pension, the best single indicator of a plan's financial health is its funding percentage. A fully funded plan will have a funding percentage of 100%--the lower the percentage, the greater the risk that the plan will become insolvent.

To find out your plan's funding percentage, check its most recent summary annual report (SAR); if one is not provided to you automatically, request it directly from your plan administrator. You also can get the information from Form 5500, which your plan is required to file with the IRS and the Department of Labor (DOL). To get a copy of your plan's Form 5500, visit freeERISA.com, a Web site that provides free access to pension and benefit data.

Once you know your plan's funding percentage, you can use Know Your Pension's classification method to assess its overall health, ranging from "little danger of loss of benefits" to "imminent risk."

Diversify retirement income sources

In 2004, the PBGC became trustee to just over 100 pension plans (in other words, the plans ended underfunded and the PBGC had to take over benefits payments). By contrast, 1,189 plans ended fully funded in the same period, meaning that many employers either decided to stop providing pension benefits or they switched to a different type of plan, such as a 401(k).

Regardless of why your plan ends, even if you receive all of the benefits you are vested in to date, the opportunity to build additional benefits in the plan is lost. Will your company follow the trend? Who knows, but that possibility is something that all pension plan participants should be prepared for.

Retirement funding often is discussed in terms of a three-legged stool, with the different legs representing Social Security benefits, employer-sponsored pensions (defined-benefit and defined-contribution), and individual savings. Ignore any one of the three sources of retirement income, and the stool--your retirement plan--just won't stand up.

So, what about that third leg of the stool, individual savings? This is where you have the most control over your retirement plan and the greatest opportunity to shape your future.

As Linda Robertson, a Certified Financial Planner� with Financial Finesse, a company based in Manhattan Beach, Calif., that provides unbiased financial education to organizations' employees and members, explains it, workers have no control over how much their employer contributes for them or how the funds are invested in a defined-benefit pension plan. In a 401(k) or other defined-contribution plan, their control is limited by rules regarding the percentage of salary that can be put away tax-deferred, how much the employer is willing to contribute, and what investment options are offered.

"Saving outside an employer-sponsored plan gets rid of all those limitations on investment options and how much you can save," says Robertson, "and gives you more control over your future."

Once you've maxed out any savings plan offered at work and put away an emergency fund that will get you through most things that fate could throw your way, Robertson recommends opening an IRA (individual retirement account) at your credit union or another trusted financial institution.

In Robertson's opinion, most people are going to benefit more from a Roth IRA than from a traditional IRA. While a Roth account offers no tax deduction on deposits, it allows savers to withdraw earnings tax-free in retirement; a traditional IRA offers a tax deduction on contributions for those who qualify, but it requires that taxes be paid on the earnings when the money is withdrawn.

"To me, it's better to know that money is going to come out tax-free, rather than just postponing those taxes," she says.

Also, for many savers with access to a retirement plan at work, a traditional deductible IRA may not be allowed, or at least the contributions won't be tax-deductible. More savers will be eligible for the Roth IRA, since the income limitations for participants are much higher than those for a traditional IRA, and there is no "participation clause" that precludes workers who also save through a retirement plan at work.

Either IRA will allow any accountholder to save up to $4,000 per year. Special catch-up provisions permit older workers to save an additional $500 in 2005 and an extra $1,000 in 2006.

Still want to save more? Congratulations! Once you max out your IRA, you might consider a tax-deferred annuity. There's no limit on how much you can invest, but Robertson cautions that some of these accounts have high fees that negate the benefits of any tax deferral you're getting.

Another option is to save outside tax-advantaged retirement accounts. There's a big benefit: no penalty for early withdrawal. Designated retirement accounts impose an age threshold, usually 59�, for withdrawals, and typically levy a 10% penalty on funds taken out earlier.

To make saving on your own as painless as possible, set up an automatic transfer from your credit union checking account to your IRA or other investment account each payday.

Robertson encourages future retirees to never stop saving.

"After 18 years in financial planning, I've never heard a retiree say, 'Oops, I saved too much,'" says Robertson. "They always wish they had started earlier and saved more." If you do have any money left over at the end of your retirement, she points out, that is your legacy to pass on to loved ones or a cherished cause.

January 23, 2006