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The Perilous State of Pension Plans

If you’re among the minority of American workers who are still covered by a pension plan, take note: state and private pensions all across the country are under financial stress and may not be able to pay out promised benefits in full.

Pension plans have taken a beating from the same sources as defined-benefit plans: the economy and turbulent investment returns over the last several years. Unlike defined-contribution plans, whose asset levels depend mostly on employee contributions, pension plans depend entirely on employer contributions. But the formula for employer funding depends on the promises it has made for specific annual lifetime payouts related to the number of qualified employees, how much they make (often in their final five, highest-earning years), and how long they worked for the company.

If assets are equal to the amount of promised payments owed to workers, the pension is said to be “fully funded”. If the asset level is higher than the fund’s current obligations, the fund is said to be “overfunded;” and if the asset levels aren’t sufficient to meet the funds obligations, it’s said to be “underfunded.”

Pensions that are underfunded are a problem for company sponsors, because it means that the company is going to have to contribute more to catch up. Poor investment returns and drastic reductions in tax revenues have hit state and municipal employee pensions particularly hard.

These difficulties help explain why the number of pension plans decreased so drastically over the last 30 years. According to the U.S. Department of Labor, the number of defined-benefit pension plans peaked in 1983 at 175,000; in 2009, the latest year for which figures are available, the number was 47,000 – a 73% decline. It was mirrored by the growth in the number of defined-contribution plans like 401(k) plans – from 472,000 to 660,000 over the same period (a 40% increase). And while more than 60% of the American workers covered by a retirement plan were enrolled only in a pension plan in the late 1970s, today that number stands at under 10%.

The real problem is the number of pension plans still in place that are underfunded. The risk is that underfunded pension plans will be terminated, either voluntarily or through sponsor bankruptcy, and pay out reduced benefits, even if the pension is backed by the federal Pension Benefit Guaranty Corporation.

A recent survey by the investment bank Credit Suisse found that 97% of all corporate pensions are underfunded to the tune of some %500 billion. Meanwhile, The New York Times reported in July 2012 that all but 18 of the pension funds sponsored by America’s largest companies – Those listed on the S&P 500 Index –are underfunded.

Pension experts say that state government employee pension funds are in even worse shape. A 2010 study released by two Chicago-based university economists estimated that state pensions had $1.2 trillion in unfunded obligations; and by 2023, 23 state funds could run out of money. Since 2009, 45 states have cut back pension benefits for teachers, police, firefighters, and other public workers.

What does all of this mean? If you’re covered by a pension, it means you shouldn’t take for granted that the checks your employer currently promises to pay you will actually arrive in the amount promised. It also means that you should strongly consider starting or increasing your contributions to your own retirement plan, like an IRA.

Please call if you’d like to discuss this in more detail.

Copyright © Integrated Concepts 2012. Some articles in this newsletter were prepared by Integrated Concepts, a separate, nonaffiliated business entity. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.

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