In 2014, the Bipartisan Policy Center (BPC) launched the Commission on Retirement Security and Personal Savings, led by former Senator Kent Conrad and WL Ross & Co. Vice Chairman Jim Lockhart. The commission will consider and make recommendations regarding Social Security, pensions, defined contribution (DC) savings vehicles, strategies to generate lifetime income and other factors that affect retirement security.
This BPC-staff authored post is the seventh in a series that will outline the state of retirement in America and provide a sense of the challenges that the commission seeks to address in its 2015 report.
For more information on the topics below and in the rest of this series, see our recently released staff paper, A Diversity of Risks: The Challenge of Retirement Preparedness in America.
Our last post in the series detailed how defined benefit (DB) pension plans have historically helped to ameliorate some of the risks that retirees face, as their retirement investments are managed for them and they are offered a monthly income through the rest of their lives. In recent years, DB plans in the U.S. have rapidly disappeared, and for the vast majority of retirees going forward, a defined contribution (DC) account will be their sole workplace retirement plan.
There are still many Americans, however – particularly those who are in the later stages of their careers – who are owed DB pensions, and those individuals face a number of risks to their retirement prospects. Some of the risks to DB plans, such as voluntarily leaving an employer before benefits vest or choosing a lump-sum payment (upon retirement) that must be managed rather than a monthly income, are at least somewhat within the participants’ control. Other risks – such as plan underfunding, freezes, or failures, the subjects of this blog – are entirely out of their hands.
Participants Can Be Hurt When Plans Terminate or Fail
When a company decides to stop offering its DB pension plan, it first implements a freeze, which can take various forms. Under a soft freeze, the plan is closed to new employees, a change that is usually not damaging to the retirement security of current employees, who continue to accrue benefits as scheduled. But under a hard freeze, all employees are prevented from accruing further benefits, though they retain any benefits that have already vested. Hard freezes can be particularly damaging to the retirement security of older workers, who may expect large late-career accruals of benefits and do not have much time left in their careers to grow DC accounts.
Plan sponsors can also combine elements of both a hard and a soft freeze. For example, a company might implement a hard freeze for employees with shorter tenures and a soft freeze for employees with longer tenures. In any case, once a plan is frozen, many decades may pass before the plan is fully terminated, as pre-freeze participants continue to be eligible for benefits during retirement.
Many companies have frozen their defined benefit plans in recent years. In 2014 alone, Boeing, Lockheed Martin, and The Washington Post all announced that they were freezing traditional DB pension plans for some or all of their employees.
Sometimes, underfunded plans, whether open or frozen, fail outright. Plans become underfunded as a result of insufficient employer contributions and/or poor investment choices. Ideally, employers with underfunded plans would increase their contributions (as they are now required by law to do) over a period of time until the plans are once again fully funded, but this assumes that the employer is and will remain viable and profitable.
For most of the 20th century, when companies with underfunded pension plans went out of business, participants could lose some or all of their promised benefits. Congress attempted to address this problem in 1974 by enacting the Employee Retirement Income Security Act (ERISA), which set funding requirements for private-sector DB plans and established the Pension Benefit Guaranty Corporation (PBGC) as an independent agency charged with promoting the health of DB plans and insuring benefits for DB plan participants who find themselves in plans that cannot pay. In 2006, Congress updated some of these rules through the Pension Protection Act of 2006.
PBGC Insurance Protects Participants When Plans Fail
PBGC currently insures over 42 million Americans who participate in private-sector DB plans. The agency is funded through a combination of premiums from all insured plans and assets from those plans that have been taken over by PBGC after the plan sponsor declared bankruptcy or ceased operations. All plans are charged a flat premium per participant; underfunded plans are also charged a variable premium that is highest for the plans with the greatest unfunded obligations.
Two separate trust funds hold PBGC assets – one is for the approximately 30 million participants who are in single-employer plans, and the other is for the remainder who are in multiemployer (or “Taft-Hartley” plans). Multiemployer plans are formed by agreement among a union and more than one employer, usually within the same industry. They are particularly common in construction, manufacturing, and trucking.
PBGC does not guarantee all unfunded liabilities of plans, although it generally covers most of the promised benefits for participants in single-employer pension plans. For example, a 65-year-old retiree in a failed single-employer plan is eligible for a guarantee of about $60,000 per year in benefits. (The guarantee amount is lower for those who retire earlier.) Retirees who had been promised larger benefits – usually those who had very high career earnings, such as former executives or airline pilots – have faced some benefit cuts depending on the funded status of the plan.
In contrast, participants in multiemployer plans are especially at risk for substantial benefit cutbacks if their plan fails. Those employees with 30 years of qualified service are only guaranteed around $13,000 in annual benefits—far less than participants in single-employer plans.
PBGC’s benefit and premium levels are set by Congress, and are often not directly determined by the agency’s needs and resources. As a result, the agency has a current deficit of approximately $35 billion (for Fiscal Year 2013). A 2014 PBGC report estimated that the present value of its projected combined deficit for both trust funds (defined as assets minus liabilities) is as high as $57 billion.
More importantly, the multiemployer trust fund has a 95-percent likelihood of exhausting by 2025.1 Should this occur, PBGC would be unable to pay out even its modest guarantees to multiemployer plan participants. Stay tuned for the next post in this series for more on multiemployer plans and PBGC.
The Bottom Line
While employees with DB plans may have some ability to ensure that their benefits are vested before leaving a job and can decide whether or not to opt for a lifetime annuity in lieu of a lump-sum payment, some major risks inherent in DB plans are beyond participant control. PBGC was created to help address some of these greater risks, but its own solvency is now in question and may require congressional action. Although the U.S. retirement system is moving away from DB plans, there remain significant policy issues that policymakers cannot ignore for the millions of Americans who continue to rely on their DB pensions.
Alex Gold and Harry Baumgarten contributed to this post.
View all posts in BPC’s Retirement in America series under Related Stories below.
1 The single-employer trust fund is projected to remain solvent over this period.