The Association of U S West Retirees



How Safe Is Your Pension?
Freeze of IBM Plan Leaves Workers Worrying If Their Employer Is Next;  Who Is Most Vulnerable
By Ellen E. Schultz and Theo Francis, Staff Reporters  
Thursday, January 12, 2006

International Business Machines Corp.'s plan to freeze its $48 billion pension sent a chill through workplaces across the nation, with employees questioning whether their own benefits were also at risk.

IBM is the latest in a litany of corporations that have announced pension freezes in recent years, including Verizon Communications Inc. and Sears Holdings Corp. The actions mean that even though workers will get their pensions when they leave or retire, their benefits won't grow with additional years on the job. IBM instead increased contributions to its employee 401(k) retirement plan.

So far, there hasn't been a mass exodus by large companies from pension plans. Although smaller companies have been scaling back pensions in favor of 401(k) plans for years, two-thirds of companies that make up the S&P 500 still have pensions.

In the first comprehensive government study of frozen pension plans, the Pension Benefit Guaranty Corp. last month said that nearly one in 10 pension plans at private employers had halted accruals to at least some participants as of 2003, the most recent year for which complete data are available. But most of these cuts were at companies with fewer than 100 participants, and represented only 2.5% of total pension participants in PBGC-insured plans, the study found.

Still, a number of factors make it likely that more large companies could put the brakes on pension benefits soon. What's more, this is likely to happen even if the companies and their pension plans are financially healthy.

Here are some answers to questions confronting employees:

What's a "freeze?"

In a "hard freeze" like those at IBM and Verizon, all participants stop earning benefits. The assets remain in the pension and will be paid out when the workers retire or leave the company, but the workers' benefits don't grow with additional years on the job. It's as if the affected employees had changed jobs and stopped building a pension at their former employer. So far, relatively few large companies have done this, including Circuit City Stores Inc., Sears and hospital-products firm Hospira Inc.

More common are "partial freezes," such as closing the pension to new workers, which is something Motorola Inc., Lockheed Martin Corp. and Aon Corp. have done, or to workers under a certain age, as NCR Corp. has done.

Companies often freeze their pensions in stages. Sears froze its pension as of Jan. 1. But in 2004, before its merger with Kmart Corp., Sears stopped offering pensions to new workers and cut off existing employees below age 40 from building benefits.

Why are companies freezing pensions?

Companies say they're trying to become more competitive and adapt to changing times. Some, including technology firms like Hewlett-Packard Co. and IBM, say they must compete with younger companies that never made pension promises, or foreign companies where the government provides significant retirement benefits.

Workers in many industries are concerned that their employers will put the brakes on their pensions.  Here are some groups that are most at risk:

 People in companies with a large percentage of older, longtime employees.
 Managers and other employees not covered by a collective-bargaining agreement.
 Employees whose companies have already cut some retiree benefits in the past. These firms are most likely to do so again.
But freezing pensions can bolster a company's profit, too. Because workers stop building pensions, the company gets to reduce a liability it has already recorded on its books that represents the promise to pay their future benefits. This generates accounting gains that boost income, at least on paper. Berkshire Hathaway Inc. froze the pension of a subsidiary effective Jan 1. The company recorded a gain to income of $70 million when it announced the move in 2004. A Berkshire executive didn't return a call seeking comment.

In short, thanks to the accounting rules, companies can realize income from cutting benefits they haven't paid. That could encourage employers to cut or freeze pensions even when the plans are fully funded and don't require any additional contributions from the companies.

Why now?

This turns out to be an opportune time for companies to freeze pensions, for a variety of reasons. For one thing, people aren't surprised: Financial crises at steelmakers and airlines, several of which have actually abandoned their pensions, mean people are used to hearing about a "pension crisis." Also, as more companies in a certain industry end pension benefits, rivals can argue more persuasively that they need to stay competitive. Moreover, thanks to arcane accounting rules, low, long-term interest rates mean the accounting benefit for freezing a pension is higher than it would be if long-term rates rise as expected. (See related article.)

Who's most vulnerable to a freeze?

Salaried employees are most vulnerable. Companies typically have to negotiate to cut benefits for workers covered by a collective-bargaining contract. Companies can't cut or revoke pension benefits already earned, but employers are generally free to freeze plans for nonunion workers at any time.

Who gets hurt the most?

Workers who have been at the company many years -- especially in their 40s and 50s -- could end up with substantially less money than expected. Traditional pension benefits build up fastest in an employee's final years at a company. That's because benefits are typically calculated by multiplying years of service by the average salary in the final years, when pay usually is highest. As much as half of a person's pension is earned in the last five years on the job. Even with bigger 401(k) contributions, these workers may never catch up.

Retirees aren't affected by freezes. Younger workers and those who switch jobs frequently also will be less affected.

Won't an enhanced 401(k) help?

Something is better than nothing, but employees whose companies switch to a 401(k), even one with more-generous benefits, could well prove worse off than with a pension. Investing their savings themselves means that just a few years of bad returns could leave them with no time to recover -- and a poorer retirement.

What's more, there's nothing to stop employers from cutting the 401(k) contribution in the future. "They have the discretion to change those contributions at any time, whereas they really didn't have that" with the pension, says Jay Hanson, national director of accounting for Minneapolis-based accounting firm McGladrey & Pullen LLP.

What if I'm in a cash-balance plan?

Many companies, including IBM and Verizon, are freezing their cash-balance pension plans. In these plans, employees' benefits grow by a percentage of their pay plus interest each year. These employees have faced multiple freezes of their pensions. When companies converted to these plans from a traditional pension, they froze the benefit buildup under the traditional formula, which reduced the pensions by 20% or more. What's more, the cash-balance pension was also effectively frozen for many older, longer-service workers. That's because they started with an account balance in their new pensions that was lower than the value of their former pensions. As a result, their pensions didn't grow until their annual cash-balance plan credits built up to the level of their old benefit, a phenomenon called "wearaway."

How is freezing different from terminating a pension plan?

When employers terminate a pension, they must pay out all of the benefits immediately, either in lump sums or by buying each worker an annuity. With rare exceptions, only companies operating under bankruptcy protection can dump unfunded liabilities on to the Pension Benefit Guaranty Corp., the government-run insurer that guarantees private-sector pensions. For all of the media attention about companies terminating underfunded pensions, it isn't common. Fewer than 2% of the plans that were terminated from 1986 to 2004 lacked enough money to pay every employee's pension, according to the PBGC.

Write to Ellen E. Schultz at and Theo Francis at