The Association of U S West Retirees



Pensions Likely to Stay Dying Breed
Law Fails to Offset Reasons For Employers to Freeze, End Defined-Benefit Programs
By Steven D. Jones
The Wall Street Journal
Tuesday, August 29, 2006

President Bush recently signed into law a comprehensive bill aimed at rehabilitating the traditional pension plans still operated by many American companies.  The irony is that many companies whose pensions are in fine form probably will limit benefits anyway.

More corporate leaders and their advisers are assessing the costs of so-called defined-benefit retirement plans and coming to more or less the same conclusion:  The costs of maintaining these plans are still simply too great.  Defined-benefit plans  -- your grandfather's pension, for example -- guarantee retirees set monthly payments for life, with the size of checks generally based on years of service and salary levels in the final years on the job.

The Pension Reform Bill compels many companies to fully fund their defined-benefit plans over a period of years and pay a small additional premium to shore up the U.S.'s pension-insurance fund, which essentially is the pension insurer of last resort.  But the bill also may add to incentives to freeze benefits.

"I believe we will witness an unprecedented number of companies closing their well-funded, defined-benefit pension plans to new employees," James Klein, president of lobbying group American Benefits Council, wrote in a media release when the bill was signed.

Verizon Communications Inc., Motorola Inc., Hewlett-Packard Co., International Business Machines Corp. and others have announced freezes of defined-benefit pension plans.  Delta Air Lines and Northwest Airlines intend to impose freezes as part of reorganizations under the U.S. bankruptcy code.

Yesterday DuPont Co. said starting next year it will cut its contribution to its pension plan by two-thirds while raising its contribution to an employee savings and investment plan.

Companies freeze plans generally either by locking out new employees -- a soft freeze, in the argot of the pension industry -- or by halting such new enrollments and stopping the accrual of benefits to existing employees, a hard freeze.  Retirees generally aren't affected.

Hewlett-Packard, for example, imposed a freeze in January on its defined-benefit plan for workers other than those close to retirement, while raising its matching contribution for 401(k) defined-contribution plans to 6% of salary from 4%.

IBM by comparison converted it into what is known as a cash-balance pension, which creates a hypothetical account for each worker that grows by an annual amount, then later announced it would freeze the plan.  A court ruling supported IBM's switch, a decision pension experts say will pave the way for more companies to adopt such a strategy.

For companies, there are clear economic benefits to freezing a pension plan.  Jack VanDerhei, a professor at Temple University and a research director at the Employee Benefit Research Institute, has analyzed pension freezes and estimates a hard freeze can cut the annual retirement payout to a worker by more than half.

Payments to most pensioners in a defined-benefit plan are calculated using what is referred to as final-average defined-benefit formula.  The company multiplies the number of years worked by the average of the worker's three highest years of pay times 1%.

Take an employee who retires at age 65 after 35 years on the job, who earned an average $103,000 a year during his final three years of employment.  His benefit would be about $36,000 a year, or $103,000 times 35 years times 0.01.  If that retiree lives to age 85, the total benefit paid would be $720,000.

Yet consider what would happen if the company had frozen the pension plan when the worker was age 50 and had put in 20 years on the job.

Suppose the employee's average salary for the three years before the freeze was $70,000.  Upon retirement at age 65 the benefit would be just $14,000 a year ($70,000 times 20 times 0.01.), or $22,000 a year less.  At 85, the total benefit paid out would be $280,000, or $440,000 less than the total benefit had the pension not been frozen.

Even companies whose traditional pensions are fully funded -- meaning they have enough assets on hand to cover benefits of all participants -- are freezing plans.  The reasons:  retirees are living longer, raising overall costs, and because of the new pension-accounting rules to be implemented that require companies to deduct their plans' shortfalls from net worth.

"I believe a fair number [of companies] have looked at what this is likely to do to their stock prices and loan covenants and decided that kind of risk is just too much," says David John of the Heritage Foundation, a conservative think tank.

One upside to the possible extinction of traditional pensions is that financial-service companies probably will look for new ways to help workers save for their Golden Years on their own, a decidedly tall order:  The 50-year-old worker whose pension was frozen in the example would have to begin putting aside nearly 13% of his salary annually for 15 years to make up the $22,000 gap created by the freezing of the employee's defined-benefit plan.

Write to Steven D. Jones at