How Safe Is Your Pension?

Are you eligible for a pension, or already drawing upon one? If so, I have good news and bad news.

The good news is that you have a pension at all. Most people don't. In 1980, the Department of Labor estimated that 40% of all workers in the private sector had a defined-benefit (pension) plan, 19% were participating in a defined-contribution plan (401(k), 403(b), or 457), and 11% participated in both types of plans. By 2004, those statistics had been turned on their head, with just 19% of workers covered by a pension plan and 40% participating in a defined-contribution plan. (It's very likely that the percentage of employees covered by pensions has shrunk further still since then.)

The bad news? Many pensions, both in the public and private sectors, are in bad shape, owing to economic malaise and pension providers' overly rosy expectations about market returns. Many of the private-sector firms that offer pensions operate in the hard-hit industrial sector. A Watson Wyatt study showed that the 100 largest private-sector pension funds were underfunded by $217 billion in 2008. Government pensions are in even worse shape: A study by academics Robert Novy-Marx and Joshua Rauh put the amount of unfunded pension liability at the state and local levels at a staggering $3.2 trillion. Yes, trillion.

Even if your employer hasn't been making headlines as a result of worries about its financial health and the future of its pension plan, it's still worthwhile to check up on your plan's viability before relying on it for even a portion of your retirement income. And if it turns out that you have something to worry about, it's important to do some contingency planning in case part of or all of your pension benefit isn't there when you need it.

Homework Assignment for Pension-Plan Participants
To check up on the health of your pension, start by requesting that your company provide you with its pension-funding notice, a document that apprises plan participants of the financial status of the plan. That form should show you the extent to which your plan's assets cover its liabilities. A funding rate of 80% or better is considered a sign of reasonably good health; if your plan falls below that threshold, that's a red flag.

The Pension Protection Act of 2006 requires employers to provide that pension-funding notice annually. But if you can't get your mitts on this document, you'll have to do a bit more sleuthing. Ask your employer for form 5500, which provides detailed information on a firm's employee benefits, including the assets and liabilities of any pension plans. You can also find a company's form 5500 on www.freeerisa.com. (You'll need to sign up as a free user to unearth specific documents on the site.) Within that document, look for the current value of the plan's assets as well as the total amount the plan owes in benefits. Again, 80% is a reasonable threshold.

The information on the form 5500 can be complicated to wade through: This fact sheet provides helpful guidance, and the Pension Rights Center website provides a wealth of other helpful information about evaluating your pension plan. However, it's worth noting that firms' form 5500s don't always include the most up-to-date information because firms have a grace period to file their updated information.

Additional Safety Net
If it turns out your pension isn't in great shape, that's not automatically cause for panic because there's an additional safety net for pension-holders. Most pension plans in the private sector are also covered by the Pension Benefit Guaranty Corporation, which provides backup protection if one of its participating firms falls into bankruptcy or otherwise cannot provide the benefits it has promised to workers. In the case of a failed pension at a PBGC-covered institution, the agency currently provides up to $4,500 a month in benefits for workers who retire at age 65. To see whether your plan is covered by PBGC, ask your employer for a summary plan description--a document that provides details about your plan, including PBGC coverage.

Unfortunately for pension-holders, PBGC isn't a failsafe backstop: There are also questions about the financial health of PBGC itself. Much like the FDIC, PBGC charges participating firms a premium to be covered, but those premiums have arguably not been high enough given the number of companies that have had to rely on PBGC to help shore up their pensions in recent years. PBGC's most recent annual report, released in May, noted that the agency could have a $34 billion shortfall by 2019. (It's widely assumed that the government would step in to rescue PBGC under such a scenario. But that's a big number, and there are no guarantees.)

What to Do
If you've researched your pension plan and are feeling alarmed, your next step is to determine how best to protect yourself from a shortfall in retirement.

Start by mulling your options. If you're nearing retirement and have the option to receive your pension in a lump sum versus an annuity, logic holds that the lump sum is the better bet if the health of your pension is in question. And no matter the financial condition of your company, taking your pension in a lump sum gives you greater flexibility--and a greater ability to outearn the long-term rate of inflation--than is the case with an annuity. (On the flip side, of course, imprudently investing a lump sum can leave you way behind where you would have been if you had opted for the annuity.)

If you're still employed and your company is offering buyouts as part of an overall downsizing plan, taking the package and looking around for another job may be preferable to staying put and hoping for the best on the pension front. If your company's financial condition worsens, you could find yourself not only out of the full pension benefits you were promised, but out of a job, too.

In addition, a looming pension shortfall should also prompt you to take a closer look at how--and how much--you're investing for your own retirement. Obviously, saving more and spending less are key. And while conventional wisdom argues that pension-holders can invest their retirement assets more aggressively than non-pension-holders in the same age band, because the former can expect a steady stream of income in retirement, it pays to rethink that wisdom if your pension is on shaky ground. On one hand, an uncertain pension makes it all the more important that you expand your total retirement nest egg as large as you can, but it also necessitates that you hold more in liquid assets and bonds that you can tap to cover your living expenses.

See More Articles by Christine Benz

Become a Morningstar Content Contributor Today! Contributing content to Morningstar allows you to increase your firm's exposure to a premium audience of financial advisors and individual investors. Please click here to learn more about the Morningstar Content Submission Platform. For additional guidance in using the Content Submission Platform, please view this video.
		New! 30-Minute Money Solutions
	Need help picking up the pieces in this turbulent market? 30-Minute Money Solutions by Morningstar director of personal finance Christine Benz simplifies the daunting task of getting your financial house in order. Written for novice and experienced investors alike, this book offers manageable, step-by-step solutions for tackling money challenges and building a comprehensive financial plan in simple 30-minute increments. Learn more.
	Order Your Copy Today--$16.95