Can my pension be reduced?

Question: Does the current crisis have any effect on my defined-benefit pension plan? I just turned 55 and was getting ready to start drawing from it. Will the amount I receive change now? —Lynn, Hephzibah, Georgia

Answer: The short answer is no. Just because the stock market has been reeling and the economy is in a major funk, your employer can’t reduce the size of the pension you’ve earned or take it away from you.

If nothing else, the current financial crisis has highlighted a major difference between traditional check-a-month defined-benefit pensions and defined-contribution plans like 401(k)s.

With a 401(k), a market meltdown can dramatically reduce your account balance. And if that happens after you’ve retired or are close to doing so, you may have to cut back on the income you draw from your 401(k) to avoid running out of money late in retirement.

With a traditional defined-benefit pension, on the other hand, the amount you receive is based on the number of years you worked for your company and your salary (typically the average for your last five years or your highest-earning five years). Once you’re “vested” in your plan - which usually takes five years in a traditional defined benefit plan - your employer is obligated by law to pay you the pension you’ve earned, regardless of how the financial markets perform (although you’ll typically have to wait until you’re 55 to 65 to collect it).

In short, if you have a 401(k), you assume the market risk. If you have a defined-benefit pension, your employer is on the hook.

The risks

Of course, plummeting stock prices have put a strain on the value of pension fund assets, and those assets are what employers are counting on to pay the pensions of current and future retirees. Generally, pension funds invest about 65% of their assets in stock and spread the rest among bonds, real estate and other investments. So when the stock market takes a dive, it cuts into the amount available to pay pension benefits.

That said, pension funds overall went into this year in pretty good shape. According to benefits consulting firm Hewitt Associates’ Pension Risk Tracker, the overall “funded ratio” of the pensions of companies in the Standard & Poor’s 500 index was 98% at the beginning of the year, which means the value of the assets in the funds was just about sufficient to cover the benefits due to plan participants. By mid-October, however, falling stock prices had pushed that ratio down to just over 80%.

The safety nets

But that doesn’t mean pension funds won’t be able to meet their commitments. Pension funds pay out their benefits over many decades. Indeed, a 35-year-old worker may not begin collecting for another 20 to 30 years and even then the payments will likely stretch over another 20 to 30 years. So there’s plenty of time for asset values to bounce back.

What’s more, the Pension Protection Act of 2006 set tough new standards for how much money employers must contribute to their pensions annually to maintain their plan’s financial health. (The PPA doesn’t apply to defined-benefit plans of state and local governments, but those benefits are protected by state law and ultimately backed by tax revenues.)

Besides, even if your company were to go bankrupt and the pension plan’s assets were insufficient to meet its obligations, you would still likely collect all or most of the pension you have coming to you. That’s because the Pension Benefit Guaranty Corp., a government agency charged with assuring the payment of private-sector pensions, would step in and make payments up to certain limits.

The PBGC’s maximum payment for plans ended in 2008 is $4,312.50 a month, or $51,750 a year, for a 65-year-old. This ceiling is higher if you’re older and it’s lower if you retire earlier or if your pension includes payments for a survivor.

There are instances when the maximum payments aren’t enough to cover someone’s full pension, as has been the case with many pilots of airlines that went bankrupt. But more than 80% of the people whose pensions are taken over by the PBGC see no reduction in payments.

There’s one other way that the current crisis could affect defined-benefit pensions, however. If pension funds’ investment losses are deep enough, employers could be required to inject big sums of cash into their plans at the very time when their profits are being squeezed by the weak economy. If that happens, more companies might follow the example of companies like IBM, Unisys, Gannett, Equifax and others that have already frozen their pensions or announced plans to do so.

In the event of a freeze, you would typically no longer accrue additional benefits in the frozen plan for additional years on the job, although companies that freeze plans may enhance benefits other ways, such as by adding a 401(k) or improving the 401(k) if the firm already offers one. In any case, you would still be eligible for whatever benefits you had accrued before the freeze. Any pension benefit you’ve earned can’t be taken away. (If you think you have been unfairly denied pension benefits, check out your rights.)

So unless your pension plan is seriously underfunded and your company is in financial trouble and your pension is significantly above the PBGC ceiling, you can cross your defined-benefit pension off your list of things to worry about. And then turn your attention to your 401(k) and other retirement savings accounts to be sure you’re following the right investment strategy there.