New Rule Signals Kiss of Death for Pensions
A little-known rule change that allows companies to contribute fewer dollars to pension funds is signaling just how meaningless the retirement vehicle has become.
"This proves that pensions are pretty much dead," said Greg McBride, chief economist at Bankrate.com. "The change is just another charade to mask the underfunding of pensions and increases the odds of having less money for retirement."
"It's not necessarily the immediate end of pensions but it's not good for them and it's certainly a bad sign," McBride added.
The pension change was part of a transportation bill—called Moving Ahead for Progress in the 21st Century or MAP-21—passed by Congress last June. The change became mandatory this year.
In essence, MAP-21 lets employers put less money in their pension plans by allowing them to value their liabilities— what they have to pay out to pensioners—using a 25-year average of interest rates instead of current rates.
When interest rates are low, like now, pension plan liabilities are estimated to be higher and companies have to put in more money. When rates are higher, the liabilities are figured to be smaller and employers' contributions are less. The 25-year average is expected to be at least 2-3 percentage points higher than rates today.
The reduced amount that companies will be putting in has to be figured out by each firm based on the higher rates. But Madison Pension Services, a consulting firm, has reported that some minimum pension contributions in 2012 were reduced by 33 percent.
Employers are not required to offer pension plans, but the government encourages them to do so by offering tax breaks. For 2012, the tax subsidy for private and public retirement plans was $135.8 billion, the largest of all federal tax expenditures, according to the Pension Rights Center, a consumer advocacy group.
But the number of workers with pensions has been on a steep decline. According to the Bureau of Labor Statistics, about 18 percent of full-time private industry workers had a defined pension benefit in 2011—down from 35 percent in 1990.
To end pension obligations and escape from having to keep throwing money into pensions that may be underfunded, many firms, including General Motors and Ford, have offered lump-sum payouts to retirees.
"Companies want to get away from pensions totally," said Steve Pavlick, worker benefit specialist at the law firm McDermott Will & Emory.
"It's costing them a lot to come up with the cash to fund these plans and it's adversely affecting them, especially now with these lower rates," Pavlick said. "Most companies don't want to fund them in the future and aren't offering them anymore to new workers."
What's replaced pensions since the 1990s have been the employee contribution model like 401(k)s, which are now the main form of retirement plans offered to workers.
(Read More: How to Lose $90,000 on your 401(k))
But pensions are still a key source of income for many current retirees, according to the Pension Rights Center. The group said that only 52 percent of seniors receive income from financial assets—and half of those seniors receive less than $1,260 a year from Wall Street.
And Social Security payments to retirees average only $15,179 a year, roughly two-fifths of their earnings before retirement.
(Read More: 4 Ways to Maximize Your Social Security Benefit)
The Pension Rights Center calls for more pension funding, not less.
"While the Pension Rights Center is sympathetic to business concerns, we believe that Congress must strike the right balance between giving employers a break on making pension contributions and protecting the pension fund and workers' and retirees' long term security," the group's executive vice president, Karen Friedman, said on the center's website.
Getting long-term pension security won't be easy. The government likes the current change as much as companies do.
Pension contributions are not taxed until benefits are paid to retired workers. As such, the government is literally counting on money from the lower contributions by assuming it will get more tax revenues from higher wages of current workers—wages given instead of pension contributions.That money (a projected $9.5 billion over 10 years) is targeted for highway construction and student loans.
The MAP-21 rule on pensions is supposed to phase out, but Pavlick said plans are underway to get it or something like it extended.
"There's a lobbying effort to make this type of change permanent," he said. "It's clear that companies would rather have the higher interest rates and figure their pension contributions on such a plan."
While current pension holders seem likely to escape the fallout from the contribution cuts, analysts say future retirees with pensions will have to figure on fewer dollars.
(Read More: Six Signs You Could Retire Early)
"People getting pension checks this week or next month won't be affected," McBride said. "It's the young person of today that has to worry about getting full pension benefits when they retire."
While MAP-21 might not be a final nail in the coffin for nongovernment pensions, experts say it does mean future retirees face an even tougher struggle to survive.
"Pensions are just not relevant anymore," said Pavlick. "Companies feel overregulated and can't afford them. In today's world, pensions are relics."