Likely to Stay Dying Breed
Law Fails to Offset Reasons For Employers to Freeze, End
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.,
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.
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
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
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