In November of 2011, American Airlines filed for bankruptcy protection. One of the goals of management was to reduce the cost of running the company’s pension plan. Pilots, flight attendants, and baggage handlers who retired from the company had been promised a retirement income for the rest of their lives based on their average wages and how long they worked for the company. Now their retirement lifestyle is in jeopardy. Could the same thing happen to you?
To answer this question, we first need to understand the different kinds of pension plans. Historically, when an employer wanted to attract and retain the best talent as employees, they created a pension plan. Throughout most of the 20th Century that pension plan was most likely a “defined benefit” pension plan. That means that a formula based on how long someone worked for the company and theiraverage income, was used to calculate a stream of monthly income for the rest of the employee’s life.
The employer had all the responsibility for setting money aside, investing it, and making sure it lasted a lifetime. In the 1980’s, after the passing of the Employee Retirement Income Security Act (ERISA) of 1974, “defined contribution” pension plans began to become the retirement vehicle of choice for employers and employees. All the responsibility of setting money aside, investing it, and making it last, was left up to the employee.
Differences between Defined Benefit & Defined Contribution Plans
Another major difference in the two types of pension plans, involves what happens to the plan if the employer goes bankrupt. Under ERISA, all the assets in a defined contribution plan have to be held outside of any assets of the employer. These accounts are to be placed in a segregated trust account held by a custodian that can only be used by the employee and must be beyond the reach of the employer or any of the employer’s creditors. This is not true with a defined benefit plan. That type of plan is part of the employer’s overall balance sheet, and could end up under-funded if the employer becomes insolvent.
Do you know what type of plan you have? If you make contributions out of your paycheck, you have a defined contribution plan. If your plan has a name like 401(k), 403(b), 401(a), SEP or SIMPLE then you have a defined contribution plan. If you get to choose your own investments, then you have a defined contribution plan. In fact, today over 76%i of companies with greater than 100 employees are covered by a defined contribution plan.
What about those American Airlines retirees? If a company does go bankrupt with a defined benefit plan, then that plan will generally be picked up and benefits paid by a government agency called the Pension Benefit Guaranty Corporation (PBGC). However, retirees may still be required to forfeit part of their pension benefit. Eighty-five percentii of those receiving benefits from the PBGC will receive their full benefit, but another 15% will not. These benefits are based on a formula from the ERISA law which establishes a maximum benefit someone may receive at age 65 of $55,841ii.
Today, most employees’ retirement savings are not at risk should something happen to their employer. But remember; along with the added safety of your retirement plan being held outside of your employer, comes added responsibility. Now, only you are responsible for saving enough money for retirement, investing it prudently, and then making sure you do not withdraw your savings too quickly.
ihttp://www.bls.gov/ncs/ebs/benefits/2011/ownership/private/table01a.htmiihttp://www.pbgc.gov/news/press/releases/pr12-07.htmliiihttp://www.pbgc.gov/news/press/releases/pr12-07.htmlPCI’s archived blog entries are dated, the rules and statutes referenced may have changed. The analysis or guidance within these blog entries may have become stale, dated, or no longer accurate. PCI will not update or change these entries to reflect the latest analysis or development.
WRITTEN BY
Pension Consultants, Inc.
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