What You Need to Know to Protect Your Pension Benefits

    by Lynn O'Shaughnessy

    Pensions have always been complicated, but in today’s financial environment, the need to understand them has never been more critical.

    Ultimately, it falls upon you to safeguard your own pension. In this article, you’ll find out what you need to understand about your pension. Be Alert For Changes Companies are free to tinker with their pension plans, but they aren’t allowed to eliminate or reduce benefits you’ve already earned. If you have earned $100,000 in a pension plan that is now being radically altered, you’ll still be entitled to that $100,000.

    Companies usually promote proposed pension changes as good for employees and necessary to remain competitive. But remain wary—in recent years, most of the changes that employers have made to their pensions benefit the employer but have hurt some employees.

    Corporate America has put its pension plans on a variety of diets. Some of the ways they have cut pensions include the following:

    • Change the pay formula: Many pension plans rely heavily upon the last three to five years of someone’s pay to calculate the pension. This practice is favorable to you because you’re presumably making the biggest bucks in those final years. However, some companies are now using a worker’s salary from as far back as 10 years when calculating benefits, which lowers a person’s ultimate pension payout.

    • Reduce a plan’s pension multiplier: A pension is typically calculated by multiplying three figures: years of service, pay, and a multiplier. The higher the multiplier, the better off you are.

    • Freeze the pension plan: When a company freezes its pension plan, future raises and years on the job won’t boost an individual’s pension. In addition, when a pension is frozen, whatever benefits a worker has earned begin to deteriorate in purchasing value terms at the rate of inflation.

    • Cap years of service: Some companies institute a limit, say 25 years, on the years of service they use to calculate pension benefits.

    • Convert to different type of pension plan: For example, a cash balance or pension-equity plan.
    Although companies enjoy tremendous latitude in shrinking pension benefits, you need to know how proposed changes will impact you. In some cases, workers, particularly older ones, have been grandfathered into a corporation’s former and more generous pension plans. Meanwhile, some corporations have backed down or modified a proposed pension overhaul after employees complained loudly.

    If a company isn’t dissuaded, you need to know enough to assess whether you should remain at the company, take early retirement (if possible), pursue another job, or at the very least simply increase your own personal savings.

       Cash Balance Brouhaha
    One pension change that is drawing considerable fire from employees is the switch some corporations have made from pension plans to cash balance pension plans—which calculate benefits differently from the traditional pension plan.

    What’s all the fuss about?

    A cash balance plan is essentially a hybrid of defined-benefit plans (such as the traditional pension) and defined-contribution plans (such as a 401(k) or other account funded by employee contributions). In a typical cash balance plan, each year the employer distributes a “pay credit” (usually equal to a percentage of an employee’s wages) and an “interest credit” (at either a fixed or variable rate) to an account in each employee’s name.

    Traditional pensions define an employee’s benefit as a series of monthly payments beginning upon retirement and continuing for life, but cash balance plans define the benefit in terms of each employee’s account balance—and pay out no more than the total of those yearly contributions and interest payments.

    Cash balance plans save most corporations huge amounts of money. Unfortunately, the conversions can also be devilishly difficult for workers to understand, and many don’t even realize what’s happening. Some features of the cash balance pension plan work to the benefit of certain employees:

    Younger employees may fare better. Under traditional pension plans, benefits build at an excruciatingly slow pace until the last five or 10 years before retirement. At that point, someone’s pension may balloon by 50%. This traditional arrangement may not be ideal for somebody who has no intention of sticking around until those final years. A cash balance plan lets workers accrue pension benefits more evenly from the start.

    Cash balance plans are portable. If you quit your job after you’re vested in a cash balance plan (work the required length of time to gain full rights to your pension), you can take your pension money with you.

    Cash balance plans are easier to decipher. Just like a 401(k), participants in cash balance plans receive regular statements that show the build-up of cash within their pensions. Cash balance updates are more understandable than traditional plan statements, which forecast what a pension will be worth at someone’s retirement age. These traditional forecasts, however, are simply projections based on uncertain assumptions concerning salary increases, continuing years on the job, and other factors.

    There are also drawbacks to cash balance plans, and these are causing most of the controversy:

    Cash balance conversions hurt older employees. Workers in their 40s, 50s, and 60s, with lengthy service records, generally lose out because the value of a traditional pension typically jumps significantly during the last few years of a career. Cash balance plans stop that acceleration.

    A cash balance plan can freeze your benefits. ERISA, the federal law that governs corporate pension plans, guarantees that you won’t lose any pension benefits that you’ve accumulated before the pension conversion, but there’s no guarantee that those benefits will keep growing. If your pension is worth $200,000, for instance, it will still be worth that amount on the day a cash balance plan begins. However, in calculating opening balances, companies enjoy some latitude when plugging in assumptions about retirement age and interest rates, as well as mortality figures. Thus, your opening balance may be much smaller than expected when you examine your first cash balance account statement.

    Cash balance plans hurt short-termers. Cash balance plans are often worthless for workers who don’t stay at a job for at least five years. Although the money can start building faster with a cash balance, you won’t be entitled to it if you leave before you’re vested.

    Cash balance plans may underpay employees. In 2002, the U.S. Labor Department’s inspector general concluded that more than 20% of the nation’s cash balance plans were violating the law by underpaying participants. Based on a study of 60 plans, the inspector general estimated that the country’s cash balance plans are annually withholding anywhere from $85 million to $199 million that should be going to employees. Investigators believe that companies are improperly using low interest rates to determine benefits.

    Keep All Records

    What’s the best way to protect your pension benefits?

    If you are preparing to retire, make sure all of your pension documents are correct before you retire. Get all your questions answered before you leave.

    Even if retirement is years away, you shouldn’t be complacent. Establish a file folder and put all pension statements and documents you receive in it. This group of documents also includes any modifications made to your company’s plan. Within this file, also keep a record of your yearly salaries and start and departure dates of all your career moves. If you haven’t saved any paperwork, ask your employer to replicate as much of it as possible.

    Here are the key pension documents you should have:

    • Your pension program’s Summary Plan Description. Ask your employer for a copy of the Summary Plan Description, which outlines how your company’s pension system works. This document explains what pension benefits are offered, eligibility requirements, and how pension calculations are made.

    • Individual pension benefit statement. Your statement tells you what pension benefits you have earned and how many years you’ve been enrolled in your employer’s plan. The statement may include a projection of what your monthly checks will be when you retire as well as what a lump sum payment would be worth.

    • Your pension plan’s annual report. The annual report includes information on the plan’s financial condition, including its assets and liabilities plus income and expenses. (A worker should automatically receive a Summary Annual Report, which is a one-page overview of a private pension plan’s finances.)
    You should be able to obtain the annual document from your employer. It’s also available from the U.S. Department of Labor’s Pension and Welfare Benefits Administration (PWBA) through its public disclosure room in Washington, D.C., or by mail to Pension and Welfare Benefits Administration, U.S. Dept. of Labor, 200 Constitution Ave., NW, Room N-5638, Washington, D.C. 20210. You can also contact the PWBA by phone at 866/275-7922, or via the Internet at www.dol.gov/dol/pwba.

    Ask the Right Questions

    What specifically do you need to know about your pension? Make sure you have answers to these crucial questions.

    Do I have a pension? Even if your company has a pension plan, don’t assume you’re covered. You need to specifically ask about yourself, because some employees may be excluded from a company’s pension plan.

    Am I vested? Your company might operate a generous pension plan, but you won’t be entitled to any of it until you’re vested. Vesting refers to the magical number of years you must toil at one place before you earn a pension stake. Once you are past the eligibility hurdle, you can receive monthly pension checks after reaching retirement age, or, in some cases, you can walk away with a lump sum when leaving a company—even if you’re young.

    Most people in company and union pension plans are fully vested after five years of employment. Companies, however, are permitted to stretch out the vesting period to as long as seven years.

    Plans covering state and local government employees, railroad workers and the military, aren’t covered by ERISA, the federal law that governs corporate pension plans, so the wait could be even longer—as much as 20 years in the case of military pensions.

    Will my spouse receive pension checks if I die first? When you begin receiving pension payments, you will have a choice as to how it is paid out. The biggest possible monthly pension check comes by selecting payments as a single worker—this is referred to as a single-life annuity. Under this payout, all payments stop once the worker dies.

    A joint-and-survivor pension has smaller monthly payments, but pension payouts continue to be made to the spouse even after the death of the worker—although the payments are reduced.

    If you are married and you don’t want a joint-and-survivor annuity payout, you must first obtain your spouse’s permission in writing.

    A joint-and-survivor pension may be the best choice for most married couples. There are times, however, when it might be undesirable. For instance, choosing a single-life pension might be more appropriate if the spouse is independently wealthy or terminally ill.

    What are my payout options? In the good old days, a retiree simply drew a monthly pension check. But today corporations are increasingly offering lump-sum payments as an option.

    Although choosing the lump sum might seem like a no-brainer, it isn’t always the appropriate choice. For example, choosing between a lump sum and a monthly check is tricky if you’ve been offered an early retirement subsidy. This subsidy has traditionally been offered to encourage older workers to leave. But here’s what workers don’t often realize: While the subsidy will be included in the calculation for monthly checks, a company can offer a departing worker a lump sum that doesn’t take into consideration the value of the subsidy.

    You may need help from an actuary or financial expert when it comes to analyzing important pension issues such as this one, and it is critical that the person you consult with is unbiased. The box on page 38 includes information on where you can find these experts.

    What happens to a pension in a divorce? One of the most valuable assets up for grabs during a divorce is a pension. Typically, the husband enjoys the fatter pension. In fact, he may be the only one who has one. No matter whose pension it is, the other spouse may be awarded a portion of the pension checks once they start arriving.

    Anyone wishing a piece of a former spouse’s pension won’t be entitled to any of it without a court order that instructs a pension plan administrator how and when to divide up the benefits after a marriage fails. Be aware, however, that if the order isn’t precise, the client could suffer big time years later.

    Women who need to learn more about this issue can obtain the book, “Your Pension Rights at Divorce: What Women Need to Know” from the non-profit Pension Rights Center. The cost is $24.95, which includes postage and handling. Contact the Pension Rights Center at 1140 19th St., NW, Suite 602, Washington, DC 20036; 202/296-3776; www.pensionrights.org.

    Because valuing pensions, 401(k) plans, stock options, and other workplace assets is so tricky, you should rely upon experts for advice on your particular situation. A solid resource is the Institute for Certified Divorce Planners. The Institute can provide the names of financial experts, including financial planners, attorneys, and certified public accountants who have obtained the Certified Divorce Planner (CDP) designation. You can contact the Institute for Certified Divorce Planners at 800/875-1760 or www.institutecdp.com.

    Will my pension have built-in inflation protection? Don’t count on built-in inflation protection. Companies are not legally required to provide inflation protection. Consequently, when reviewing what assets you’ll have during retirement, you should assume your payments will be frozen. Automatic cost-of-living increases are fairly rare except for government workers, and periodic increases are clearly declining.

    What happens to my pension if my company goes out of business? Your company going out of business isn’t as scary a prospect as you might assume. One of ERISA’s successes was the creation of the Pension Benefit Guaranty Corporation (PBGC), which guarantees the pensions of millions of workers and retirees. The program is funded by insurance premiums that private pension plans are required to pay into the system.

    The PBGC steps in when a company declares bankruptcy or for some catastrophic reason can’t meet all of its pension obligations. The federal agency then meets the pension obligations.

    However, the PBGC won’t completely replace the most generous pension checks. A benefit ceiling exists, which means executives and other highly paid workers might not recoup their full benefits if disaster strikes. The benefit cap for a pension plan disbanded in 2001 was $3,392 a month for a 65-year-old retiree, $2,679 for a 62-year-old, and $1,526 for a 55-year-old.

    The PBGC also won’t reimburse a retiree for lost life insurance, health insurance, disability, or severance pay.

    You can review all of the maximum monthly guarantees and obtain other information about the PBGC by visiting the agency’s Web site at www.pbgc.gov.

    Not all employers are covered by the PBGC. Government employees, as well as those who work for churches and fraternal organizations, don’t quality; neither do professional service employers, such as doctor and lawyer offices that employ less than 25 workers.

    Do I have any “lost” pension benefits? In some cases, the PBGC can also help when someone is desperately trying to locate a long-lost pension benefit.

    Through the PBGC, you may be able to discover if you are owed a misplaced pension. On a voluntary basis, companies have listed with the PBGC individuals who are entitled to a pension whom they can’t find. These names are placed into a massive database.

    You can easily access the database by visiting the PBGC’s Web site and clicking on the Pension Search link. Thousands of pensions have been found this way.

    Before you start a search, order a free copy of the booklet, “Finding a Lost Pension,” from the PBGC by mail at Pension Benefit Guaranty Corporation, 1200 K St., NW, Washington, DC 20005-4026, by phone at 800/400-7242, or via the Internet at www.pbgc.gov.

    Often it is not the participants who have lost their pensions, but the plans that have lost their participants. Because there is no requirement to notify participants when a plan relocates, is bought, or is merged, former employees are left in the dark as to the location of their old company and its pension plans. How can you protect yourself?

    A former employee should always notify the sponsor of their pension plan whenever they relocate. Use certified mail and request a return receipt.

    Am I getting the wrong pension? Pension administrators do mess up, and the mistakes aren’t as rare as you might think. Most mix-ups aren’t intentional. One culprit is federal pension laws, which are incredibly difficult to understand even for experienced actuaries. Not only are the rules complex, they are also constantly changing. The other culprit is plain old human error.

    According to the U.S. Department of Labor, companies often make these common errors when calculating a person’s pension benefits:

    • Your employer overlooked commissions, overtime, or bonuses when determining your pension.
    • The company failed to include all your years of service; this error may occur if you have worked in different corporate divisions.
    • The company used an incorrect benefits formula, such as the wrong interest rate.
    • The firm relied upon the wrong Social Security number or birth date.
    • Math mistakes were made in the calculation.
    • Company mergers created confusion about the correct pension benefits.
    • You failed to update the company personnel office with changes, such as marriage, divorce, or death of a spouse, that may affect your benefits.
    The best way to protect yourself against these errors is to save your own records and double-check the information given to you by your employer.

       When in Doubt, Seek Help: Where to Find the Experts
    Pensions are incredibly complicated, and you should seek qualified help when you have questions or concerns. Here are several sources you can turn to for more help in understanding your own pension, and pension issues in general.

    One option is consulting with an actuary who specializes in pension matters. However, most actuaries who specialize in pensions do a lot of work for corporations, and consequently, some may refuse to accept an individual as a client. Actuaries typically charge by the hour. Before hiring an actuary, find out what his or her background is and try to get a sense of any biases.

    Two groups can help you find actuaries in your area:

    The American Academy of Actuaries, a public policy and professional organization, can steer you to its members specializing in pensions. The academy maintains a free nationwide referral service, called the Pension Assistance List (PAL), which links people to actuaries willing to volunteer their services. You can contact the organization by mail at 1100 17th St., NW, 7th Floor, Washington, DC 20036, by phone at 202/223-8196, or via the Internet at www.actuary.org.

    The American Society of Pension Actuaries is a national organization devoted exclusively to the pension field. Its membership includes actuaries, attorneys, consultants, and others. You can contact the organization by mail at the American Society of Pension Actuaries, 4245 N. Fairfax Dr., Suite 750, Arlington, VA 22203, by phone at 703/516-9300, or via the Internet at www.aspa.org.

    Federal Pension and Welfare Benefits Administration
    The Pension and Welfare Benefits Administration, which is within the federal Department of Labor, can help people who are covered by private-sector pension plans. Contact information: PWBA, U.S. Department of Labor, 200 Constitution Ave., NW, Washington, DC 20210; 866/275-7922 www.dol.gov/dol/pwba. The PWBA’s publications include “How to File a Claim for Your Benefits,” “Protect Your Pension,” “What You Should Know About Your Pension Rights,” and “Cash Balance Plans: Questions and Answers.”

    Non-Profit Pension-Counseling Groups
    Another little-known yet invaluable resource for workers is a network of pension-counseling projects that are partially funded by the federal Administration on Aging. These counseling outposts, which charge no fees, are scattered across the country in Alabama, Arizona, California, Illinois, Massachusetts, Michigan, Minnesota, Missouri, New York, and Virginia. Efforts are currently underway to expand the counseling project network to a national level, but until then it will remain a patchwork effort.

    The mandate of these centers goes beyond handling pension miscalculations. The projects also help track down lost pensions. The staffers can often be more thorough than the Pension Benefit Guaranty Corporation, and the service isn’t impersonal.

    Certified Financial Planners
    Another resource is a certified financial planner (CFP) who is comfortable with employee benefit issues. Some financial planners even specialize in the retirement benefits of specific companies or industries. Contact these groups for a list of CFPs in your area:

    Certified Financial Planner Board of Stardards, 1700 Broadway, Suite 2100, Denver, CO 80290-2101; 888/237-6275; www.cfp-board.org.

    Financial Planning Association, 3801 E. Florida Ave., Suite 708, Denver, CO 80210-2544; 800/282-7526; www.fpanet.org.

    Private RetrievalCompanies
    Another strategy that some people pursue is hiring a private company that specializes in retrieving lost or miscalculated pension benefits. Keep in mind that the price for this service is steep: These firms pocket a percentage of your recovered benefits until the pension checks stop coming. Using a non-profit organization or an actuary is the best way to resolve your pension problems.

    Pension Rights
    For your own protection, you should learn as much as you can about your pension rights. These resources are worth checking:

    The Pension Rights Center, 1140 19th St., NW, Suite 602, Washington, DC 20036; 202/296-3776; www.pensionrights.org. This consumer organization advocates for pension changes that help workers and retirees. The non-profit pension watchdog group offers helpful pension publications. Its Web site allows a visitor to locate his or her local pension assistance resources.

    AARP, 601 E St., NW, Washington, DC 20049; 800/424-3410; www.aarp.org. The senior advocacy group maintains a variety of information on pension issues on its Web site, including Congressional testimony by its officials.


    You work just as hard for your pension benefits as you do for your salary, so don’t let any of them slip away. To protect your pension benefits, keep the following points in mind:

    • Never throw out pension documents.
    • Always determine the impact pension changes will have on you at the time of the change; don’t wait to be surprised at retirement time.
    • Consult an actuary or other pension expert before making a final decision.
    • Don’t automatically choose a lump-sum pension payment; explore your options.
    • Check you paperwork for common pension mistakes.

    Lynn O’Shaughnessy is a personal finance writer and author of the “Retirement Bible,” (2001, John Wiley & Sons, Inc.; 877/762-2974; wiley.com) and the “Investing Bible” (2001, John Wiley & Sons, Inc.).

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