The Problem With ‘Sticky’ Pensions
There were some red faces in IBM’s executive suites in Armonk, N.Y., last month. The company’s savvy employees caught the technology giant trying to wiggle out of its costly pension plan and seriously shortchange the promises it had made to many long-term workers.
IBM said its defined-benefit pension plan was outmoded, so it had decided to replace it with something more modern: a “cash balance” plan. But once they ran the numbers through their computers, thousands of workers discovered they were in for sharp reductions in their benefits. Their protests forced IBM to back off. The company said that about 65,000 of its employees can stay in the old plan.
But the pensions of many other members of the U.S. labor force, especially those age 35 to 50, are still up for grabs. Surveys show that about 300 companies have already made the change to cash-balance plans and many more are thinking about it. Cash-balance plans trade a more generous buildup of pension wealth at younger ages for slower increases later on. The new plans credit workers with a set percentage of their salaries each year and provide a guaranteed interest rate. That’s fine for youngsters, but many IBM workers considered it a ground for an age-discrimination suit.
Benefits in traditional plans tend to be “backloaded,” with workers earning most of their pensions after spending many years with one employer. The cash-balance approach denies baby boomers this late-career pension boost. In extreme cases, losses can range as high as 50% of pension payments.
But cash-balance plans look a lot like traditional plans to employers. Both investment gains and benefit cuts can show up as profits on the company’s bottom line. Pension income last year made up 43% of operating income at Northrop Grumman, for example, and 31% at Boeing, according to a study from the Wall Street firm of Bear Stearns.
Congress is looking into the matter. The Department of Labor plans to examine the role actuaries played in these conversions. The government should learn that IBM and similar companies face a deep morass of problems with their old defined-benefit pension plans. IBM’s approach for installing its new plan was wrong. But it would be equally wrong to go back to the old way.
The old plans, which paid retirees a monthly income based on previous earnings and length of company service, seemed almost ideal in the 1950s and ‘60s. Workers typically expected to spend most of their careers at a single company. But the old-style pensions that reward a lifetime of loyalty also impose huge losses on workers who change jobs. They may never build up the service credits they need for a secure retirement.
The old-style plans were set up when companies wanted to bond workers to their jobs. These plans made employers feel safer when they spent money training their workers and helping them develop new skills. But today’s dynamically changing economy needs to be able to place workers promptly in the jobs where they will be most productive. Mobility is key.
Even if employers decide they want to hold on to workers, pensions are not an efficient way to do it. Pensions provide the same incentive to all workers. Old-style pensions actually make it harder to weed out laggards. Some of the most valuable workers today are younger. The lure of a pension that might pay off 20, 30 or even 40 years down the road isn’t as enticing as it once was.
Company pensions are one form of retirement savings, and they are best treated as only that. Companies, as IBM found out, are asking for trouble when they try to use them for anything more.
Each year, the U.S. Treasury gives up almost $80 billion in taxes to subsidize employer-sponsored pensions. Companies can deduct pension contributions from their corporate income taxes. They also don’t pay taxes on the returns from pension-plan investments.
Congress should make it clear that these tax breaks come at a price. Most people now entering the labor force should plan on working for at least four different companies during their careers. They have a right to expect more than just straightforward information about their pensions that Secretary of Labor Alexis Herman called for in her letter Wednesday. The full value of their pensions should be safe and secure, regardless of where their careers take them next or whether their employer changes its pension plan. Otherwise, companies should pay back taxpayers for all those subsidies.
But what America really needs is a new type of pension for today’s economy. Separate, individual accounts are clearly the way to go. Companies cannot simultaneously defend their workers’ pensions and maximize profits for shareholders. Only by untangling pensions from their finances can they end this conflict.
Employers should steadily contribute to pensions as workers move through their careers. There should be no backloading. Backloading gives employers the wrong reasons for hiring and firing, because older workers can be more expensive.
Today’s pensions are also inexcusably complicated thanks to the Employee Retirement Income Security Act of 1974. ERISA imposes huge, unnecessary costs. Congress should keep it simple next time, so the new pensions can help more people. It’s sobering that only about half of all working Americans are even “covered” by employer-sponsored pensions. Fewer still will eventually qualify, or “vest,” to receive benefits. Rapid vesting, in a year or less, is extremely important.
Only about 40% of today’s elderly receive any pension, and it’s not huge, either. On average, it is $8,884 a year on top of $8,889 from Social Security. But more and more pensions are cashing out workers with lump sums. So more people will run the risk of outlasting their savings, particularly now that Americans are living longer. Today’s 401(k)s and IRAs almost never pay monthly benefits. Tomorrow’s should. *
