Pension Peril: Securing income for life
How to make up for income shortfalls if your company freezes your pension.
By Jeanne Sahadi, senior writer

NEW YORK ( – Reliable income for life. Most people want it, but fewer and fewer workers can count on it.

A number of big-name companies – IBM (Research) being the latest example -- have frozen their defined-benefit pension plans and are moving all workers into a 401(k).

Here's a general estimate of how much more you need to sock away as a percent of before-tax pay if you are moved out of a traditional pension.
Your age Men Women 
35 5.7% 6.0% 
45 9.5% 10.1% 
50 12.1% 12.9% 
55 15.3% 16.2% 
60 18.5% 19.6% 
 *Assumes a worker joins a company at age 30, gets 3% annual salary increases and retires at 65. The percent-of-pay estimates include both worker and employer contributions combined.
 Source: EBRI estimates

Workers in the plan will still receive a pension when they retire, but only the benefits they accrued up to the date of the pension freeze. Since the most significant accruals of pension benefits typically occur when workers hit their late 40s and 50s after a long tenure at a company, a freeze can mean a significant reduction in expected retirement income for someone at the peak of their career.

The same is the case for workers when financially strapped companies, like United Airlines (Research), terminate their plans and turn them over to the Pension Benefit Guaranty Corp. (PBGC). The PBGC will make pension payments but only the amount accrued up to the plan's termination and then only up to a cap.

Bottom line: Workers in pension plans that are frozen or terminated will need to boost their savings now to make up for any shortfall in expected pension income.

How much more? Generally speaking, for workers in their mid-40s through early 60s, they should figure an additional 10 percent to 20 percent of their before-tax pay every year until retirement, according to estimates from Watson Wyatt and the Employee Benefit Research Institute.

In a typical pension plan, a man making $70,000 at 55 might have accrued a $16,990 annual pension assuming 25 years of service, said EBRI fellow Jack VanDerhei. By age 65 he would have an accrued pension of $31,044 a year, or another $14,054.

To make up for that $14,054 if his plan freezes when he's 55, he would need to invest another 15.3 percent of his income for the next 10 years to have enough to buy an annuity that could provide him with the same amount in retirement.

A 55-year-old woman in similar circumstances would need to set aside even more -- 16.2 percent of pay – since her life expectancy is greater.

Granted, workers may not have to come up with all the extra savings on their own.

Employers may ease the transition away from the pension somewhat. IBM, for instance, said it would double its current company match in its 401(k) plan. Plus, for some workers the company will automatically contribute 4 percent of their pay to their 401(k) accounts regardless of whether they contribute to the plan.

In that scenario, a worker could subtract at least 4 percentage points of pay from the additional savings he needs, more if he's also getting the enriched match in his 401(k).

How much would you need to save?

EBRI's calculations assume a worker joins the company at age 30, gets annual salary increases of 3 percent, and puts savings in an investment portfolio that grows more conservative as the worker nears retirement at age 65.

Just how much extra you would need to save depends on a number of factors, including:

Your gender: Women live longer, so generally need to save more than men.

Your age and years of service: Typically, the older you are and the longer your tenure at a company, the greater your pension benefit becomes.

So if you're in your late 40s through early 60s and are close to earning the maximum pension but the plan is frozen before you can attain that, you'll have a larger income shortfall to make up for than if you were younger and a shorter time to do so.

That's why "baby boomers could be holding the short stick here," said Kevin Wagner, Watson Wyatt's retirement practice director. When they were young, they entered a retirement plan that valued older workers. Now that they're older, their employer is putting them into a plan that values all workers equally.

Your marital status: If you're single and aren't worried about leaving money to a partner or beneficiary, you won't need as much as if you were married and wanted to insure that both you and your spouse get a full pension payment for life.

What your employer is doing to compensate for the pension reduction: An added match or an automatic contribution to your 401(k) can reduce your burden.

How much pension income you actually stand to lose: To figure this out you'll need two things: the formula that determines your pension benefit in retirement, which can be found in the Summary Plan Document (SPD) for the pension plan, Wagner said; and a current estimate from your company of benefits accrued to date, a calculation you're entitled to ask for once a year, he noted. To factor in important elements like assumed salary increases every year, you might confer with a financial planner or accountant to help you make the best estimate. Top of page

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