Some may profit from pension freezes
New research shows that not every worker would be worse off when a company freezes pension benefits.
By Jeanne Sahadi, senior writer

NEW YORK ( Shortchanged is a polite way to describe how employees might feel when their companies announce they're going to freeze their pension plans.

But for some pension plan participants, a freeze may actually result in more money in retirement, according to the latest research by pension expert Jack VanDerhei of the Employee Benefit Research Institute.

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The reason: companies that freeze their plans often sweeten their 401(k) contributions.

Generally speaking, the younger a worker is the more likely it is that he will be better off with the sweetener, particularly if a company's pension plan was not considered particularly generous to begin with.

For example, say a company freezes its cash-balance pension plan and agrees to contribute 4 percent of a worker's pay into his or her 401(k) to compensate. A 4 percent sweetener is fairly typical among those companies -- such as GM and IBM -- that have received a lot of coverage for freezing their plans, VanDerhei said.

According to VanDerhei's calculations, workers up to the age of 53 actually will be better off under that scenario than they would be if the plan had never been frozen. That assumes the pension would have paid out a median benefit and that the investments in the 401(k) would generate 8 percent average annual returns. A key issue, of course, is that employees assume the risk if 401(k) returns fall short.

Pension plan participants over 53 would need to contribute some of their own pre-tax income on top of their employer's 4 percent contribution, but not that much. A 62-year-old, for instance, might need to contribute another percentage or two of his own pay to do better than he would if he continued to accrue benefits under the cash-balance plan.

For more traditional defined benefit plans, where retirement benefits are based on an average of a worker's earnings, the results aren't quite as favorable. Workers up to age 44 would still do better. But since pension benefits in traditional plans grow the most in a worker's later years, the older a worker is, the more he will need to save to offset the freeze.

On top of the 4 percent sweetener, workers between 50 and 54 would need to contribute, on average, an additional 4 percent of their income pre-tax. A 60-year-old might need to contribute as much as 15 percent more.

If a pension plan is very generous -- more so than the average plan -- a 4 percent employer contribution may not be enough to adequately compensate as many workers for the loss of future benefit accruals.

While having to contribute more of one's own income is not welcome news to workers, one factor can lighten the burden a bit.

Say a worker decides he needs to save 5 percent of his pre-tax income to offset the impact of a freeze. His take-home pay will be less, but not as much as 5 percent less because his 401(k) contribution will reduce his taxable income.


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