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The Big Chill

The Big Chill

With a steadily increasing number of companies freezing their defined benefit pension plans and opting to sweeten 401(k) plans for employees, financial and benefit experts warn the trend paints a gloomy picture for many future retirees.

Employees young and old who are not financially savvy may forgo signing up for 401(k) plans. Those who do enroll might not know how to invest their money strategically to maximize retirement income.

As a result, workers may not be able to retire when they want to or when they need to leave the workforce, experts say.

Additionally, those who do retire will need the know-how to spend wisely and continue investing to ensure they'll have enough money.

"I think there is a disaster on the horizon for the employee," said Jack Abraham, principal and national leader of the retirement practice at PricewaterhouseCoopers L.L.P. in Chicago. "Employees are not equipped to manage their retirement."

So why are companies going into the deep freeze with their pensions?

Diverse reasons

"There are as many reasons as there are companies," said Kevin Wagner, a Southfield, Mich.-based retirement practice director for Watson Wyatt Worldwide, which recently released a report that found 113 of the Fortune 1000 companies in 2005 had frozen or terminated their defined benefit pension plans. That was up from 71 in 2004 and 45 in 2003. Figures include those companies that froze their pension plans as a result of bankruptcy reorganizations.

Among reasons for the terminations cited by Mr. Wagner and other experts are companies saving money, the lack of volatility of defined contribution plans and the shift away from paternalistic employer-employee relationships.

Mr. Abraham said companies can greatly cut annual benefits costs and plan more effectively for future costs with defined contribution plans, which shift market volatility risks onto employees.

"The risks are lower for the companies," said Mr. Wagner.

The age of the workforce is also a major factor, Mr. Abraham said. As more baby boomers retire, companies are being forced to live up to their commitments and provide pension payments to retirees for the rest of their lives in a time when people are living longer.

"A significant part of the workforce is older or getting there," said Mr. Abraham. "Defined benefit plans are becoming very costly for companies. (They) don't want those long-term commitments to employees."

"(Companies) are moving away from a paternalistic system—the kind where the company takes care of the employee (for retirement) and the employee doesn't have to do that much," he added.

Rationale aside, Mr. Abraham said some companies may be caught in a herd mentality.

"Today, the picture is a race to the bottom" line, he said. "Company X cut benefits, so we have to cut benefits to compete."

Mr. Wagner agreed: "To a certain degree, the cork is off the bottle, so many companies have done this and many are just waiting for their company to do this."

Taking over where defined benefit plans leave off are a variety of defined contribution plans and hybrids of the two (see story, page 16).

Despite the drawbacks noted by experts regarding pension freezes, Larry Sher, director of retirement policy for New York-based Buck Consultants L.L.C., said defined contribution plans are popular among today's employees.

"Some of the traditional-type pension plans don't fit with the current workforce or the future workforce because (pensions) tend to provide most of the benefits to longer-service employees, and people who leave early don't get much value in a traditional pension," Mr. Sher said.

Meanwhile, defined contribution plans are mobile and concrete. "Employees like 401(k)s," he said. "They get statements. They see their money grow. They can see their company's match. They tend to see the bright side, maybe until they get to retirement and then they start to worry, 'How am I going to budget this? Is this enough?"'

Mr. Sher said panic will strike once employees realize the difference between a secured defined benefit pension and a good-on-paper defined contribution plan. "There will come the time when there will be outcry, 'I want my pension back. Why did you take my pension?"'

Other experts speculated as to why there hasn't been any outcry.

"The biggest reason is that they don't understand what they are losing," said Mr. Abraham.

Too little money

Droves of employees now in defined contribution plans also may not understand how to manage their accounts, Mr. Abraham said. What tends to happen is employees invest in the wrong funds and wrong types of funds, resulting in too little money in their plans when employees are ready to retire, he said.

For example, trained investors would have a younger worker invested in riskier funds, such as stocks, which tend to ebb and flow with the markets but typically produce over the long term the largest investment returns. Conversely, older employees would need to put their money in safer investments, such as bonds, which often produce smaller long-term returns but have less risk of near-term volatility.

Employees "are not equipped to manage the dollars they have," Mr. Abraham said.

The result is scary for most employees, who could be forced to work well past retirement age because they haven't accumulated sufficient funds in their defined contribution plans, said Mr. Wagner. "There's going to be a lot of what we call 'retiring on the job,"' he said. "Employees will say 'I would love to retire, I am no longer engaged or interested in my job. But I can't afford to retire."'

And once employees with the defined contribution plans retire, their real job begins: managing the pot of money that must last the rest of their lives, said Mr. Abraham.

"Basically, not only do you have to invest wisely, you have to accumulate additional funds to deal with the probability of living too long," he said.

Several experts predict that companies eventually will consider rebooting traditional pensions or introducing more plans, like cash balance plans, that have both defined benefit and defined contribution plan features, but legally are defined benefit plans.

Ethan Kra, chief actuary for Mercer Human Resource Consulting in New York, said once all baby boomers move into retirement, some companies likely will reestablish defined benefit plans to attract younger, talented workers.

Competition will drive the shift back to defined benefit plans, albeit leaner versions of traditional pension plans, he said. "There aren't enough Generation Xers to fill all the knowledge jobs (and) executive positions as baby boomers retire," Mr. Kra said.

Mr. Abraham said he believes that as these younger employees secure more powerful positions, they will have more clout when it comes to demanding better benefits.

At least one company has already reversed its freeze on benefits as a way to stay competitive. El Segundo, Calif.-based Aerospace Corp. in 1993 froze its pension plan to save money. In 2005, the company reintroduced a leaner traditional pension plan, giving employees a choice of moving from a defined contribution plan into a plan that included both elements of a defined benefits plan and a defined contribution plan.

Charlotte Lazar-Morrison, principal director for human resources at Aerospace, said industry competition helped drive the change.

"There were a variety of reasons," she said. "But we looked at what our competitors were doing. If we wanted employees to stay with us, it was clear that defined benefits were better. In our business, experienced workers are better."