Can You Afford to Retire?

fixing underfunded pensions: the u.s. government's response

In 2006, Congress passed new pension legislation, but will it fix the problem -- or make it worse?

  • Related Link
  • "On Point: Your Pension"
    An episode of the NPR program discussing the newly signed Pension Protection Act. Real Player or Windows Media Player required for audio. (August 21, 2006)

On August 17, 2006, President Bush signed into law what he calls "the most sweeping reform of America's pension laws in over 30 years, the Pension Protection Act of 2006."

Debated in both houses of Congress since 2005, the 907-page law "establishes sound standards for pension funding," according to Bush. "Yet, in the end," he said, "the primary responsibility rest with employers to fund the pension promises as soon as they can."

But many retirement experts predict that the new law will only hasten the trend of companies abandoning their traditional pensions in favor of 401(k)-style retirement plans. If that happens, it will be only the latest in a series of pension laws (see table) to have unintended consequences.

Walking a Tightrope

Tightening pension funding is a balancing act: Reforms must be tough enough to force compliance, but not so strict that companies decide to freeze their pensions -- as IBM, Hewlett Packard and Verizon have done -- or terminate them and leave the Pension Benefit Guaranty Corporation (PBGC) holding the bag. Since 2000, many companies have done just that, leaving the PBGC with a $23 billion budget deficit.

Under the new law, companies will have seven years, starting in 2008, to fully fund their pension plans. Companies with "at-risk" plans -- those 70- to 80-percent funded, depending on the calculation -- face accelerated funding schedules. Employers and labor unions are barred from upping benefits unless a plan is more than 80-percent funded, a provision that some labor groups opposed as shifting the balance at the negotiation table too much towards management.

Fixing 401(k)s

The law makes 401(k) plans more attractive for both employers and employees. It allows companies to automatically enroll their workers; workers have to opt-out rather than opt-in. It encourages companies to offer workers annuities, preventing them from spending their savings too quickly. And it encourages workers to save by making permanent the higher 401(k) and IRA contribution limits introduced in 2001.

Some pension experts argue that while these reforms will help bring more workers into 401(k) plans, they don't go far enough. If Congress were serious about bringing workers into 401(k), they contend, why not make participation mandatory, and at contribution levels that will give employees enough savings to retire on? Some critics also argue that the higher contribution limits tend to benefit only the highest-paid employees, who can afford to max-out their plans, but do little for low- and middle-income workers.

A Safe Harbor for a New Type of Pension

The Pension Protection Act also addresses a new kind of pension, the cash-balance or "hybrid plan." Since the late-1990s, many companies have converted their traditional lifetime pensions into cash-balance plans, which give employees individual retirement accounts like 401(k)s, but funded by the employer rather than by the employee.

But the legality of such plans has been in doubt since a court ruled against IBM's 1999 cash-balance conversion, finding that the move discriminated against older workers. (The ruling was later reversed, but legal questions remained.) In traditional pensions, workers accrue most of their benefits in their final years before retirement. In cash-balance plans, workers accrue benefits at the same rate throughout their careers, meaning workers approaching retirement at the time of a cash-balance conversion lose out. The new law establishes a legal test to determine whether a company's cash-balance plan discriminates against older workers, ending the legal uncertainty.

Special Attention for Airlines, Financial Services

Finally, the Pension Protection Act contains special provisions affecting the two industries featured in FRONTLINE's report: airlines and the financial services industry.

Under the new law, airlines have an additional 3 years (for a total of 10 years) to fully fund their pension plans; bankrupt airlines like Northwest and Delta get 10 extra years (for a total of 17 years). Proponents of the extensions argue that a shorter timeframe might prompt airlines to dump their pension plans in bankruptcy, but critics fear that troubled airlines will choose to terminate their pensions anyway.

The Pension Protection Act also lifts restrictions on financial services companies offering advice to 401(k) investors, even if the companies' own funds are among the investment options. Critics argue this will create conflicts of interest.


Table: Pension Law: A History of Unintended Consequences

Bill, Year Passed



Employee Retirement Income Security Act (ERISA), 1974

Shore up private-sector pension plans by setting funding and other requirements; create the Pension Benefit Guaranty Corporation (PBGC) to insure pensions.

Lax enforcement has allowed companies to underfund their pensions to record levels; some say PBGC insurance has created "moral hazard" by offering a fall-back for companies who want to dump their pension plans.

Chapter 11 of U.S. Bankruptcy Code, revised 1978

Protect employees' jobs and retirees' benefits by allowing companies to reorganize, rather than liquidating their assets in Chapter 7 bankruptcy.

Bankruptcy law trumps ERISA requirements for funding pensions; companies can emerge from bankruptcy without the "legacy costs" of pensions and other retiree benefits.

Section 401(k) of the Internal Revenue Code, revised 1978

A technical fix to protect executives' deferred compensation arrangements; in 1981 the IRS interpreted 401(k) to allow all employees to save for retirement on a tax-deferred basis

401(k) plans have largely replaced traditional lifetime pensions; 401(k)s shift the cost and risks in retirement savings onto employees, despite evidence that employees do not save enough and cannot manage their own investments.

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posted october 30, 2006

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