The conglomerate GE took steps earlier this month to shore up their retirement program by freezing the pensions of 20,000 existing employees and offering buyouts to 100,000 former employees who have yet to start collecting their benefit.
This has become a common trend over the past couple of decades as companies shift away from pensions, and to 401(k) plans.
I wanted to take the opportunity to explain exactly what it means when a pension is frozen. How a pension freeze affects both existing employees and those who are retired, receiving their pension benefits.
What exactly is a pension and what is a 401(k)?
A pension is considered a “Defined Benefit Plan” where the employer funds a pooled investment account each year, and the employee receives a monthly payment for life, at retirement, based on their years of service and salary (generally speaking).
A 401(k) is a “Defined Contribution Plan” in the employee’s name, funded by both the employee and employer. The employee has control of the investments, and essentially has full control of the account during their career and in retirement.
Why is GE freezing the pension for existing employees and offering a buyout to former employees?
The pension is underfunded by over $27 billion. This means the pooled investment account does not have the money to pay its future obligations, and is short by about $27 billion.
What happens when a pension is frozen?
The employee is entitled to the benefit they have accrued up until the freeze. They do not lose their pension, the benefits just stop accruing. There is no effect on former employees who are receiving their benefit unless the company goes bankrupt.
What if the company goes bankrupt and cannot fulfill their pension obligations?
The Pension Benefit Guaranty Corporation (PBGC) steps in to fulfill some of the obligation. All companies that sponsor a pension have to pay premiums to the PBGC each year, essentially as insurance. Current and former employees may see pension cuts as a result but they should receive some of their promised pension benefit from the PBGC.
Why are companies shifting away from pensions and to 401(k) plans?
Cost and liability. Sponsoring a pension plan can be a costly endeavor for an employer, and they assume the liability of providing retirees their main source of retirement income. A 401(k) is a much cheaper option, and the liability is shifted to the employee to save and invest for their own retirement.
Should a former employee take the buyout, or elect for their pension benefit?
That is the big question. Do you trust GE to turn around their business and have the ability to pay the pension benefit into the future? Or, would you prefer to take your retirement into your own hands by taking the buyout and investing it yourself.
I would expect the trend of pension freezes to continue, as well as the shift from pensions to 401(k) plans. I hope this update was helpful, if you have any questions at all please do not hesitate to contact the office.