Benefits Cuts: Prepare to Work Longer, Save More and Expect Less

nest egg

Benefits cuts in multiemployer pension plans that the U.S. Congress authorized last week have been a long time coming. Many plans have been in a precarious state for years. They endanger the survival of the federal Pension Benefit Guaranty Corp. (PBGC) that provides them with a safety net. Some 1 million employees in 200 pension plans may see benefits cuts of up to 50% in a tiered program where younger workers could be hit the hardest.

In order to protect their retirement savings, today’s workers will have to stay longer in the workforce, save more and expect less in pension benefits, according to Olivia S. Mitchell, Wharton professor of business economics and public policy. Mitchell’s research areas include the economics of public and private pensions, and she also oversees Wharton’s Pension Research Council and the Boettner Center on Pensions and Retirement Research, also at Wharton.

“This was a moment of crisis,” said Mitchell, pointing to a government report last year that found that the multiemployer pension system was in “deep trouble.” The report warned that many of the plans, or maybe the entire system, could go bust in a decade. Mitchell believes it is time now to address concerns of insolvency in the Social Security system, “because we are not doing a good job financing that fundamental pillar of our nation’s retirement system either.” She discussed the causes of the pension system’s difficulties and possible solutions on the Knowledge@Wharton radio show on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

Haircut or Beheading?

The $1.1 trillion spending bill that Congress passed last weekend doubles the premiums on employers who remain in the multiemployer pension system. “That will help delay the ultimate day of reckoning in some cases,” noted Mitchell, pointing out that similar actions have been taken in the past. “What’s very different in this case is [that] Congress gave the trustees of the plans — who are the legal fiduciaries — permission to cut benefits if a plan looked like it [would] go insolvent,” she added. In the past, benefits have been cut when a plan went insolvent. “But to do it proactively and try to keep the plans in business is a very different animal.”

“In the worst case, the cuts could potentially reduce benefits by half.” –Olivia S. Mitchell

The benefit cuts will not kick in immediately, Mitchell said. In the 200 plans whose finances are in bad shape, the trustees will be allowed to review options and if necessary, propose benefit cuts to people depending on their age. Those over the age of 80 will be protected; the cuts will be moderate for those between the ages of 75 and 79, but could be bigger for younger workers. “In the worst case, the cuts could potentially reduce benefits by half Twitter ,” Mitchell said.

Any cuts the trustees propose will require a vote by plan participants. But the federal department of treasury could override those votes if it feels a plan’s insolvency would threaten the survival of the PBGC. Military pension plans will not be affected by the latest move, she reassured a listener in Cape Girardeau, MO, who called in with that concern. “A haircut is better than a beheading,” Mitchell said, quoting former Congressman Earl Pomeroy. “Many people may agree with [the benefits cuts], given that it is the lesser of two evils.”

What Went Wrong

Over the years, the government has tried to keep the PBGC afloat by raising premiums, but other circumstances came into play. “The financial crisis didn’t help at all. There were caps on contributions that employers were allowed to put in, and many employers have pulled out,” she said. Some, like the Teamsters Central States Pension Fund, is about $17 billion underfunded, she noted. “The problem is that any employers that can remain in business will want to try to withdraw; no new firm would try to enter that problematic pension fund because of the unfunded liabilities.”

According to Mitchell, many companies that sponsor these pension plans “didn’t know what they were getting into” and managed them badly. “They made promises and bargained benefits without setting aside the cash to ensure the benefits could be paid,” she said.

“[Longevity] was something that pension plans back in the 1940s and the 1950s never even countenanced.” –Olivia S. Mitchell

Increasing longevity made it worse for the pension plans, noted Mitchell. “[Longevity] was something that pension plans back in the 1940s and the 1950s never even countenanced,” she said. In earlier years, pension plans pooled risks among participants, but that option is no longer available in most defined contribution plans or 401(k) plans. Here, Michell found it encouraging that the government this year made it easier for people to get longevity protection, i.e., to buy an income stream for life within 401(k) plans.

Changing Times

Mitchell also talked about how times have changed. “I’m fond of the phrase ‘You only get old once,’” she said. “The problem is many of us baby boomers look to our parents, and our parents still have secure defined benefit plans. They had a well-behaved Social Security and Medicare system. Their houses grew in value. That was the golden age of retirement. Many of us think the same will be there for us, but the reality is that that’s not true anymore.”

Another listener from Atlanta, Ga., said the problems facing pension plans could mean that she would have to take care of her great grandmother, or grandmother or mother “because they can’t rely on these things for the future.” Mitchell congratulated her for her “sense of responsibility — not everybody will go that route.” Mitchell noted that one change in the last 30-40 years is that “children are no longer quite as willing and or able to take care of their parents or their grandparents as they were in the old days.” She attributed that to changes in marital patterns, divorce patterns and so on. “We see more and more people getting into retirement without a close relationship with their children.”

Mitchell recommended that everyone should keep working as long as they can. “That is the best way to try to husband your nest egg and protect it, so you don’t have to draw on it very long,” she said. “Let’s teach our children and grandchildren that they are not going to retire before they are 75 or 80 years of age.”

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