web analytics

Why do Employers Freeze Pension Plans?

Why do employers go through the process of freezing pension plans, especially when it causes its employees’ such frustration as a result? It’s difficult to comprehend sometimes. All of a sudden, a pension plan that an employee had been relying on to afford a secure retirement, one that the employee didn’t have to fund and invest themselves, is gone and being replaced by a 401(k) plan, one that where the employee is saddled with all the work and decision-making

The reality is that as 401k’s became increasingly popular in the late 80’s and 90’s, many employers started dumping their old defined benefit (DB) pension plans and replacing them with DC plans such as 401k’s. While this may be a major blow to you as the employee, this move makes perfect sense from an employer’s perspective. Especially when you consider all that is required from an employer to manage a DB plan.

Put simply, in a pension plan the employer is responsible for everything. Freezing pension plans makes the most business sense sometimes.

Step number one for an employer who sponsors a pension plan is to ensure the plan is properly funded. In order to ensure proper funding, the employer considers how many employees are covered by the plan, how long each employee has before they retire, the amount of money they must put into the plan (without contributing too little or too much), and ensuring the money is invested properly so that it is not subjected to unnecessary risk and will be available to all retirees who are eligible to benefit under the plan.

As you can see, this is a lot of work. And talk about expensive! The pension account must be handled by skilled managers and actuaries to ensure proper funding levels and investment allocations. Improper handling of the money can be a nightmare and lead to funding shortfalls in the future which can impact a retiree’s potential income.

On top of all this the employer must also pay hefty insurance premiums to the Pension Benefit Guaranty Corporation (PBGC) to cover benefit payments to retirees in the event the employer runs into financial difficulty (or worse, bankruptcy) and is unable to make payments.

By freezing pension plans and switching to defined contribution (DC) plans such as 401k’s, the employer has effectively shifted the retirement burden to the employee and away from themselves. No longer is the employer required to determine, using complex formulas, the amount that must be contributed to the plan and how the money should be invested to maintain a sufficient holdings to pay its retirees. This is now on YOU, the employee. This truly impacts those individuals who are older and have been expecting this pension income only to find out that you aren’t getting it. (It’s worth noting here that most employers are afraid of the lash back they are going to receive when they freeze their pension plans, so they will usually provide a large cash value comparable to the pension value and have that placed into a defined contribution plan. Don’t feel as though you are starting all over, because you’re not.)

Scary, huh? It doesn’t have to be. In fact, with your financial future now in your control and not someone else’s you have the ability to set yourself up quite nicely for retirement. And if done right, chances are you could end up with more than your old pension plan would have done for you.

All it takes is a little bit of knowledge and a lot of commitment to outperform your old pension plan. This is your future, after all.

© 2023 About401K.com - Theme by WPEnjoy · Powered by WordPress