4 Ways Pensions Stirring Up Trouble

Lately, I’ve been hearing ‘He’s going to be OK, because he has a pension.’

As 401(k) balances have dropped dramatically, some older Americans with guaranteed pensions feel secure.  

Statue in downtown Manhattan honors the bull financial markets.

But if you are a stock market investor, you may be feeling queasy. Why? Pension managers invest in the market the same way as 401(k) plans. The difference is the employer handles the investments instead of the employee.

In 2008, the S&P lost 37% of its value, therefore, many pension plans could see their values drop by a huge margin. How bad is a 37% drop? Well, it would take a return of more than 58% just to get back to even! Put differently, assuming the pension plan earned a decent 10% every year, it would take roughly 4.9 years to get back to the point where the pension plan was even! That is not going to be enough time given the funding deadline, so companies must add in cash to the pension plan, which is even more difficult given the economic climate! Some will not be able to fund properly.

1. The 2006 Pension Protection Act’s rules will be phased in by 2011, but companies must “close any funding gap on certain pension plans by 2018” — aptly put by Liam Denning in Tuesday’s Wall Street Journal.
2. This means that companies with pension funds that are underfunded — meaning they need to have X amount in their pension coffers but instead have X-$80 million because of losses in the stock market — will have to increase their contributions to their respective funds.
3. The mandated timetable set by the 2006 Pension Protection Act means that underfunded pension plans must make up the pension shortfall by 2018.
4. Easier said than done, given that in the past year many pension funds have experienced an unprecedented drop in value. One can easily envision that for some companies with pension shortfalls, they’ll be funneling their cash to the pension fund first for the next few years to close the funding gap.

In short, once the profit outlook for some companies becomes more cheery, it is tempered by the pension shortfall problem.

And that’s a drag.

Photo Source: James Manners