Cutting Contributions

Making it even harder for defined contribution plan participants to recoup, a number of employers are scaling back or eliminating matching contributions in the face of a slowing economy.

In March, a survey of employers by WorldatWork, an association of human resource managers, and the American Benefits Council, representing companies that provide benefits to their employees, found that 3% of the 505 responding companies had eliminated their 401(k) match, and 8% had either decreased the match or were considering a decrease. The Pension Rights Center, a Washington, D.C.–based consumer organization focused on retirement security, lists on its Web site more than 150 companies that have either changed or suspended 401(k) matches.

The fact that companies can scale back on their match during tough economic times could be positive, some argue. "Unlike a freeze in a pension plan, a freeze in a [defined contribution] plan is not usually permanent," says Jan Jacobson, senior counsel for retirement policy at the American Benefits Council. "To the extent that a company is choosing between laying off workers or stopping their match for a while, some companies will choose to stop the match. And I think I'd rather work for the company that stops the match." Brady, of the ICI, notes that "this flexibility is actually a strength of the 401(k). It might be a way [for companies to save money] that doesn't have a short-term cost to employees. And I assume they'll resume contributions when the economy recovers.... I'm sure people would rather lose their 401(k) match than lose their job."

Participants in defined benefit plans at private companies face a different set of problems. Companies that offer pension plans are being squeezed by a sudden decline in assets, an increase in liabilities and changes in the law that force them to make up the shortfall faster than in the past. "Many companies might have to lay workers off, walk away from their pensions, shut down a plant," says Alan Glickstein, senior consultant at the Washington, D.C.–based human resources and financial management consultancy, Watson Wyatt. "Companies [have] to make very difficult decisions."

The nation's top 100 pension plan sponsors saw their pension funds drop by $303 billion in 2008, going from an $86 billion surplus -- relative to the minimum amount required by pension regulations -- at the end of 2007 to a $217 billion deficit at the end of 2008, an analysis by Watson Wyatt found in March. Aggregate funding decreased by 30 percentage points, from 109% funded -- meaning they held 9% more than the minimum-required funding -- at the end of 2007 to 79% funded at the end of 2008. A different survey by Mercer, a New York–based human resources consulting company, found that aggregate funding of pension plans of S&P 1500 companies fell to 74% at the end of February, with an aggregate deficit of $373 billion. Year-end figures, which are what plan sponsors generally use to calculate pension expenses and contribution requirements for the coming year, showed an aggregate deficit of $409 billion at the end of December, with funding at 75%.

The shortfall stems not only from a decline in equity values, but also from falling interest rates, which have forced companies to increase the amount they set aside for future benefit payments. As a result, money that could have been spent on growing the business is being funneled into pension obligations. Mercer estimates that pension expenses for S&P 1500 companies will jump to $70 billion in 2009, compared to $10 billion in 2008 and $35 billion in 2007. "Companies need to put these assets and liabilities on their financial statements," says Adrian Hartshorn, a principal in Mercer's financial strategy group. "It affects their balance sheets and it affects the profits they report, and clearly it also affects the amount of cash they have to put into the plan."

Changes under the Pension Protection Act (PPA) of 2006, many of which took effect in 2008, are also making it more difficult for companies to ride out the storm. Actuaries calculate annual shortfalls in pension funds using a method called "smoothing," which averages investment gains and losses over several years. "Under the old law, we had the ability to spread ups and downs over a four- to five-year period," says Glickstein. "So we could sort of calm the ups and downs to make sure it's not just noise in the market."

The new law limits smoothing to just 24 months, meaning the dramatic losses of 2008 will have a proportionately larger impact on the calculated shortfalls. In essence, the new accounting rules are forcing companies to act now to make up for a huge financial gap, even though a quick turn-around in the economy could ultimately negate the deficit. "The challenge is, what is the real number?" asks Glickstein. "What is the right posture [for companies] to take in the face of a temporary phenomenon that has created a huge amount of pressure?"

The pressure has spurred some companies to reconsider their pension offerings. "Continuing to operate a [defined benefit] plan is a risk and a cost that they are no longer willing to bear," says Hartshorn. Some companies are freezing their defined plans voluntarily, meaning they stop making contributions and employees stop earning benefits. (Under the PPA, a plan is automatically frozen if it is less than 60% funded.) Phone maker Motorola, newspaper publisher McClatchy, aerospace company GenCorp, insurer Aon, and apparel retailer Talbots are among the nearly 100 companies that have frozen pension plans in the last few months, according to the Pension Rights Center.

Freezing a plan can save money on contributions but does not remove the long-term risk and volatility for the employer, notes Hartshorn. Companies will still have to pay out on promises that have already been made and benefits that employees have already earned.