01/17/06 - IBM Pension Freeze: Is This The Tipping Point?
By: Frank Armstrong, CFP, AIF
IBM's announcement early this month (January 2006) that it would freeze all of its defined benefit plans may be the beginning of the end for the traditional retirement plan. Perhaps we have reached a tipping point where other large and profitable corporations will feel free to freeze their defined benefit plans. This isn't an airline struggling to emerge from bankruptcy, or a steel company overwhelmed by foreign competition. This is IBM, Big Blue: One of the largest, most profitable companies in the world, high tech, innovative, and likely to be a dominant player in tomorrow's economy. You can bet that other companies will notice what IBM does, and begin to wonder if maybe they shouldn't dump their plans too.
Going forward IBM will provide only 401(k) plan benefits. Under the freeze existing accrued benefits will be retained, but no new benefits will accrue. For a worker in mid-career, this could be devastating because defined benefit plans are "back loaded" in that most benefits accrue towards the end of a career. Whatever this plan accomplishes will come at the expense of older, long term employees. For a mid-career employee, the combination of existing accrued benefits and future benefits from a 401(k) plan will certainly fall far short of the retirement benefit that the employee expected under the old plan.
For companies like IBM, the issue may not be cost but uncertainty. Even if annual pension funding costs are identical for the two plans, IBM gains significant control over future balance sheet and costs. Interest rates and investment performance of plan assets have a huge impact on the funding levels of a defined benefit plan. Small changes in either factor swing funding adequacy almost exponentially. These changes in turn flow through to the balance sheet, and impact future funding requirements.
Pension liability is a risk that companies do not particularly enjoy. They would rather have their future financial performance determined by their skill and cunning as computer consultants than by pension investment results, something entirely unrelated to their core business. By terminating their traditional plans and substituting a 401(k) companies transfer all this risk to the employee. If investment results are poor, or the employee mismanages his account it's just tough. IBM has no further liability. It's not going to affect their balance sheet, and they know exactly what their pension costs as a percentage of payroll will be.
The message to employees is clear. In a Defined Benefit Plan you have little to no control over your benefit. You are just along for the ride. If you have a defined benefit plan today, even if your company and industry are healthy, you shouldn't expect to continue to accrue benefits until retirement. Management can pull the plug at any time. More and more companies will be following in IBM's path.
Of course, if your company isn't healthy or in an industry that is floundering (airlines, steel and auto companies, for instance) you may become a client of the PBGC as bankrupt companies dump their pension obligations in "distress terminations". If you are a highly compensated employee, a distress termination can mean receiving a very small portion of your accrued benefit.
The bottom line is that for financial planning purposes, you should consider your defined benefit plan much like a lottery ticket. If you get it, you are a big winner! But, in the new real world of rugged individualism, compassionate conservatism, individual responsibility, the ownership society, and cradle-to-grave insecurity, you shouldn't count on it.
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