Pension Freeze: When You're Left Out in the Cold

When some of the country's biggest employers and industry trade associations pleaded with Congress for temporary funding relief, several key unions and employee groups supported their request, hoping it would prevent companies from freezing their pension plans. (A pension freeze means employees keep the retirement benefits they have already earned but do not accrue any further benefits. That minimizes employers' future costs, but it doesn't relieve them from having to make up current shortfalls in the plan's funding.) But pension freezes seem to be picking up steam since last year's stock-market meltdown.

More than a dozen major corporations, from telecommunications giant Motorola to publishing icon Random House, have announced pension freezes effective this year. Because a freeze reduces future retirement benefits for employees, companies often introduce a new 401(k) plan or enhance their existing plan by boosting employer contributions.

That can be a boon for younger workers. Most of them probably wouldn't stick around long enough to benefit from a traditional defined-benefit plan, which typically generates the greatest benefits toward the end of a long career. And older workers nearing retirement are often unscathed by pension freezes because they have already accrued the bulk of their benefits, which are based on a formula that includes years of service and the average of your highest three or five years of salary.

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But for mid-career workers in their fifties, a pension freeze can be devastating. Future raises and years of service won't be factored into their pension calculation, causing them to miss out on the most lucrative part of the back-loaded retirement benefit. And they have less time to make up the loss by saving in a 401(k).

For example, the Center for Retirement Research at Boston College found that a pension for an employee who joins a company's pension plan at age 35 and continues to earn benefits until he retires at 62 would replace about 43% of his final earnings. But if the pension is frozen when the employee is 50 and replaced with a 401(k), the worker's retirement-income replacement rate drops to just 28% of final earnings. Even with 401(k) enhancements, retirement benefits decline.

In both cases, Social Security benefits would supplement retirement income. But the worker whose pension was frozen would have to rely more heavily on personal savings to maintain his preretirement income or cut expenses after he leaves his job. Plus, the investment risk shifts from employer to retiree.

What can you do? Financial planner David Kudla says you should focus on the things you can control, such as contributions to your 401(k) and other personal savings. Although he sympathizes with retirement savers who may want to walk away from the stock market forever, he says that's "wrong thinking at the wrong time for long-term investors."