As a general rule pension funds invest 65% of their assets in stocks and the rest in other investment avenues, so the effect stock market has on pension funds is a major factor. The performance of pension funds is largely dependent upon the performance of stock market.
The recent stock market crash has left many retirees wondering if there is an effect stock market has on pension funds. The truth is, retirees with an assured pension program are the least hit by the downturn in the stock market. Unlike their counterparts with 401(k)s or other retirement plans, retirees with defined-benefit pension plans do not have to worry about their benefits being affected by the weak economy.
Stock Market Crash and its Effect on Pension Funds
Investopedia defines a pension fund as a "fund established by an employer to facilitate and organize the investment of employees' retirement funds contributed by the employer and employees." The contributions from both the employer and employees forms an asset pool which is then invested in stocks, bonds and other avenues to generate growth and to produce enough income to cover the employees' pension when reach their retirement age.
In a defined-benefit pension plan, it is the responsibility of the employer to assume the risk of investments and to see that employees get their benefits no matter what happens to the investment. The employers ensure the stable growth of their pension funds by investing a major portion of their assets in stock because in the long run the stock market
provides the best return on investment. In fact, when the economy was in good condition most pension funds had a surplus in their accounts. However the stock market crash eroded the value of pension funds and as of 26, July 2010, the aggregate shortage of all pension plans in the S&P 500 Index is a staggering $227 billion. According to Hewitt Associates' Pension Risk Tracker, the funded ratio of all pension plans in the S&P 500 Index was around 80% at the end of June 2010. This means that the value of assets in the funds are 20 percent short of covering the benefits due to the employees.
Guaranteed Pension for Retirees through the Pension Protection Act of 2006
The Pension Protection Act of 2006 made it mandatory for employers to adequately fund their defined-benefit pension plans. It closed certain loopholes in the law which permitted employers to skip some of their contributions. The employers offering defined benefit plans are required by the law to provide pension to the employees on the eve of their death, retirement or early separation from employment due to a disability.
Since the investment risk of pension funds falls on the employers, companies with defined-benefit pension plans have to cover the deficit in their pension funds with their own funds. This deficit would eat into their revenue, would show up in their Profit & Loss statement and can even impact their credit rating. The double impact of a weak economy and shortage in pension funds can seriously threaten companies sometimes even forcing them into bankruptcy.
Pension Funds- What the future Unfolds
Unfortunately, the Pension Protection Act of 2006 while protecting the rights of retirees with defined-benefit pension plans, acknowledged also the fact that defined-benefit pension plans are on their way to oblivion. More and more companies are adopting defined-contribution plans like 401(k)s, which puts the risk of investment on employees and makes them in charge of their retirement plans. The recent market crash and its effect on the pension plans may be another factor which speeds up the demise of pension plans.
United States Dept. of Labor www.dol.gov/EBSA/pensionreform.html
Hewitt Associates' Pension Risk Tracker https://rfmtools.hewitt.com/PensionRiskTracker/
- Suffolk University Law School on The Pension Protection Act of 2006 http://www.law.suffolk.edu/highlights/stuorgs/lawreview/documents/Eriksson_Note_FINAL.pdf
Investopedia Website http://www.investopedia.com/terms/p/pensionplan.asp
Image Credit: Walter Rodriquez, http://www.flickr.com/photos/91571281@N00/728933695/