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How the IRS Helped Destroy Pension Funds

Last week I mentioned the Central States Pension Fund was running out of money, and an interested listener contacted me to find out more about it.  As it turns out, Dave (not his real name) is a recent retiree, and Dave is currently receiving a benefit from this fund.  Dave is in his 60’s, and plans on living for quite a while longer, so naturally he was not happy about this news.  He wanted to know what the potential outcomes of this situation were.  Unfortunately for Dave, it really doesn’t look good at this point.  

The Central States Pension Fund currently pays out over $3.00 in benefits for every $1.00 taken in.  Every month, the plan pays retirement and survivor benefits to about 212,000 individuals, most of whom depend on this money to survive.  This doesn’t even count the estimated 200,000 additional people who are currently accruing benefits under the plan.  At the current rate, assuming an average annual return of 7%, the fund will be bankrupt in about 10 years. 

There is a very good reason that the good folks who have worked hard for their entire lives are facing the loss of their retirement income, and you will never guess what it is.  In fact, this problem is brought to you by none other than the friendly folks at the IRS. If this doesn’t make you angry, I don’t know what will.

Prior to the 1990’s, defined benefit plans (aka: pensions) were very popular not just for big business, but also for small family offices.  They were a great way for small businesses that made a lot of money and didn’t have a lot of employees to put away huge amounts of tax-deferred money.  Well, as you may have guessed, the IRS didn’t like the fact that these businesses were deferring all that tax revenue.  They wanted to get paid now, so they got strict about enforcing the rule that didn’t allow contributions to pensions to be tax deductible if the pensions were overfunded.  

During the 1990’s, the stock market took off, and as a result, many pensions found themselves overfunded.  That’s right, they had too much money in relation to their benefit payouts, at least according to the IRS.  Well, any pension manager or money manager knows that anything that can go up can come back down, and having an overfunded pension is usually a temporary situation.  But the government, of course, failed to realize and was blinded by the potential tax revenue they were missing out on. 

This left the pension with a few of options.  First, they could suspend contributions to the pensions, which costs the companies their tax deduction from those contributions.  Second, they could continue to contribute, but those contributions would not be tax-deductible.  But many pensions, including the Central States Pension Fund, had an even bigger problem, which leads me to the third option.  Because of their collective bargaining agreement with the Teamsters, the companies that used the Central States Pension couldn’t stop their contributions to the Fund without renegotiating their entire collective bargaining agreement.  This basically left them one option, which was to increase the benefits paid out by the plan.  How could this ever go wrong?  

If anyone remembers way back in 1999 and 2000, the NASDAQ closed over 5000 a few times.  From there, the Dot Com bubble burst, and the NASDAQ retreated to its 1996 levels.  The broad market, while not affected as much as the NASDAQ, also fell, and with it fell the values of the assets held by the Central States Pension Fund, along with a handful of other pension funds.  At this point, not only were the value of the plans investments plummeting, but they were now strapped with higher plan payout benefits.  

All of this leads us to this past week, when a plan to cut the benefits for some pensioners up to 60% was rejected because it wouldn’t do enough to save the Fund.  So at this point, it is kind of like watching the Titanic heading for that iceberg.  You know what is going to happen, but there just isn’t time to turn the ship. 

There are still some potential solutions to this problem, but none of them are very appealing.  The first is the PBGC, which is a government fund that insures pensions.  However, the PBGC is also running out of money, and in many cases pays a much smaller monthly benefit than what is guaranteed by the pension plan.  The second is that companies that are part of the plan are forced to contribute additional money to the plan.  Apparently when UPS signed up for the Central States Pension Plan in 2007 they agreed to pick up payments if the plans benefits were cut.  This could potentially put UPS on the hook to the tune of $3.8 billion dollars.  There are many other potential solutions to this problem, including a taxpayer funded bailout of the fund, a cut in benefits, an increase in funding from the member companies, or a combination of any of these.  It is unlikely that any one of these solutions will generate the $11 billion needed to keep the fund solvent.