What if your pension runs out of money?

The zero-interest-rate policy in the U.S. continues to wreak havoc on those saving for retirement.

Case in point: Many companies are pouring cash into their defined benefit pension plans because of the low interest rates, according to a report this week in The Wall Street Journal. According to the report, companies are required to calculate the present value of the future pension liabilities—how much they need to pay out to retirees—by using a so-called discount rate, which based on corporate bond yields. As those rates fall, the liabilities rise. And as those liabilities increase, companies make up the difference by pouring cash into their plans.

So what does this trend portend for workers at the firms that have traditional defined benefit plans? What should workers do at firms where this might be happening or could happen? And what might small employers who have defined benefit plans consider doing to avoid problems?

Prepare for the worst

Not surprisingly, some experts say there’s plenty to worry about, others say this trend is much ado about nothing, and still others say workers with a defined benefit plan—funded or not—should be thankful for what they have.

At one extreme is Ary Rosenbaum, an ERISA/retirement plan attorney for his firm, The Rosenbaum Law Firm. He says workers ought to prepare for the possibility that their employer will freeze their pension benefit or terminate the plan.

And if that should happen, consider, at a minimum, increasing the amount of money you contribute to other retirement accounts, such as an IRA or 401(k) to make up for what you might lose in pension payments.

Others, meanwhile, say that workers whose employers have a well-funded pension plan need not worry as much about their plans being frozen or terminated. “Workers at healthy firms shouldn’t worry, because the company stands behind the promise,” said Ron Surz, president of Target Date Solutions. “That said, I don’t think there are many defined benefit corporate plans left. Defined benefit plans are now mostly union and government plans.”

And still others remind us that there’s not much a worker can do whether a plan is funded or underfunded. “First, workers have very little influence over the actual funding requirements of true pension plans,” said Christine Russell, a retirement strategist for Christine Russell Retirement Consulting. “The amount a company must fund is determined through complicated formulas calculated by actuaries.”

So what can employee today do if they are covered by a pension? “Thank their employer for continuing the pension plan,” she said. “Many companies no longer offer such plans, so an employee covered by a pension is a lucky person, indeed.”

What’s more, she said employees should let the human resources/employee benefit department know that they value this benefit. “Often, it can seem like this substantial and important benefit is ignored by employees,” she said.

By way of background, there are more than 27,500 private-sector defined benefit plans covering more than 44 million American workers, according to the Pension Benefit Guaranty Corporation.

You can learn more about how employers can terminate a pension plan or how to check if your plan is underfunded at General FAQs about PBGC.

To be fair, it’s possible that this trend where firms pour cash into defined benefit plans may not continue, or at least it won’t at some of the country’s largest companies.

The aggregate deficit in pension plans sponsored by S&P 1500 companies decreased by $74 billion to $482 billion as of the end of January 2013, according to report released this week by Mercer. What’s more, Mercer said in its release that the funded ratio (assets divided by liabilities) improved 3%, up from 74% to 77% during the month. This deficit compares to an aggregate pension deficit of $557 billion on Dec. 31, 2012 and is a slight improvement over the $484 billion deficit and funded ratio of 75% at the end of 2011, the company said.

According to Mercer, the improvement of the past month was driven by strong equity markets, which gained more than 5% in the period, and an increase in interest rates of about 15 to 20 basis points, which reduces liabilities, the company said.

Still, the company cautioned defined-benefit pension watchers: “Before sponsors celebrate too much, it is important to realize we have had numerous examples over the past few years of funded status improvements quickly being wiped out by adverse market movements,” Jonathan Barry, a partner in Mercer’s retirement business, said in a release. “In both 2011 and 2012 there were monthly improvements in funded status early in the year, only to experience market conditions that saw year-end funding levels below the start of the year.”

Russell noted, for instance, that while funding amounts today seem substantial, during good performing years companies are permitted to fund less. “The market performance of the pension investments reduces the amount of cash the company needs to contribute to the pension,” she said. “And there are even some years where the company may not have to fund the plan at all.”

In addition, even during the best of times, some companies didn't fund all of the pension contribution required, Russell said. “When that lack of full contribution is followed by a few years of market underperformance the required contribution to the pension goes up substantially,” she said. “As we know, there is usually a cost to procrastination; this is true especially where pension contributions are concerned.”

So what’s a worker with a defined benefit plan to do? Keep a close eye on the funded status of your plan, consult with a qualified expert about the health of your defined benefit, prepare for the possibility of your employer freezing or dropping your defined benefit plan, consider—regardless of the funded status of your plan—upping the amount you contribute to other retirement plans such as a 401(k) or IRA.

Small employers may have to freeze plans too

Meanwhile, small employers should consider freezing their plans at one extreme or, if nothing else, investing the assets in the plan differently.

Rosenbaum, for instance, said small employers that have a defined benefit pension may need to consider freezing their plans if they still accrue a benefit or develop a plan to terminate the plan. He noted that employers can amortize their underfunding over a seven-year period.

Others, meanwhile, suggest that small employers ought to consider shutting down their defined benefit plan and establishing a 401(k) plan. “Small corporate employers who have not yet established a defined contribution may want to do so, and if they do, they should plan on providing serious employee education,” said Surz.

By contrast, Russell doesn’t think small employers should shut down their pension plans. But they should make every effort to diversify their pool of pension assets appropriately. “When performance of the investments is greatly reduced, the company has to make up for it in larger out-of-pocket pension contributions,” Russell said. Relying on just a few asset classes in the plan might cause the pension portfolio to be too closely correlated with the stock market.”

The pension portfolio is then subject, she said, to the stock market‘s lack of performance. “Using some asset classes uncorrelated to the stock market, to broaden diversification can help with this problem,” Russell said.

In addition, some small employers may want to talk to their actuary about changing their funding formula, Russell said. “There are restrictions on what can be done, so keeping in communication with the actuary and exploring all options is important, especially if the portfolio has not performing as expected,” she said.

In addition, Russell said small employers should review their pension portfolio performance regularly to catch a problem early, and possibly save them some out-of pocket pension contributions.

Robert Powell is editor of Retirement Weekly, published by MarketWatch. Learn more about Retirement Weekly. Follow his tweets @RJPIII.