Will pension funds suffer the next financial implosion?

If you are troubled by the loss in value in your 401(k) or other retirement account, you have plenty of company. Even professionally managed pensions suffered an average 26 percent loss in 2008, marking the worst recorded year for defined benefit funds, according to Northern Trust Investment Risk and Analytical Services.

Despite the grim results, two radically different retirement profiles have emerged. One is workers with defined benefit plans. These employees are guaranteed monthly payments at retirement based on a set percentage of their last paycheck.

Some 80 percent of public-sector employees and 20 percent of private-­sector employers participate in defined benefit programs. The Center for Retirement Research (CRR) at Boston College estimates that 20 million active participants and millions of retirees are enrolled in these retirement programs.

The other group includes workers with 401(k) and other defined contribution accounts. These employees are exposed to market downturns with no set retirement benefits. Last year, many of them were too heavily committed to the stock market, suffering losses between 30 and 40 percent.

"While a bad year for every investor, 2008 was particularly bruising for 401(k) members forced to navigate sophisticated, complex market environments largely on their own, exposed to individual portfolio risks far greater than the pooled risk of professionally managed benefit programs," says Keith Brainard, research director for the National Association of State Retirement Administrators, whose members oversee pension benefits of most state and local government employees.

Employees with 401(k) plans who are five to 10 years from retirement are now faced with the possibility of delaying retirement or drastically reducing their lifestyle when they do.

For younger workers with 10 or more years of potential employment, the hope is that investment markets will rebound in 2009 and that 8 to 10 percent returns will once again prevail.

For employees with defined benefit plans, however, personal retirement plans remain largely on course.

But there are problems here, too. Corporate pension plans are underfunded by $409 billion, according to consulting firm Mercer. The CRR estimates that private firms need to increase contributions by about $90 billion this year, as required by the 2006 Pension Protection Act. The law stipulates that firms must eliminate unfunded pension obligations within a seven-year period. But those restrictions were relaxed in December due to the current economic slump.

In an effort to meet funding requirements, some private companies have already announced layoffs or pension freezes. Others have gone bankrupt. As a result, the CRR estimates employees over 50 years of age who work for companies that have taken these actions will face severely reduced benefits at retirement as they are unlikely to have saved independently of their pension plan.

Public-sector entities are not under the same requirements to supplement their unfunded obligations, and no reliable estimate exists of what additional contributions are required.

"It will take longer than expected for the total cost effect to become clear in public funds," Mr. Brainard says, "as actuarial updates lag market realities and public funds utilize smoothing formulas that extend market losses over extended numbers of years."

Unless the markets suddenly recover and reverse lost profits, defined benefit plans will require dramatic increases in funding by their sponsors. Taxpayers will face footing the bill to finance public-sector retirement programs and shareholders of companies will need to allocate limited dollars from the balance sheets to fund corporate plans.

Neither group is likely to be generous when their own retirement funding is not secure. Redefining a retirement system for all Americans that achieves retirement security may become the next politically explosive issue. Alicia Munnell, director at CRR, has proposed a third tier of mandated retirement savings to augment 401(k) savings and Social Security benefits.

To better understand defined benefit plans, consider these actions:

•Those fortunate to have this type of pension can check its funded status by requesting Form 5500 from your plan administrator or by visiting FreeERISA.com. If there is a shortfall, discuss with your employer what actions it will take to remedy the situation.

•Understand the effect of unfunded pension liabilities on taxpayers. To identify your state's exposure, visit publicfundsurvey.org and review the 2007 Public Fund Survey.

•To see if your plan is covered by government-funded Pension Benefit Guaranty Corporation in the event your employer goes bankrupt, visit pbgc.gov.

• Dr. Kathleen Connell is a professor at Haas Graduate Business School, University of California, Berkeley.