American workers have great expectations of traditional defined-benefit pension plans, the kind of pensions that promise a set income stream or a lump-sum benefit in retirement. Last year, the Consumer Reports National Research Center surveyed 6,100 people aged 55 to 75 who are still working and expect to retire. Three-quarters of respondents with a defined-benefit pension said they expect it to provide a significant portion of their income during retirement.

Yet the percentage of American workers covered by defined-benefit pension plans has been shrinking steadily in recent years, according to Consumer Reports Money Adviser (CRMA). At the same time, the Social Security system is facing a funding shortfall projected at $4.7 trillion. That funding gap could eventually require cuts in those benefits as well.

Safety nets in place

CRMA’s experts say that about the only workers who need not lose sleep over their pension benefits are state and local government employees covered by public-sector pension plans, since most benefits are protected by state laws and constitutional provisions. New hires might have to accept a less generous pension, but public-sector workers who are already rooted to a job and pension generally will be all right.

Benefit cuts might loom for many, but pension experts say that private defined-benefit plans are essentially safe. And despite its funding gap, Social Security doesn’t face an immediate crisis, although the program’s funding deficit is more easily solvable the sooner politicians deal with it.

The Pension Benefit Guaranty Corp. is a safety net for many private-sector pensions when sponsoring companies go bust. PBGC protects the retirement income of nearly 44 million American workers in 30,330 defined-benefit pension plans.

Five possible hazards

Even with these safeguards, CRMA notes that employees’ expectations for retirement income can still be upset mightily. Here’s what can go wrong for private-sector employees, and the reasons pensions could be smaller than expected.

¢ Pension freezes. Employers are free to “freeze” pensions, stopping the clock that ticks off credit for each year of service a worker racks up at a company. Some freezes shut out all employees, some keep out only new hires and some close the door to all except older workers nearing retirement. Freezes only affect benefits going forward; vested benefits already earned up to the point of the freeze can’t be taken away.

¢ Cash-balance conversions. Another way for a company to reduce the annual cost and limit the long-term liability of its pension is to convert the pension to a cash-balance plan. Under this system, the payout at retirement is determined by the amount of money in the individual’s account, not by a multiple of compensation in the final years employed by the company, when it is likely to be highest – which usually results in a smaller benefit than a traditional defined-benefit plan.

¢ Benefit formula changes. It’s possible to lose retirement income in a defined-benefit pension without even realizing it when an employer tinkers with the benefit formula. CRMA reports that tricks include changing the “compensation” part of the equation from the final year (usually the highest-paying) to an average of the last three to five years and cutting the percentage benefit multiplier from, say, 1.9 percent for each year of service to 1.5 percent.

¢ PBGC benefit limits. If an employer has not sufficiently funded its pension plan, it could be taken over by the Pension Benefit Guaranty Corp. Most employees will get the full vested benefits owed to them up to the time the pension plan is terminated. But those earning a high salary could lose accrued benefits that exceed the PBGC guarantee limit.

¢ Social Security cuts. To close Social Security’s $4.7 trillion funding gap, benefits might have to be cut. Middle- and high-income retirees are more likely than those with low incomes to have their benefits cut, meaning those who voluntarily saved more money to ensure a higher retirement income could get back less of what they contributed to Social Security.