When Pension Plans Terminate
Pension plans are set up to provide employees with income during their retirement years. In the normal course of events, most private pension plans meet their objectives and pay out benefits as envisaged. However there are some situations when pension plans are terminated by either the employer or the Pension Benefits Guarantee Corporation (PBGC).
Contributions made by an employee to a pension plan are automatically vested. In contrast, employer contributions are usually subject to a period of partial or full vesting. When a pension plan terminates, all participants are automatically considered fully vested irrespective of what their vesting status was prior to termination.
What Happens When Your Plan Terminates?
In the majority of cases, the rules of an individual pension plan determine how employees receive benefits. Refer to the Summary Plan Description provided during enrollment for details. Federal laws relating to employee benefits also affect such distributions. The PBGC normally insures defined benefit contribution plans. Termination benefits also depend on whether the pension plan is fully funded or under funded.
Types of Plans
Termination of a funded pension plan
In a "standard termination", an employer decides to terminate a plan that is fully funded. If the plan is a defined benefits plan, the employer provides proof to the PBGC that there are sufficient assets to provide the benefits promised. The plan administrator purchases an annuity from an insurance company or provides a lump sum payment, if allowed, to provide the agreed benefits. Any guaranty provided to the plan by the PBGC ends at this stage.
In a standard termination, the plan administrator is required to send a "Notice of termination" to each participant at least 60 days before the termination. This is followed up with a "Notice of Plan Benefits" no later than 6 months after the proposed date of termination providing pay out details.
If the pension plan is a defined contribution plan, the plan fiduciaries and trustee are responsible for the distribution of assets. The PBGC does not guarantee benefits for defined contribution plans.
Termination of an under funded pension plan
A defined benefits plan can also be terminated due to employer distress such as bankruptcy. In a "distress termination", the employer has to satisfy either a bankruptcy court or the PBGC that it cannot continue in business unless the plan is ended. The PBGC may also decide to terminate a defined benefit plan to protect employees and to safeguard its guarantees due to under funding.
In both the above situations, the PBGC takes over as the trustee of the plan. It informs the plan administrator and also publishes a notice in the newspapers to this effect. The participants thereafter receive a general letter from PBGC detailing insurance program and guarantees. A more specific notice is issued once PBGC completes its review of plan assets and funding requirements.
The benefits due to each employee are based on plan assets and funds guaranteed by the PBGC for this purpose. The PBGC guarantees benefits to participants at normal as well as most early retirement stages. Plan survivors continue to receive annuity benefits. Participants who claimed disability benefits before the plan terminated are also honored.
The PBGC does not guarantee a monthly pension that is greater than what a participant was originally promised. The Employee Retirement Income Security Act sets limits on the maximum benefits that the PBGC can guarantee for each year based on a participant's and beneficiary's age on the plan termination date. If not currently receiving benefits, the relevant date will be when a participant is eligible to claim benefits.
There have been situations when employers abandon individual account plans such as 401(k) plans without appointing a fiduciary to manage them. To ease employee uncertainty and worry in such cases, the Department of Labor has issued rules to create a voluntary process of plan termination. The plan custodian then handles the distribution of assets and winding up of the plan.
Other Types of Pension Plan Terminations
Mergers
Pension plans can also terminate when the employer is subject to a merger or acquisition or if a division of a company closes down. The plan may merge with another or continue to operate under the former employer. When a pension plan is merged with another, the accrued benefits for participants in a defined benefit plan cannot be reduced. They are entitled to the benefits accrued in the earlier plan. For defined contribution plans, the value of benefits may be more or less depending on the performance of merged assets.
Participant Responsibilites and Compliance
Irrespective of the situation under which a plan terminates, it is in the interest of the participant to comply with all requests for information by the plan administrator or the PBGC.
- Maintain a file with all relevant plan information.
- Inform the benefits administrator of any address or beneficiary changes.
- If the former employer is still responsible for plan administration following a merger, stay tuned to what other changes are contemplated.
Contact the plan administrator or the Department of Labor at 1.866.444.3272 for questions relating to your pension plan. To read more about the Pension Benefits Guarantee Corporation, visit their website: http://www.pbgc.gov/.
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