A PREDICTABLE, SECURE PENSION FOR LIFE Defined Benefit Pensions
C O N T E N T S Traditional Pension Plans 2 There are a variety of pension plans offered by private sector employers today. This publication offers a handy explanation of traditional defined benefit pension plans insured by PBGC: what they are, how they operate, and the rights and options of the workers covered by them. Predictable, Secure Lifetime Benefits 4 Trends 6 Pension Plan Provisions 9 Federal Insurance For Your Pension 16 Pension Checklist 20 1
Traditional Pension Plans The first private pension plan in the United States was established in 1875 by the American Express Company and was soon followed by pensions provided by utilities, banking, and manufacturing companies. Almost all of the early pension plans were traditional pension plans known as defined benefit plans that paid workers a specific monthly benefit at re t i re m e n t. Until 1974, there was little or Service (IRS) is responsible no protection for pensions. for pension plan funding and Because of shocking instances vesting requirements, and for of workers losing their retire- ensuring compliance with tax ment benefits (most notably in laws. ERISA also established 1963 when 4,000 Studebaker the Pension Benefit Guaranty auto workers lost some or all Corporation (PBGC) to insure example, $100 per month of their promised benefits), the pensions of workers cov- at retirement) or may specify a Congress in 1974 took action ered by private defined benefit formula for calculating the to prevent such tragedies pension plans. benefit (for example, $10 per or a multiemployer plan. A by enacting the Employee month for every year of service single-employer plan, which Retirement Income Security Defined benefit pension plans with the company, or a percent may be collectively bargained, Act (ERISA). may state the promised benefit of a worker s salary times provides benefits for workers as an exact dollar amount (for years of service). Generally, a of one employer. A multiem- ERISA set strict requirements company funds the pension ployer plan is a collectively for private pension plans. The plan and plan assets are invest- bargained pension arrange- U.S. Department of Labor ed, usually by a professional ment involving more than one (DOL) is responsible for seeing money manager. Importantly, unrelated employer, usually that pension plans are properly Most private defined most private defined benefit in a common industry, such as operated and that their assets are managed in a prudent benefit plans are insured plans are insured by PBGC. construction, trucking, textiles, and coal mining. manner. The Internal Revenue by PBGC. A defined benefit plan can be either a single-employer plan 2 3
P redictable, Secure Lifetime Benefits Defined benefit pension plans offer workers a number of advantages when compared to other workplace re t i rement plans. They p rovide workers with a predictable and secure benefit for life. Predictable Benefits: out of business. In most cases, Workers are promised a specific benefit at retirement. all of the earned benefit. the PBGC guarantee covers Workers can know in A worker can earn a re a s o n- advance what benefits able re t i rement benefit under they will receive. a defined benefit plan, even The benefits of workers are if the worker has not had an certain, not subject to the adequate re t i rement plan or fluctuations of the stock and was not covered by a re t i rement plan earlier in a care e r. bond markets. Employers, not workers, are responsible for providing the Lifetime Benefits: retirement benefits, and the A defined benefit plan must benefits are not dependent offer to pay an annuity, a upon the amount of salary monthly benefit, for the workers are willing or able life of a retired worker, no to contribute. matter how long the worker lives. If the value of the Secure Benefits: benefit is $5,000 or less, the PBGC pays the worker s pension up to guaranteed limits a single payment. plan may pay the benefit in if the employer cannot aff o rd to pay the benefits or goes If a worker is married, a defined benefit plan must also pay an annuity to the worker s surviving spouse for the spouse s life, unless the worker and spouse elect otherwise. The Pension Benefit Guaranty Corporation pays the worker s pension up to guaranteed limits if the employer cannot afford to pay the benefits or goes out of business. Additional Benefit Possibilities: Defined benefit plans can provide additional valuable benefits to workers, such as early retirement benefits, extra spousal benefits, disability benefits, or costof-living adjustments. 4 5
Tre n d s There have been some major shifts recently in America s pension system. While the number of workers covered by traditional defined benefit pensions has remained relatively level, there has been significant growth in defined contribution pension plans, especially 401(k) plans. Many employers began offering workers both a defined benefit plan and a 401(k) plan. Other employers offer only 401(k) plans. Workers in 401(k) plans have The retirement benefit in a individual accounts, which are cash balance plan is generally funded with worker contribu- described in terms of a hypo- tions and include a matching thetical account balance that or other contribution by looks like the account balance the employer. The ultimate in a 401(k) plan. In this hypo- Cash balance plans contain benefit depends primarily thetical account, a worker many of the important advan- upon the amounts contributed accumulates pay credits tages of traditional defined and the returns on the invest- (usually a percentage of pay) benefit plans: workers can know the value ments chosen by the workers. and interest credits (usually a benefits do not depend on of their benefits and tend PBGC does not insure defined percentage of the total account how much a worker is willing to understand them better contribution plans. balance). The interest credit is or able to contribute; when expressed as a hypo- frequently based on the inter- the employer bears the thetical individual account; A m o re recent trend, especially est rate on a U.S. Treasury investment risk; younger workers and shorter- among large employers, has security. The pay and interest plans must offer an annuity service workers, who are been to convert traditional credits, specified in the plan, with a survivor benefit; and often women, can receive defined benefit plans to resemble the actual contribu- benefits are insured by PBGC. higher benefits; and hybrid pension plans, such tions and earnings to a work- workers who do not spend as cash balance plans. These er s account under a 401(k) Cash balance plans also have their full careers with one hybrid plans are defined benefit plan. Because cash balance features that traditional employer have more portable plans and are insured by PBGC. plans are hybrid defined defined benefit plans do not: benefits that can be trans- benefit plans, they offer a pre- ferred to another plan. dictable benefit at retirement. 6 7
However, cash balance plans also: f requently offer a single, lumpsum payment, which workers often take and spend rather than rolling it over and saving for their re t i rement; and generally do not offer subsidized early retirement benefits, making it harder for workers to retire early. Many cash balance plans are conversions from traditional defined benefit plans. Conversions generally involve a change from a traditional final average pay plan, where benefits are based on workers average pay at the end of their careers when their earnings usually are greatest, to a career average cash balance plan, where benefits are based on workers average pay for their entire career. In these cases, longer- s e r v i c e workers generally will re c e i v e less under a cash balance plan than they would have re c e i v e d under a traditional defined benefit plan unless the employer p rovides transition protections. Pension Plan Pro v i s i o n s Generally, a defined benefit pension plan requires workers to meet age and service requirements before they can participate in the plan. Workers cannot be excluded from participating because they are too old, even if they are hired within a few years of the normal retirement age specified in the plan. Usually, plans allow workers to participate if they are at least 21 years old and have completed one year of service with the company. A year of service ordinarily is a 12-month period during which the worker has performed at least 1,000 hours of service. Hours of service are generally defined as: hours for which the worker is paid or is entitled to be paid, including pay for vacation and sick leave; and hours for which the worker is awarded back pay. Accruing Benefits G e n e r a l l y, workers begin to earn ( a c c rue) re t i rement benefits as soon as they become a participant in a defined benefit pension plan. However, they do not obtain a permanent right to the benefits (become vested) until they have worked a minimum period of time, as specified in the plan. Workers may lose their a c c rued benefits if they leave their job b e f o re becoming vested. Vesting Being vested in a benefit means that a worker has completed sufficient years of service and is entitled to receive benefits accrued under the plan, whether or not the worker continues working for the company until re t i rement. Pension plans have one of two vesting schedules: cliff or graded vesting. Under cliff vesting, workers must be fully vested after no m o re than five years of service with the employer. The plan, h o w e v e r, could specify a shorter period of service. Wo r k e r s have no vested rights until this 8 9
Predictable, Secure Lifetime Benefits service is completed. Under they receive about their pension graded vesting, the worker plans and their benefits. must be at least 20 percent vest- Especially helpful are the plan s ed after three years of service name, nine-digit Employer and receive an additional 20 Identification Number (EIN) p e rcent vesting for each of the and three-digit Plan Number next four years, with full vesting (PN), the name and address of coming no later than at the end the plan administrator or other of seven years of service. plan re p resentative, and copies of individual benefit statements. When workers leave a job in Most important, former workers which they earned the right to a should keep the plan adminis- pension, their employer must trator advised about any change years of service under p rovide them information about of address or marital status. the plan. their benefits. Workers should verify the information before they leave. To be sure they receive future benefits when Calculating Benefits Defined benefit pension plans use a formula to figure the ben- The longer someone works under the same defined benefit pension plan, the larger the Payment of Benefits Workers can start receiving pen- due, workers who change jobs efit amount earned. Usually, it retirement benefit. sion benefits when they re a c h should keep all the information involves salary and years of the normal re t i rement age set by service (for example, a certain Some plans are integrated their pension plan. The normal p e rcentage of the worker s final with Social Security benefits. re t i rement age generally is no or average salary multiplied In these plans, the amount later than age 65. Wo r k e r s by the number of years of ser- of pension benefits earned should check their pension The longer someone vice) or a flat benefit amount is reduced because of Social plans for the normal re t i re m e n t works under the same per year of service. The actual dollar amount will depend on Security coverage. age and become familiar with the other provisions of their defined benefit pension such factors as: Also, electing survivor benefits plans. Many pension plans plan, the larger the age at retirement; earnings (in plans that use or early retirement may reduce the monthly benefit amount. allow workers to take early re t i rement upon completing retirement benefit. salary to compute benefits); a certain number of years of and service and/or reaching a given 1 0 1 1
Predictable, Secure Lifetime Benefits age. But if workers decide to vested, the spouse will auto- re t i re early, they may receive a matically receive survivor lower monthly benefit than they benefits if the worker dies would at normal re t i rement age, unless the worker and spouse have because the benefit will be paid specifically declined the survivor over a longer period of time. option in writing. Pension plans may pay benefits If a worker dies before retire- either as an annuity (equal ment, the plan does not have to payments monthly or at other pay the benefits to the spouse regular intervals) or as a one- until the earliest date that the worker and the time payment (lump sum). If deceased worker could have spouse, and often is paid the total value of the benefit is begun receiving retirement out over a longer period of $5,000 or less, the plan may benefit payments. For example, time, the worker s monthly pay the benefit in a single sum if a worker dies at age 50, and pension payment is usually less without the worker s consent. the plan says that the earliest than it would have been if the O rder (QDRO) that is, it must If the benefit is worth more than a worker can receive benefits worker and the spouse had meet legal re q u i rements con- $5,000, the plan must pro v i d e is at age 55, the spouse might declined the survivor benefit. cerning the information it con- the benefit as a monthly pay- have to wait five years to tains and the benefits involved. ment unless the worker (and the receive benefits. G e n e r a l l y, pensions cannot be spouse, if the worker is married) consent to another benefit form. If the worker dies after re t i r i n g, attached for debts owed. H o w e v e r, in the event of a Pension Plan Funding Defined benefit plans usually the surviving spouse will d i v o rce or separation, a judge- are funded entirely by the Survivor Benefits Defined benefit pension plans receive at least 50 percent of the benefits the re t i ree had been ment, decree, or order made in a c c o rdance with a state domestic employer. Employers generally contribute enough annually to normally provide survivor receiving if the worker was relations law can direct the pen- cover the normal cost of the benefits if a worker dies either receiving benefits that included sion plan to pay a share of a plan an amount that is at before or after retirement bene- a survivor benefit. The benefits w o r k e r s pension directly to a least the value of the benefits fits begin. This means that if will continue until the spouse spouse, former spouse, child that participants in the plan the worker is partially or fully dies. Because this type of annu- or other dependent. For this to earned that year. In addition, ity takes into account the com- o c c u r, the order must be a bined life expectancy of the Qualified Domestic Relations 1 2 1 3
employers may have to make must be notified each time an Summary Plan Description. the funding level of their pen- additional contributions for employer requests a funding This document includes infor- sion plan, indicating how much various reasons, such as to waiver or fails to make mini- mation on how the plan of their pensions are curre n t l y make up for any investment mum funding contributions. To operates, when participants c o v e red by the plan assets. losses by the pension fund. protect plan benefits, in certain are eligible to receive their The notice also explains what cases the plan may file for a pensions, how participants can benefits in the plan would be If an employer fails to make lien (legal claim) against calculate the amount of their c o v e red by PBGC s insurance the legally required contribu- employer assets for unpaid benefits, and how to file for in the event the plan terminates. tions, the employer can be contributions, or the employer their pensions. This informa- assessed penalty taxes for each may have to post security for a tion must be given to workers Individual Benefit Statement. year the deficiency exists. If an portion of the underfunding. within 90 days after they This statement, which partici- employer is experiencing tem- become participants in the pants may request annually porary financial hardships, the IRS may permit the employer to pay the contribution in Pension Plan Administration The person who administers plan. The plan administrator must also notify participants about changes in the plan and, and when they leave for another job, shows the benefits a participant has accrued under the future years under a funding the pension plan is known as every five years, provide work- plan and tells whether the waiver arrangement. Workers the plan administrator. The ers with an updated version of participant has a vested right plan administrator s responsi- the summary plan description to receive them. bilities include keeping the if the plan has been modified. workers fully informed of their If any of the required informa- rights and benefits, making Summary Annual Report. tion is not provided, workers Generally, participants in pension payments to retirees This report contains informa- should contact the Division plans that are less than and beneficiaries, paying insurance premiums to PBGC, and tion on the financial activities of a pension plan and must be of Technical Assistance and Inquiries, Pension and Welfare 90 percent funded must making reports to plan partici- p rovided to workers annually. Benefits Administration receive an easy-to- pants and to DOL, IRS and PBGC as required by law. Notice to Participants. (PWBA), U.S. Department of Labor, 200 Constitution understand report on G e n e r a l l y, participants in plans Avenue NW, N-5625, the funding level of their Under the law, the plan administrator must give workers the that are less than 90 perc e n t funded must receive an easy- Washington, D.C. 20210. pension plan. following information: to-understand notice re p o r t i n g 1 4 1 5
Federal Insurance For Your Pension PBGC is the federal agency that insures the pensions of American workers covered by private defined benefit pension plans. PBGC receives no funds ment insurance plans, plans from general tax revenues. that are not tax-qualified Operations are financed largely and plans not funded with by premiums paid by insured employer contributions. pension plans (pension insurance stays in force even if premiums are not paid) and Two Insurance Programs PBGC operates two insurance investment returns. p rograms: one covers single- When this happens, employer pension plans and the PBGC begins to pay pension Today, PBGC insures the pen- other covers multiemployer pen- benefits to the plan participants sions of about 42 million work- sion plans. The single-employer a l ready receiving benefits and ers in more than 44,000 private p rogram is by far the larg e r, to others when they re t i re. defined benefit plans. PBGC covering almost 42,000 pension In a standard termination, an does not insure defined benefit plans sponsored by federal, plans. There are about 2,000 multiemployer pension plans. Pension Plan Termination Employers voluntarily estab- employer may end a plan only if there is enough money to state, and local governments. lish and maintain pension pay all pension benefits Nor does it insure some church Under the multiemployer pro- plans. They may terminate accrued by workers as of the and fraternal organization gram, PBGC provides financial defined contribution plans at termination date. The plan plans, professional service assistance through loans to any time. But they may termi- administrator will pay the employer plans (such as plans plans that are insolvent nate defined benefit plans promised benefits by purchas- for lawyers and doctors) unable to pay benefits (at least insured by PBGC only in two ing annuities from a private with fewer than 25 active par- equal to PBGC s guaranteed ways: standard termination insurance company or making ticipants, plans maintained benefit limit) when due. Under or distress termination. In lump-sum payments to partici- outside the U.S. primarily for its single-employer pro g r a m, addition, PBGC may terminate pants. Once a plan ends in a non-resident aliens, worker PBGC takes over and becomes a plan in certain circumstances, standard termination, PBGC s compensation and unemploy- t rustee of an insolvent plan such as when a plan does not insurance responsibility ends. when the sponsoring company have sufficient assets to pay can no longer support the plan. benefits when they come due. 1 6 1 7
A distress termination involves In a distress termination, PBGC a plan that does not have will step in and take over the enough money to pay all plan as trustee, and use its pension benefits accrued by insurance funds to make sure workers. A plan can end in a the guaranteed benefits are distress termination only if paid to the plan participants the employer meets one of when due. the following distress criteria: Chapter 7 bankruptcy If PBGC becomes trustee of a liquidation. pension plan, it will notify all Chapter 11 bankruptcy re o r- plan participants of this action. ganization. The employer As trustee, PBGC will keep the guarantee certain must demonstrate to the court records of plan participants types of benefits, such as that liquidation would neces- and their benefits, pay benefits health and life insurance bene- sarily follow if the pension to retirees, and begin benefit fits, severance and vacation plan were not terminated. payments to new retirees. pay, death benefits, and some A determination by PBGC early retirement benefits. they are due. Where there are that the employer is in such poor financial condition that Insurance Coverage Under the single-employer The maximum benefit PBGC reductions, they normally occur among higher-salaried unless the plan terminates program, PBGC insures pen- can pay is set by law each year workers whose benefits exceed the employer cannot pay its sion benefits provided by the under provisions of ERISA. PBGC s guarantee or in cases debts when due and cannot pension plan up to certain The maximum guarantee is where benefits have been continue in business. limits set by law. These are reduced if a worker begins increased within five years of A determination by PBGC benefits beginning at normal receiving benefit payments plan termination. that, due solely to a decline retirement age, certain early before age 65 or if the pension in the employer s workforce, retirement and disability bene- includes a survivor benefit. Under the multiemployer pro- pension costs have become fits, as well as certain benefits gram, PBGC insures a portion unreasonably burdensome. for survivors of deceased plan Historically, most participants of the pension earned times the participants. PBGC does not in plans taken over by PBGC worker s years of service. receive all of the benefits 1 8 1 9
Pension Checklist If you are covered by a private defined benefit pension plan, here is a checklist for important information about your plan and your benefits that you should keep current. The name of my defined benefit pension plan is: The plan s EIN (Employer Identification Number) is: The plan s PN (Plan Number) is: The name of the plan administrator is: I can contact my plan administrator at: I became/will be vested in the plan on (date): Under the plan, I can take early retirement, with reduced benefits, at age: I can retire with full benefits at the normal retirement age, which is: I will reach normal retirement age on (date): My plan allows me to receive my benefits (in a lump sum and/or as an annuity in monthly installments for life, depending on the benefit value): My Social Security benefit (will/will not) be deducted from my pension benefit. Both my spouse and I (have/have not) declined in writing the joint-and-survivor option that would allow my spouse to continue receiving a portion of my benefit if I die first. Both my spouse and I (have/have not) declined in writing the preretirement survivor annuity option that would provide a benefit to my spouse in the event I die before I retire. I have learned from my plan administrator which of my benefits are covered by PBGC insurance if my plan is terminated and taken over by PBGC: Other Useful Publications The PBGC publication Your Guaranteed Pension provides additional details about the single-employer insurance program. To obtain a copy, please write to Your Guaranteed Pension, No. 521E, Pueblo, CO 81009. Your Guaranteed Pension, as well as other pension information, is also available on PBGC s homepage at www.pbgc.gov on the Internet. Another publication that provides useful information about pension plans is What You Should Know About Your Pension Rights, which is available from the Pension and Welfare Benefits Administration, U.S. Department of Labor, 200 Constitution Avenue N.W., Room N-5619, Washington, D.C. 20210. Other information is available on DOL s homepage at www.dol.gov/dol/pwba on the Internet. Prepared by Communications and Public Affairs Department, Pension Benefit Guaranty Corporation 2 0
PENSION BENEFIT GUARANTY CORPORATION 1200 K Street, NW Washington, DC 20005-4026 http://www.pbgc.gov PBGC Publication 1007 January 2000