A PREDICTABLE,SECURE PENSION FOR LIFE

Defined Benefit Pensions

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C O N T E N T S

Traditional Pension Plans 2

Predictable, Secure Lifetime Benefits 4

Trends 6

Pension Plan Provisions 9

Federal Insurance For Your Pension 16

Pension Checklist 20

There are a variety of pension

plans offered by private sector

employers today. This publica-

tion 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.

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Until 1974, there was little orno protection for pensions.Because of shocking instancesof workers losing their retire-ment benefits (most notably in1963 when 4,000 Studebakerauto workers lost some or allof their promised benefits),Congress in 1974 took action to prevent such tragedies by enacting the EmployeeRetirement Income SecurityAct (ERISA).

ERISA set strict requirementsfor private pension plans. TheU.S. Department of Labor(DOL) is responsible for seeingthat pension plans are properlyoperated and that their assetsare managed in a prudentmanner. The Internal Revenue

Service (IRS) is responsible for pension plan funding andvesting requirements, and forensuring compliance with taxlaws. ERISA also establishedthe Pension Benefit GuarantyCorporation (PBGC) to insurethe pensions of workers cov-ered by private defined benefitpension plans.

Defined benefit pension plansmay state the promised benefitas an exact dollar amount (for

example, $100 per monthat retirement) or may specify aformula for calculating thebenefit (for example, $10 permonth for every year of servicewith the company, or a percentof a worker’s salary timesyears of service). Generally, acompany funds the pensionplan and plan assets are invest-ed, usually by a professionalmoney manager. Importantly,most private defined benefitplans are insured by PBGC.

A defined benefit plan can beeither a single-employer plan

or a multiemployer plan. Asingle-employer plan, whichmay be collectively bargained,provides benefits for workersof one employer. A multiem-ployer plan is a collectivelybargained pension arrange-ment involving more than oneunrelated employer, usually in a common industry, such asconstruction, trucking, textiles,and coal mining.

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 .

Most private defined

benefit plans are insured

by PBGC.

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Predictable Benefits:• Workers are promised a spe-

cific benefit at retirement.• Workers can know in

advance what benefits they will receive.

• The benefits of workers arecertain, not subject to thefluctuations of the stock andbond markets.

• Employers, not workers, areresponsible for providing theretirement benefits, and thebenefits are not dependentupon the amount of salaryworkers are willing or able to contribute.

Secure Benefits:• PBGC pays the worker’s pen-

sion up to guaranteed limitsif the employer cannot aff o rdto pay the benefits or goes

out of business. In most cases,the PBGC guarantee coversall of the earned benefit.

• A worker can earn a re a s o n-able re t i rement benefit under a defined benefit plan, even if the worker has not had anadequate re t i rement plan orwas not covered by a re t i re-ment plan earlier in a care e r.

Lifetime Benefits:• A defined benefit plan must

offer to pay an annuity, amonthly benefit, for the life of a retired worker, nomatter how long the workerlives. If the value of the benefit is $5,000 or less, theplan may pay the benefit in a single payment.

• If a worker is married, adefined benefit plan mustalso pay an annuity to theworker’s surviving spousefor the spouse’s life, unlessthe worker and spouse electotherwise.

Additional BenefitPossibilities:• Defined benefit plans can

provide additional valuablebenefits to workers, such as early retirement benefits,extra spousal benefits, disability benefits, or cost-of-living adjustments.

P redictable, Secure Lifetime Benefits

Defined benefit pension plans offer workers a number of advan-

tages when compared to other workplace re t i rement plans. They

p rovide workers with a predictable and secure benefit for life.

The Pension Benefit

Guaranty Corporation

pays the worker’s pen-

sion up to guaranteed

limits if the employer

cannot afford to pay

the benefits or goes

out of business.

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Workers in 401(k) plans haveindividual accounts, which arefunded with worker contribu-tions and include a matchingor other contribution by the employer. The ultimatebenefit depends primarilyupon the amounts contributedand the returns on the invest-ments chosen by the workers.PBGC does not insure definedcontribution plans.

A m o re recent trend, especiallyamong large employers, hasbeen to convert traditionaldefined benefit plans to“hybrid” pension plans, such as cash balance plans. Thesehybrid plans are defined benefitplans and are insured by PBGC.

The retirement benefit in a cash balance plan is generallydescribed in terms of a hypo-thetical account balance thatlooks like the account balancein a 401(k) plan. In this hypo-thetical account, a workeraccumulates pay credits (usually a percentage of pay)and interest credits (usually apercentage of the total accountbalance). The interest credit isfrequently based on the inter-est rate on a U.S. Treasurysecurity. The pay and interestcredits, specified in the plan,resemble the actual contribu-tions and earnings to a work-er’s account under a 401(k)plan. Because cash balanceplans are hybrid defined benefit plans, they offer a pre-dictable benefit at retirement.

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.

Cash balance plans containmany of the important advan-tages of traditional defined benefit plans: • benefits do not depend on

how much a worker is willingor able to contribute;

• the employer bears theinvestment risk;

• plans must offer an annuitywith a survivor benefit; and

• benefits are insured by PBGC.

Cash balance plans also havefeatures that traditionaldefined benefit plans do not:

• workers can know the valueof their benefits and tend to understand them betterwhen expressed as a hypo-thetical individual account;

• younger workers and shorter-service workers, who areoften women, can receivehigher benefits; and

• workers who do not spendtheir full careers with oneemployer have more portablebenefits that can be trans-ferred to another plan.

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benefits are based on workers’average pay at the end of theircareers when their earningsusually are greatest, to a careeraverage cash balance plan,where benefits are based onworkers’ average pay for theirentire career.

In these cases, longer- s e r v i c eworkers generally will re c e i v eless under a cash balance planthan they would have re c e i v e dunder a traditional defined ben-efit plan unless the employerp rovides transition protections.

However, cash balance plansalso: • f requently offer a single, lump-

sum payment, which workersoften take and spend ratherthan rolling it over and savingfor their re t i rement; and

• generally do not offer subsi-dized early retirement benefits, making it harder for workers to retire early.

Many cash balance plans areconversions from traditionaldefined benefit plans.Conversions generally involvea change from a traditionalfinal average pay plan, where

A year of service ordinarily is a12-month period during whichthe worker has performed atleast 1,000 hours of service.Hours of service are generallydefined as: hours for which theworker is paid or is entitled to be paid, including pay forvacation and sick leave; andhours for which the worker isawarded back pay.

Accruing BenefitsG e n e r a l l y, workers begin to earn( a c c rue) re t i rement benefits assoon as they become a partici-pant in a defined benefit pen-sion plan. However, they do notobtain a permanent right to thebenefits (become vested) untilthey have worked a minimumperiod of time, as specified in

the plan. Workers may lose theira c c rued benefits if they leavetheir job b e f o re becoming vested.

VestingBeing vested in a benefit meansthat a worker has completedsufficient years of service andis entitled to receive benefitsaccrued under the plan,whether or not the worker con-tinues working for the companyuntil re t i rement. Pension planshave one of two vesting sched-ules: cliff or graded vesting.Under cliff vesting, workersmust be fully vested after nom o re than five years of servicewith the employer. The plan,h o w e v e r, could specify a short-er period of service. Wo r k e r shave no vested rights until this

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.

service is completed. Undergraded vesting, the workermust be at least 20 percent vest-ed after three years of serviceand receive an additional 20p e rcent vesting for each of thenext four years, with full vestingcoming no later than at the endof seven years of service.

When workers leave a job inwhich they earned the right to apension, their employer mustp rovide them information abouttheir benefits. Workers shouldverify the information beforethey leave. To be sure theyreceive future benefits whendue, workers who change jobsshould keep all the information

The longer someone

works under the same

defined benefit pension

plan, the larger the

retirement benefit.

Predictable, Secure Lifetime Benefits

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they receive about their pensionplans and their benefits.Especially helpful are the plan’sname, nine-digit EmployerIdentification Number (EIN)and three-digit Plan Number(PN), the name and address ofthe plan administrator or otherplan re p resentative, and copiesof individual benefit statements.Most important, former workersshould keep the plan adminis-trator advised about any changeof address or marital status.

Calculating BenefitsDefined benefit pension plansuse a formula to figure the ben-efit amount earned. Usually, itinvolves salary and years ofservice (for example, a certainp e rcentage of the worker’s finalor average salary multiplied by the number of years of ser-vice) or a flat benefit amountper year of service. The actualdollar amount will depend onsuch factors as:• age at retirement;• earnings (in plans that use

salary to compute benefits);and

• years of service underthe plan.

The longer someone worksunder the same defined benefitpension plan, the larger theretirement benefit.

Some plans are integrated with Social Security benefits. In these plans, the amount of pension benefits earned is reduced because of SocialSecurity coverage.

Also, electing survivor benefitsor early retirement may reducethe monthly benefit amount.

Payment of BenefitsWorkers can start receiving pen-sion benefits when they re a c hthe normal re t i rement age set bytheir pension plan. The normalre t i rement age generally is nolater than age 65. Wo r k e r sshould check their pensionplans for the normal re t i re m e n tage and become familiar withthe other provisions of theirplans. Many pension plansallow workers to take earlyre t i rement upon completing a certain number of years of service and/or reaching a given

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age. But if workers decide tore t i re early, they may receive alower monthly benefit than theywould at normal re t i rement age,because the benefit will be paidover a longer period of time.

Pension plans may pay benefitseither as an annuity (equal payments monthly or at other regular intervals) or as a one-time payment (lump sum). Ifthe total value of the benefit is$5,000 or less, the plan may pay the benefit in a single sumwithout the worker’s consent. If the benefit is worth more than$5,000, the plan must pro v i d ethe benefit as a monthly pay-ment unless the worker (and thespouse, if the worker is married)consent to another benefit form.

Survivor BenefitsDefined benefit pension plansnormally provide survivorbenefits if a worker dies eitherbefore or after retirement bene-fits begin. This means that ifthe worker is partially or fully

vested, the spouse will auto-matically receive survivor benefits if the worker dies —unless the worker and spouse havespecifically declined the survivoroption in writing.

If a worker dies before retire-ment, the plan does not have topay the benefits to the spouseuntil the earliest date that thedeceased worker could havebegun receiving retirementbenefit payments. For example,if a worker dies at age 50, andthe plan says that the earliest a worker can receive benefits is at age 55, the spouse mighthave to wait five years toreceive benefits.

If the worker dies after re t i r i n g ,the surviving spouse willreceive at least 50 percent of thebenefits the re t i ree had beenreceiving if the worker wasreceiving benefits that includeda survivor benefit. The benefitswill continue until the spousedies. Because this type of annu-ity takes into account the com-bined life expectancy of the

worker and thespouse, and often is paidout over a longer period oftime, the worker’s monthlypension payment is usually lessthan it would have been if theworker and the spouse haddeclined the survivor benefit.

G e n e r a l l y, pensions cannot beattached for debts owed.H o w e v e r, in the event of ad i v o rce or separation, a judge-ment, decree, or order made ina c c o rdance with a state domesticrelations law can direct the pen-sion plan to pay a share of aw o r k e r’s pension directly to aspouse, former spouse, child or other dependent. For this too c c u r, the order must be aQualified Domestic Relations

O rder (QDRO) — that is, it mustmeet legal re q u i rements con-cerning the information it con-tains and the benefits involved.

Pension Plan FundingDefined benefit plans usuallyare funded entirely by theemployer. Employers generallycontribute enough annually tocover the normal cost of theplan — an amount that is atleast the value of the benefitsthat participants in the planearned that year. In addition,

Predictable, Secure Lifetime Benefits

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employers may have to makeadditional contributions forvarious reasons, such as tomake up for any investmentlosses by the pension fund.

If an employer fails to makethe legally required contribu-tions, the employer can beassessed penalty taxes for eachyear the deficiency exists. If anemployer is experiencing tem-porary financial hardships, theIRS may permit the employerto pay the contribution infuture years under a fundingwaiver arrangement. Workers

must be notified each time anemployer requests a fundingwaiver or fails to make mini-mum funding contributions. Toprotect plan benefits, in certaincases the plan may file for alien (legal claim) againstemployer assets for unpaidcontributions, or the employermay have to post security for aportion of the underfunding.

Pension PlanAdministrationThe person who administersthe pension plan is known asthe plan administrator. Theplan administrator’s responsi-bilities include keeping theworkers fully informed of theirrights and benefits, makingpension payments to retireesand beneficiaries, paying insur-ance premiums to PBGC, andmaking reports to plan partici-pants and to DOL, IRS andPBGC as required by law.

Under the law, the plan admin-istrator must give workers thefollowing information:

Summary Plan Description.This document includes infor-mation on how the plan operates, when participants are eligible to receive their pensions, how participants can calculate the amount of theirbenefits, and how to file fortheir pensions. This informa-tion must be given to workerswithin 90 days after theybecome participants in theplan. The plan administratormust also notify participantsabout changes in the plan and,every five years, provide work-ers with an updated version ofthe summary plan descriptionif the plan has been modified.

Summary Annual Report.This report contains informa-tion on the financial activitiesof a pension plan and must bep rovided to workers annually.

Notice to Participants.G e n e r a l l y, participants in plansthat are less than 90 perc e n tfunded must receive an easy-to-understand notice re p o r t i n g

the funding level of their pen-sion plan, indicating how muchof their pensions are curre n t l yc o v e red by the plan assets. The notice also explains whatbenefits in the plan would bec o v e red by PBGC’s insurancein the event the plan terminates.

Individual Benefit Statement.This statement, which partici-pants may request annuallyand when they leave for anotherjob, shows the benefits a partic-ipant has accrued under theplan and tells whether the participant has a vested rightto receive them.

If any of the required informa-tion is not provided, workersshould contact the Division of Technical Assistance andInquiries, Pension and WelfareBenefits Administration(PWBA), U.S. Department of Labor, 200 ConstitutionAvenue NW, N-5625,Washington, D.C. 20210.

Generally, participants in

plans that are less than

90 percent funded must

receive an easy-to-

understand report on

the funding level of their

pension plan.

In a standard termination, anemployer may end a plan onlyif there is enough money topay all pension benefitsaccrued by workers as of thetermination date. The planadministrator will pay thepromised benefits by purchas-ing annuities from a privateinsurance company or makinglump-sum payments to partici-pants. Once a plan ends in astandard termination, PBGC’sinsurance responsibility ends.

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PBGC receives no funds from general tax revenues.Operations are financed largelyby premiums paid by insuredpension plans (pension insur-ance stays in force even if premiums are not paid) andinvestment returns.

Today, PBGC insures the pen-sions of about 42 million work-ers in more than 44,000 privatedefined benefit plans. PBGCdoes not insure defined benefitplans sponsored by federal,state, and local governments.Nor does it insure some churchand fraternal organizationplans, professional serviceemployer plans (such as plansfor lawyers and doctors) with fewer than 25 active par-ticipants, plans maintainedoutside the U.S. primarily fornon-resident aliens, workercompensation and unemploy-

ment insurance plans, plansthat are not tax-qualified and plans not funded withemployer contributions.

Two Insurance ProgramsPBGC operates two insurancep rograms: one covers single-employer pension plans and theother covers multiemployer pen-sion plans. The single-employerp rogram is by far the larg e r, covering almost 42,000 pensionplans. There are about 2,000multiemployer pension plans.

Under the multiemployer pro-gram, PBGC provides financialassistance through loans toplans that are insolvent —unable to pay benefits (at leastequal to PBGC’s guaranteedbenefit limit) when due. Underits single-employer pro g r a m ,PBGC takes over and becomest rustee of an insolvent planwhen the sponsoring companycan no longer support the plan.

When this happens,PBGC begins to pay pensionbenefits to the plan participantsa l ready receiving benefits andto others when they re t i re .

Pension Plan TerminationEmployers voluntarily estab-lish and maintain pensionplans. They may terminatedefined contribution plans atany time. But they may termi-nate defined benefit plansinsured by PBGC only in twoways: standard termination or distress termination. Inaddition, PBGC may terminatea plan in certain circumstances,such as when a plan does nothave sufficient assets to paybenefits when they come due.

Federal Insurance For Your Pension

PBGC is the federal agency that insures the pensions of American

workers covered by private defined benefit pension plans.

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A distress termination involvesa plan that does not haveenough money to pay all pension benefits accrued byworkers. A plan can end in adistress termination only if the employer meets one of the following distress criteria:• Chapter 7 bankruptcy

liquidation.• Chapter 11 bankruptcy re o r-

ganization. The employermust demonstrate to the courtthat liquidation would neces-sarily follow if the pensionplan were not terminated.

• A determination by PBGCthat the employer is in suchpoor financial condition thatunless the plan terminatesthe employer cannot pay itsdebts when due and cannotcontinue in business.

• A determination by PBGCthat, due solely to a declinein the employer’s workforce,pension costs have becomeunreasonably burdensome.

In a distress termination, PBGCwill step in and take over theplan as trustee, and use itsinsurance funds to make surethe guaranteed benefits arepaid to the plan participantswhen due.

If PBGC becomes trustee of apension plan, it will notify allplan participants of this action.As trustee, PBGC will keep therecords of plan participantsand their benefits, pay benefitsto retirees, and begin benefitpayments to new retirees.

Insurance CoverageUnder the single-employerprogram, PBGC insures pen-sion benefits provided by thepension plan up to certain limits set by law. These arebenefits beginning at normalretirement age, certain earlyretirement and disability bene-fits, as well as certain benefitsfor survivors of deceased planparticipants. PBGC does not

guarantee certaintypes of benefits, such ashealth and life insurance bene-fits, severance and vacationpay, death benefits, and someearly retirement benefits.

The maximum benefit PBGCcan pay is set by law each yearunder provisions of ERISA.The maximum guarantee isreduced if a worker beginsreceiving benefit paymentsbefore age 65 or if the pensionincludes a survivor benefit.

Historically, most participants in plans taken over by PBGCreceive all of the benefits

they are due. Where there arereductions, they normallyoccur among higher-salariedworkers whose benefits exceedPBGC’s guarantee or in caseswhere benefits have beenincreased within five years ofplan termination.

Under the multiemployer pro-gram, PBGC insures a portionof the pension earned times theworker’s years of service.

Other Useful Publications

The PBGC publication Your Guaranteed Pensionprovides additional details about the single-employer insurance program. To obtain a copy, please write toYour Guaranteed Pension, No. 521E, Pueblo, CO 81009.Your Guaranteed Pension, as well as other pensioninformation, is also available on PBGC’s homepage atwww.pbgc.gov on the Internet.

Another publication that provides useful informationabout 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 AvenueN.W., Room N-5619, Washington, D.C. 20210. Other information is available on DOL’s homepage atwww.dol.gov/dol/pwba on the Internet.

Prepared by Communications and Public Affairs Department, Pension Benefit Guaranty Corporation

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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 sumand/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 myspouse 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 wouldprovide a benefit to my spouse in the event I die before I retire.

• I have learned from my plan administrator which of my bene-fits are covered by PBGC insurance if my plan is terminatedand taken over by PBGC:

PENSION BENEFITGUARANTY CORPORATION

1200 K Street, NWWashington, DC 20005-4026

http://www.pbgc.gov

PBGC Publication 1007

January 2000