A pension plan, referred to as a defined benefit plan, is a retirement plan that requires an employer to make contributions to a pool of funds set aside for an employee’s future benefit. The employer guarantees that the employee receives a definite amount of benefit upon retirement, regardless of the performance of the investment pool, and is funded solely by the employer. The dollar amount of the benefit is determined by a formula, usually based on years of service and earnings.
In the past, it was common for companies to offer a pension plan to employees. As employers move away from traditional defined benefit pension plans in favor of defined contribution plans, such as a 401(k), the number of companies choosing not to offer a pension plan or choosing to freeze their existing pension plan is increasing.
According to a report released in 2018 by professional services firm Towers Watson, the amount of Fortune 500 companies offering traditional pensions to new hires in 2017 was down to 16%, compared to 59% in 1998. A recent example of this trend is the General Electric announcement on October 7, 2019, that there will be a pension freeze for 20,000 salaried workers to go into effect January 1, 2021. GE had already closed its pension to new hires in 2012.
What does it mean to “freeze” a pension plan?
When a company freezes its pension, the plan is closed to new employees and some or all of the current employees may stop earning benefits, but the plan continues to operate. The plan is still federally insured and employees will still receive the amount of benefit that was already accrued. Generally, your accumulated benefits will stay in the plan until you retire because a freeze can be reversed at any time.
Types of pension freezes:
A “hard freeze” means that employees stop earning future benefits under the defined benefit plan altogether. All employees become 100% vested in what they have earned under the plan, but they lose the ability to continue earning future benefits.
A “soft freeze” generally only prohibits new employees, or certain types of employees, from participating in an existing pension plan. It may also signify the end of benefit accumulation based on years of service, but then provide for additional pension benefits based on pay.
Note: Pension Termination: When a pension plan is terminated, the plan is stopped and ceases all operations completely. A company can terminate a pension plan by applying for a standard or distress termination with the Pension Benefit Guaranty Corp (PBGC). A “standard” termination means that the employer has the option of transferring your accrued benefits into an annuity or give you a lump-sum distribution. A “distress” termination can happen if the company does not have the funds to make the payout of employee benefits and the PBGC will take over the plan and will pay out benefits up to a certain limit.
Why would a company freeze a pension plan?
Companies give many different reasons for freezing their pension plans as a way of “de-risking”. Since pension plans are costly to maintain, financially healthy employers may freeze their pension plan to remain competitive with other companies that do not provide the benefit, Financially unhealthy employers may freeze their pension plan in order to reduce expenses. In some cases, a company may freeze a plan when it merges with another company if it would be too costly and difficult to merge the retirement plans together. An additional benefit to companies that do freeze plans is that it allows them to report increases in operating income on their annual reports to shareholders.
What protections do employees have regarding their pension plan?
Companies have great flexibility to change their pension plans. At the same time, employees do have protections. Companies do have the ability to freeze a pension plan, it does not have the right to take away any benefits that the employee has already earned up to the point of the freeze. Also, by law they are required to provide employees with at least 45 days advance notice prior the effective date of the plan freeze.
The Employee Retirement Income Security Act of 1974 (ERISA) was created to oversee how employers provide benefit plans to employees and protect the interests of employee benefit plan participants and their beneficiaries. ERISA protects retirement savings from mismanagement and establishes standards of conduct for plan managers. The Pension Benefit Guaranty Corp.(PBGC), is a federal agency created by ERISA to provide a safety net for participants by insuring the participants’ benefits under the plan and is funded by premiums charged to defined benefit plan sponsors.
What should you do if your plan is frozen?
A pension freeze can make a significant impact on your retirement savings strategy. Pensions are “back-loaded”, meaning their peak value will be in your last years before retirement, which are usually the highest earning years. A freeze especially during this time can leave you needing to readjust your retirement plan.
You will want to contact your human resources department for specifics of your pension benefits. Since a pension freeze can dramatically change your retirement situation, it would be good practice to update your past retirement projection or complete one for the first time. This will help you to determine the effects of losing those future pension benefits you had planned on. You may determine the need to increase savings, extend your retirement age, delay the start of Social Security benefits, reduce your income in retirement, or a combination of the above. You may discover that even with a pension freeze, you can achieve your retirement goals with no changes at all. Careful planning and proactive practices can help you to secure the retirement lifestyle you desire, especially when the unexpected happens.
Carol Chaudet
(last updated 01/02/2020)