Many employees still have some form of pension plan, although they aren't as common as they used to be.
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Pension plans became popular during the Second World War, when there were more jobs than workers. Employers used fringe benefits such as pensions to attract and keep workers without violating the wartime wage freeze rules. Since the early 1950s, unions and employers have both recognized pension plans as crucial elements in labor negotiations.
But, until the mid-1970s, having a pension plan and actually collecting a pension benefit check were two different things. Many people were promised a pension as part of the terms of their employment, and many workers contributed to pension funds through payroll deductions, but relatively few actually received much in the way of benefits at retirement. There were several reasons for the failure of pensions to deliver what they promised: People changed jobs and had to leave their pension rights behind; workers were not-so-mysteriously let go just before they reached retirement age; and pension plans, or whole companies, went out of business.
This article explains the ins and outs of pensions.
Jargon dominates the pension industry. Here are some terms you may need to know:
Defined benefit plan. The employer promises to pay the employee a fixed amount of money, usually monthly, after the employee retires. Although a defined benefit plan is what usually comes to mind when people think about pensions, this plan has become far less common than the defined contribution type.
Defined contribution plan. The employer promises to pay a certain amount into the employee’s retirement account while the employee is working but does not promise a specific amount of income for the employee after retirement. Your employer may promise to pay $50 per month per employee into the company’s pension plan, for example, but the size of the monthly pension check you receive after retirement would depend on the interest rate paid on your pension account and other economic factors.
Defined contribution plans can take several different forms, including 401(k) plans, through which your employer and you can contribute jointly to retirement savings. Defined contribution pension plans are individual savings accounts that usually have some tax advantages—but also some limitations on withdrawals and reinvestment—that regular savings accounts do not have.
Integrated plan. When a pension plan is integrated with Social Security, the actual monthly or yearly pension benefit is reduced by some—or all—of your Social Security check. This approach allows employers who sponsor their own pension plans to take credit for the fact that their FICA contributions on behalf of lower-income workers buy proportionately more generous benefits than their contributions for higher-income workers. Pension benefits are thereby lowered for all workers, and total retirement benefits—that is, pensions plus Social Security—replace a more uniform percentage of final pay for all employees. Both defined benefit and defined contribution plans may operate as integrated plans.
Employee Retirement Income Security Act (ERISA). Administered by the U.S. Department of Labor, the Internal Revenue Service, and the Securities and Exchange Commission, ERISA sets minimum standards for pensions and attempts to guarantee that pension rights cannot be unfairly taken from or denied to workers.
Pension Benefit Guaranty Corporation. An organization that insures many pension plans in the United States, the PBGC is half private and half public. It is supposed to get its money from insurance premiums paid by the pension plans it covers, but it regularly turns to the federal government for money when it runs short.
Plan administrator. The person or organization with the legal authority and responsibility for managing your pension program.
Vesting. Getting a legal right to collect from a benefit program. Some pension plans require you to work a certain number of years for a company before you have a right to a pension. Once you are vested, you continue to have rights to the pension plan even if you no longer work there.
Legal Controls on Pensions
Since the passage of the federal Employee Retirement Income Security Act (ERISA) in 1974, at least some of the worst sorts of disappearing pension acts have been halted. ERISA sets minimum standards for pension plans, guaranteeing that pension rights cannot be unfairly denied or taken from a worker. ERISA also provides some protection for workers if certain types of pension plans cannot pay all the benefits to which workers are entitled. But, while ERISA provides the protection of federal law for certain pension rights, its scope is limited.
The Incredible Shrinking Pension Check
Inflation is an old enemy of your right to receive a decent retirement pension. The figures an employer shows you as your potential pension benefit may seem decent when you are hired, and may even pay a reasonable amount when you first retire. But, because few private pension plans are indexed to the rising cost of living, the amount you receive when you retire will seem smaller and smaller as inflation cuts into the value of your pension dollar. In other words, the cost of living will go up, but your pension check will not. Unfortunately, ERISA does not require pension plans to respond to inflation’s bite into your retirement benefits.
There is no law that requires an employer to offer a pension plan. However, if a company chooses to do so, ERISA requires that the pension plan spell out who is eligible for coverage. Pension plans do not have to include all workers, but they cannot legally be structured to benefit only the top executives or otherwise discriminate—for example, by excluding older workers. The plan administrator for your company’s pension program can tell you whether you are eligible to participate.
If you are eligible to participate in your employer’s pension program, the administrator must provide you with several documents to help you understand the plan:
- A summary plan description. Explains the basics of how your plan operates. ERISA requires that you be given the summary plan within 90 days after you begin participating in a pension plan, as well as any updates issued. This document will also tell you the formula for vesting in the plan (if it is a plan that includes vesting), the formula for determining your defined benefits or the defined contributions that your employer will make to the plan, and whether or not your pension is insured by the Pension Benefit Guaranty Corporation or PBGC. (See “Mismanaged Plans,” below.)
- A summary annual report. A yearly accounting of your pension plan’s financial condition and operations.
- Survivor coverage data. A statement of how much your plan would pay to a surviving spouse should you die first.
Your plan administrator is also required to provide you with a detailed, individual statement of the pension benefits you have earned, but only if you request it in writing or are going to stop participating in the plan because, for example, you change employers. Note, however, that ERISA gives you the right to only one such statement from your plan per year.
Each pension plan has its own rules on the minimum age for claiming benefits. Most private pension plans still consider 65 to be the normal retirement age. However, some private pensions also offer the option of retiring early, usually at age 55. If you elect early retirement, however, expect your benefit checks to be much smaller than they would be if you had waited until the regular retirement age.
Many corporations now use the early retirement option of their pension plans to cut staff. By making a temporary offer to increase the benefits available to those who opt to retire early, these corporations create an incentive for employees to voluntarily leave the company’s payroll before turning age 65. Sometimes companies make the early retirement offer even more attractive by throwing in a few months of extra severance pay.
Some early retirement offers are very lucrative and some are not. Before accepting one, study the details carefully, keeping in mind that the offer you accept may have to serve as your primary income for the rest of your life. Because pension law is so specialized and complex, you may also consider consulting a lawyer who specializes in it if the terms of your employer’s early retirement offer are not clear.
Filing for Benefits
Although ERISA does not spell out one uniform claim procedure for all pension plans, it does establish some rules that must be followed when you retire and want to claim your benefits. All pension plans must have an established claim procedure, and all participants in the plan must be given a summary of the plan that explains it clearly. When your claim is filed, you must receive a decision on the claim, in writing, within a “reasonable time.” The decision must state specific reasons that any claimed benefits were denied and must explain the basis for determining the benefits that are granted.
From the date you receive a written decision on your pension claim, you have 60 days to file a written appeal of the decision. The rules on where and how this appeal should be filed must be explained in the plan summary. In presenting your appeal, the claim procedures must permit you to examine the plan’s files and records and to submit evidence of your own. ERISA does not, however, require the pension plan to actually give you a hearing regarding your appeal. Within 60 days after you file your appeal, the pension plan administrators must file a written decision on your appeal. If your claim is still denied, in whole or in part, you then have a right to press your claim in either state or federal court.
Each pension plan has its own system for appeals. If your pension plan denies you benefits to which you are entitled, its administrator is required to tell you how to appeal that decision. You will have 60 days to request such an appeal, and the group that reviews your appeal will, in most cases, have 120 days after you file it to issue its decision. ERISA requires that you be given a plain-English explanation of the decision on your appeal.
If your pension plan’s internal review system also rules against you, you are entitled to appeal that decision by contacting the Employee Benefits Security Administration.
In addition, the rules of ERISA permit you to file a specific ERISA enforcement lawsuit in federal court to enforce any rule or provision of the ERISA law or of a pension plan covered by ERISA rules. In particular, you may file a federal court lawsuit under ERISA to:
- recover benefits that have been unfairly denied
- challenge a ruling by the pension plan that would affect your future benefits— such as a ruling regarding eligibility, accrual, or vesting
- force the plan to provide information required by ERISA
- correct improper management of the plan or its funds, and
- protect any other right established by the rules of your particular pension plan or by ERISA itself.
Your employer may simply decide to terminate your plan, even if it is financially sound. About 10,000 firms do just that every year, mostly in the name of cutting back on corporate costs. If your employer terminates your pension plan, your plan administrator is required to notify you of the approaching termination, in writing, at least 60 days before the plan ends.
If the termination is a standard one, that means that your plan has enough assets to cover its obligations. Your plan administrator is required to tell you how the plan’s money will be paid out and what your options are during the payout period.
If the termination happens under distress, the Pension Benefit Guaranty Corporation may become responsible for paying your pension benefits. If your plan is not insured by the PBGC and it is terminated, your pension rights may be reduced—or lost entirely.
In recent years, a number of pension funds have gone broke, because of mismanagement, fraud, or overextended resources. The future is likely to bring an increasing number of pension plan failures. Under ERISA, there is some insurance against pension fund collapses. ERISA established the Pension Benefit Guaranty Corporation, a public, nonprofit insurance fund, to provide protection against bankrupt pension funds. Should a pension fund be unable to pay all its obligations to retirees, the PBGC may, under certain conditions, pick up the slack and pay much of the pension fund’s unfulfilled obligations.
However, the PBGC does not cover all types of pension plans and does not guarantee all pension benefits of the plans it does cover. Only defined benefit plans are covered—through insurance premiums they pay to the PBGC—and only vested benefits are protected by the insurance. Also, PBGC insurance normally covers only retirement pension benefits; other benefits, such as disability, health coverage, and death benefits, are not usually covered.
If you have a question about termination of benefits because of the failure of your pension plan, contact the Pension Benefit Guaranty Corporation.
If you think you can prove that the people managing your pension plan are not handling your pension money in your best interests— for example, they are making questionable investments—ERISA gives you the right to file a lawsuit against them in federal court. You will probably need to hire a lawyer to help you with this type of lawsuit.