Understanding Pension Plans

Your employer’s retirement savings plan is an essential part of your future financial security. It is important to understand how your plan works and what benefits you will receive. Just as you would keep track of money that you put in a bank or other financial institution, it is in your best interest to keep track of your retirement benefits. Pension plans of Defined benefit plans are solely funded by your employer. These plans are governed by Federal laws and guidelines in the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code. ERISA is a Federal statute that sets standards for most employer and union sponsored retirement plans in private industry and imposes responsibilities on those running the plan. Participants in these plans have certain rights as well as responsibilities.

Defined benefit plan, is funded by the employer, promises you a specific monthly benefit at retirement. The plan may state this promised benefit as an exact dollar amount, such as $100 per month at retirement. Or, more often, it may calculate your benefit through a formula that includes factors such as your salary, your age, and the number of years you worked at the company. For example, your pension benefit might be equal to 1.5 percent of your average salary for the last 5 years of employment times your total years of service. There are Federal rules that set amounts that employers must contribute to plans in an effort to ensure that plans have enough money to pay benefits when due. There are penalties for failing to meet these requirements.

One of the very important features of pension plans is that the Federal government, through the Pension Benefit Guaranty Corporation (PBGC), guarantees some amount of benefits. In case of other retirement plans such as 401(K), or IRAs, there is no federal guaranty for any amount of benefits.

Remember, 401(K plans may or may not have a gradual vesting schedule. All employee contribution is 100% vested immediately but employer contribution may have a gradual schedule. For example, once of the most common vesting schedule is five-year schedule where 20$ of employer contribution is vested after one year on service, 40 % of employer contribution is vested after two-year of service an so on and so forth. In this plan, 100% of employer contribution is vested after five-year of service. So if an employee decide to leave after three-year of service, he/she only gets 60% of employer contribution but they become eligible to receive 100% employer contribution if they stay five-year. On the other hand, Defined benefit or pension plans have more employer control since they are 100% funded by employer.

Defined benefit plans may change the rate at which you earn future benefits but cannot reduce the amount of benefits you have already accumulated. For example, a plan that accrues benefits at the rate of $5 a month for years of service through 2006 may be amended to provide that for years of service beginning in 2007 benefits will be credited at the rate of $4 per month. Plans that make a significant reduction in the rate at which benefits accumulate must provide you with written notice generally at least 15 days before the change goes into effect. Most employees get a benefit statement every year for a pension plan they are enrolled in . However, If you are in a defined benefit plan and don't receive a statement, you should request an individual benefit statement once a year and review its description of the total benefits you have earned and whether you are vested in those benefits. Also check to make sure your date of birth, date of hire, and the other information included is correct.

Also, in most situations, if a company terminates a defined benefit plan that does not have enough funding to pay all of the promised benefits, the Pension Benefit Guaranty Corporation will pay plan participants and beneficiaries some retirement benefits, but possibly less than the level of benefits promised. (For more information, see the PBGC’s Web site.)

If you are in a defined benefit plan (other than a cash balance plan), you most likely will be required to leave the benefits with the retirement plan until you become eligible to receive them. As a result, it is very important that you update your personal information with the plan administrator regularly and keep current on any changes in your former employer’s ownership or address. You also need to pay close attention to the term "eligibility". Most Pension plans have no vesting unless you work for a minimum period of 5 years for your employer. If you leave before 5 years, none of the pension benefit is vested and you're not eligible to receive any benefit when you reach the age of 55. However, if you have worked for more than 5 years, You become eligible for benefit but it is not payable until your retire. Pension plans could be very confusing so make sure you understand if you have any vested benefit and if you do, how you need to proceed with the application for benefit at a later time. You employer is your best source for getting information on defined benefit or pension plans. You can also contact PBGC for any questions that you may have.

Pension Benefit Guaranty Corporation
1200 K Street, NW
Washington, DC 20005-4026
Tel: 202.326.4000
Toll free: 1.800.400.PBGC (7242)

Finally, an employer may terminate a defined benefit or a defined contribution plan, but may not reduce the benefit you have already accrued in the plan.

Glossary : -

Benefit Accrual – The amount of benefits accumulated under the plan.

Cash Balance Plan – A type of defined benefit plan that includes some elements that are similar to a defined contribution plan because the benefit amount is computed based on a formula using contribution and earning credits, and each participant has a hypothetical account. Cash balance plans are more likely than traditional defined benefit plans to make lump sum distributions. (For more information, see Frequently Asked Questions about Cash Balance Pension Plans on the Department of Labor’s Web site, at www.dol.gov/ebsa/faqs/.)

Defined Benefit Plan – This type of plan, also known as the traditional pension plan, promises the participant a specified monthly benefit at retirement. Often, the benefit is based on factors such as your salary, your age, and the number of years you worked for the employer.

Employee Retirement Income Security Act of 1974 (ERISA) – A Federal law that sets standards of protection for individuals in most voluntarily established, private-sector retirement plans. ERISA requires plans to provide participants with plan information, including important facts about plan features and funding; sets minimum standards for participation, vesting, benefit accrual, and funding; provides fiduciary responsibilities for those who manage and control plan assets; requires plans to establish a claims and appeals process for participants to get benefits from their plans; gives participants the right to sue for benefits and breaches of fiduciary duty; and, if a defined benefit plan is terminated, guarantees payment of certain benefits through a federally chartered corporation, known as the Pension Benefit Guaranty Corporation (PBGC).

Individual Benefit Statement – An individual benefit statement provides information about a participant’s retirement benefits, such as the total plan benefits earned and vested benefits, on a periodic basis. Additional information may be included depending upon the type of plan, such as how a 401(k) plan account is invested.

Money Purchase Plan – A money purchase plan requires set annual contributions from the employer to individual accounts and is subject to other rules.

Multiemployer Plan – A retirement plan sponsored by several employers under collective bargaining agreements that meets certain other requirements. A participant who changes jobs from one sponsoring employer to another stays within the same plan.

Plan Administrator – The person who is identified in the plan document as having responsibility for running the plan. It could be the employer, a committee of employees, a company executive, or someone hired for that purpose.

Plan Document – A written instrument under which the plan is established and operated.

Plan Fiduciary – Anyone who exercises discretionary authority or discretionary control over management or administration of the plan, exercises any authority or control over management or disposition of plan assets, or gives investment advice for a fee or other compensation with respect to assets of the plan.

Plan Trustee – Someone who has the exclusive authority and discretion to manage and control the assets of the plan. The trustee can be subject to the direction of a named fiduciary and the named fiduciary can appoint one or more investment managers for the plan’s assets.

Plan Year – A 12-month period designated by a retirement plan for calculating vesting and distribution, among other things. The plan year can be the calendar year or an alternative period, e.g., July 1 to June 30.

Profit-Sharing Plan – A profit-sharing plan allows the employer each year to determine how much to contribute to the plan (out of profits or otherwise) in cash or employer stock. The plan contains a formula for allocating the annual contribution among the participants.

Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) – A plan in which a small business with 100 or fewer employees can offer retirement benefits through employee salary reductions and matching contributions (similar to those found in a 401(k) plan). It can be either a SIMPLE IRA or a SIMPLE 401(k). SIMPLE IRA plans impose few administrative burdens on employers because IRAs are owned by the employees and the bank or financial institution receiving the funds does most of the paperwork. While each has some different features, including contribution limits and the availability of loans, required employer contributions are immediately 100 percent vested in both.

Simplified Employee Pension Plan (SEP) – A plan in which the employer makes contributions on a tax-favored basis to individual retirement accounts (IRAs) owned by the employees. If certain conditions are met, the employer is not subject to the reporting and disclosure requirements of most retirement plans. Under a SEP, an IRA is set up by or for an employee to accept the employer’s contributions.

Summary Plan Description – A document provided by the plan administrator that includes a plain language description of important features of the plan, e.g., when employees begin to participate in the plan, how service and benefits are calculated, when benefits become vested, when payment is received and in what form, and how to file a claim for benefits. Participants must be informed of material changes either through a revised Summary Plan Description or in a separate document called a Summary of Material Modifications.

Vested Benefits – Those benefits that the individual has earned a right to receive and that cannot be forfeited.

Years of Service – The time an individual has worked in a job covered by the plan. It is used to determine when an individual can participate and vest and how they can accrue benefits in the plan.