What happens to your pension if ...
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What happens to your pension when the unexpected occurs? For instance, what happens to it if your employer offers a lump sum after you've already begun getting paychecks; if your company goes bankrupt before you claim benefits; if the Pension Benefit Guaranty Corp. takes over your plan; if your pension is frozen; or if it's converted to a cash balance plan? What happens to it if you divorce or die?
The short answer to most of these questions is that your pension will remain safe. Uncle Sam offers protections for private pension plans that help make sure you will get the benefits you were promised. These protections are guaranteed by the Employee Retirement Income Security Act of 1974, or ERISA, and they apply to both 401(k) plans and old-fashioned defined benefit pension plans.
More pension protections were layered on with the passage of the Pension Protection Act of 2006.
Together, these two laws hold employers to their commitments. Read on to learn the particulars of what happens to your pension if one of eight scenarios transpires.
What if you get a divorce?
Every state is a little different, says Cynthia Hounsell, president of Women's Institute for a Secure Retirement, or WISER. But don't hesitate to ask for at least half of your soon-to-be former spouse's pensions -- both old-fashioned defined benefit and 401(k)s, she advises. It is usually -- but not always -- the husband's pension that has to be split, but whoever has to give up something never likes it very much, Hounsell says.
Making the divorce agreement stick can be tricky. If you find yourself trying to claim part of a pension, don't settle for a promise -- written or oral -- Hounsell advises. You have to have a qualified domestic relations order, often referred to as a QDRO. "That's the ticket. If the employer doesn't have that, it isn't going to pay the pension out," she says.
A surprising number of people whose divorce settlements call for a pension to be split don't actually walk away with a QDRO, and when the time comes, they can't claim what they were given. So make sure your attorney is on top of this. "A lot of lawyers aren't," Hounsell says. "If they are family lawyers and not pension lawyers, sometimes they just don't get it."
What if you die?
If you have an old-fashioned defined benefit pension, your employer is required to offer a plan that leaves the surviving spouse with at least 50% of the deceased employee's pension. In the case of a 401(k), the surviving spouse gets all the vested benefits -- even if you name another beneficiary. In both cases, the spouse can waive these rights, but he or she must agree in writing.
Spousal protections went into effect when President Ronald Regan signed the Retirement Equity Act of 1984 into law. According to The New York Times, he said at the time, "No longer will one member of a married couple be able to sign away survivor benefits for the other."
Should you sign away your spousal rights in return for life insurance or some other option? Hounsell says, "We're against it. When a spouse dies, the surviving spouse almost always needs the money. Some people advise buying life insurance instead, but for many people, that doesn't work out."
One final point: individual retirement accounts aren't covered by ERISA, so in this case, a named beneficiary takes precedence over spousal rights. This means if you leave your ex-spouse as beneficiary of your IRA, he'll get it. That makes it particularly important to change your beneficiary form when you divorce.
What if you want more income for your spouse?
The average defined benefit pension plan offers between four and 10 payout options, estimates actuary Wendy Foster, senior vice president of defined benefit product management for Fidelity Investments, one of the nation's largest providers of defined benefit plans. Picking the payout option that will provide the largest stream of income over the duration of two lives is a very personal decision that can be complicated by such things as age disparity between spouses.
"You can't know what the most generous option is until you look back, and you have to be dead to do that," Foster says.
Her advice to a couple looking to generate enough income throughout both lifetimes is to make sure that there is a guaranteed income stream -- from the pension, Social Security, an annuity or a combination of these -- that is sufficient to cover basic living expenses no matter how long both live. "After that is in place, then a couple can look at other sources of income to pay for the extras," Foster says.
What if a former employer offers a lump sum?
Retirees who are already collecting a pension check have been getting these buyout offers lately.
The Pension Protection Act of 2006 and the Moving Ahead for Progress in the 21st Century Act combine to make it very attractive for companies to persuade you to accept a lump sum rather than an annuity. These laws also say you don't have to accept the offer. You can continue to opt for the annuity.
Making the decision isn't a slam-dunk, says Leon LaBrecque, an attorney and financial adviser who has worked with hundreds of Ford Motor and General Motors retirees offered these deals.
LaBrecque says you should ask yourself these questions if you are offered a buyout.
How healthy am I? How healthy is my spouse? What kinds of retirement income will I have? Will my spouse have a significant pension? How important is it for me to leave money to my children or a charity? Is it important to be able to have flexibility in the amount I withdraw? Will I manage my own money or delegate investment management to someone else? What kinds of financial obligations will I have after I retire? What will be my tax bracket after age 70 ½? What is my risk tolerance?
What if your company folds before you retire?
Don't assume the worst. "A bankruptcy doesn't mean a pension plan automatically comes to PBGC," says J. Jioni Palmer, senior adviser and director of public affairs at the Pension Benefit Guaranty Corp., which sometimes takes over plans. "We work with businesses to help them keep their plans going," says Palmer.
Attorney Jeffrey R. Capwell, practice group leader for the employee benefits group at McGuireWoods law firm, says the PBGC doesn't just work with employers -- it pushes, shoves and insists that a bankrupt firm meet its pension obligations.
Defined benefit pension plans are a cash drain, which is why companies facing bankruptcy are inclined to turn them over to the PBGC. But because of the PBGC's aggressive approach, Capwell says that if the company is sold or reorganized, the plan will remain in place and viable.
"The PBGC has a whole arsenal of legal powers and tactics available to it, and it gets actively involved with companies when they are in an early warning stage before they declare bankruptcy. This is an agency that is very active in monitoring plans. It isn't an agency that wants to be in the business of assuming plans," Capwell says.
What if the PBGC takes it over?
In dire circumstances, the PBGC steps in to take over a company's pension obligations. Don't panic. "Last year, we assumed responsibility for more than 57,000 additional workers and retirees in 134 failed plans. No one ever misses a payment, and about 85% of the retirees we pay get their full benefit," says Palmer.
In 2013, the maximum monthly benefit the PBGC will pay for a worker retiring at 65 is $4,789.77.
If the PBGC takes over your plan, you will be asked to confirm the information that it has on file about you. While it reviews your records, any pension benefits you are currently receiving will be continued.
At the end of the review, you will see no changes unless the PBGC decides the benefits it will pay are less than what you are currently receiving. In that case, your payment will be adjusted, but the annuity form you chose at retirement will stay the same. For instance, if you chose a 50% joint and survivor annuity, the money would still be split that way.
If you are still working when the PBGC takes over the plan, then four months before retirement, you must apply directly to the PBGC to begin payments. The PBGC's customer service number is (800) 400-7242.
Benefits are generally paid by direct deposit, with paper checks available under limited circumstances.
What if your pension freezes?
When a pension is frozen, it usually means participating employees can't accrue any more benefits. Federal law protects you from losing what you already have earned, but because pensions are based primarily on earnings during the last few years you work, a freeze means you will collect a greatly reduced benefit.
Alan Glickstein, a senior retirement consultant at Towers Watson, offers this illustration, which reflects a typical pension formula:
Annual pension equals average salary for the five consecutive highest-paid years times the number of years of employment times an accrual rate of 1%.
For most people, the highest-paid years are the last five years of work. If your pension is frozen at age 50 after 20 years of employment and your pay averages $50,000 over the last five years you worked when the pension was active, when you retire, you'll get a pension of $10,000 a year. However, if you work an additional 15 years and end up averaging $77,000 a year near retirement, your pension would have risen to nearly $27,000 a year had it not been frozen.
Glickstein says not all freezes are the same. A soft freeze generally eliminates the plan for future employees only. Other companies announce a freeze but delay its effective date for five, 10 or even 20 years for current employees, giving them time to adapt.
What if pension becomes a cash balance plan?
Cash balance plans are increasingly popular among both small and large companies, says Alexander Pekker, author of a recent report on these plans for management firm Sage Advisory Services.
With a cash balance plan, the employer commits to putting a "pay credit," or a percentage of each employee's pay, into the plan annually. It can be somewhere between 5% and 10%. An "interest credit," based on a predetermined market rate, is also applied. The employee doesn't contribute directly.
Pekker predicts that more large companies will convert to this form of pension because it caps company risk. "Conversions in large organizations give these companies greater predictability, less investment risk and less longevity risk," he says.
The most common situation, Pekker says, involves converting employees' accrued defined benefits to a plan with an account balance, much like a 401(k) plan.
"You are guaranteed the larger of the cash balance or the older defined benefit plan up to that point," Pekker says. "You aren't going to lose anything you have been guaranteed so far, but the new cash balance plan will probably be less generous than the old plan."