The Pension Benefit Guaranty Corporation (PBGC) is a governmental agency established by ERISA in 1974 to provide a degree of security for workers' retirement benefits. It protects the pensions of more than 44 million workers and retirees, in over 33,000 private pension plans. See the PBGC site for details of the PBGC Financial Statements and the current deficit.
Basically, employer-sponsored pension plans promise a future benefit to their employees. Certain minimum funding requirements must be met (see 412 requirements), but benefits may not always fully funded at a particular point in time. The role of the PBGC is to guard against situations in which a plan has to be terminated, but the assets are not yet sufficient to cover all the benefits that have been promised. In this event, for a plan covered by the PBGC, the PBGC will take over the assets and liabilities of the plan and pay benefits to the plan participants.
The PBGC collects annual premiums from sponsors of covered pension plans. These premiums are placed into a trust fund, along with assets from any which are taken over by the PBGC. These assests are then available to pay benefits to plan participants of plans that have been taken over. Only a certain level of benefits are guaranteed by the PBGC.
A plan sponsored by a Professional Service Employer as long as the plan has never had more than 25 active participants. This includes plans sponsored by doctors, lawyers, engineers, accountants, pharmacists, etc. (see link for more details).
These two provisions are good news for many small employers who want to sponsor a Defined Benefit Plan. The reason is not simply that they get to avoid PBGC premiums, but that for any small employer that does have to pay the PBGC premiums, it is virtually certain that the PBGC will never have to take over any unfunded liabilities for the plan.
Small Plans Generally Do Not Benefit
Generally, small plans are not terminated and taken over by the PBGC due to these factors:
The burden of proof is on the sponsor that the plan must be terminated in a Distress Termination.
The lion-share of the liability is generally related to the owner's benefit.
The non-owner participants have a higher priority in receiving their full benefits, and, except in very extreme cases, the assets are sufficient to cover benefits for non-owners.
The guaranteed benefit levels for Substantial Owners are graded-in over 30 years. Generally (except in very extreme cases), the plan assets are also sufficient to cover more than the value of the guaranteed benefit level for the owner(s).
So, instead of entering into a Distress Termination in which the PBGC would take over the plan liabilities and assets, if an underfunded small plan must be terminated for financial reasons, they do a Standard Termination, the non-owners receive their full benefit, and the Substantial Owner (s) sign a waiver of that portion of their benefit that is not funded. See Defined Benefit Plan Termination for more information.
Flat Rate premium: $30 per participant (was $19 prior to 2005)
Variable Rate premium: $9 per $1,000 of Unfunded Vested Benefits
The Actuarial Assumptions used to calculate the benefit liabilities are specified by law and are a subject of current discussion.
A properly designed plan should seek to minimize or even eliminate the Variable Rate premium. In other words, a plan should be designed and maintained in such a way that it is properly funded and Unfunded Vested Benefits to not develop.
Note that unless Congress takes action to provide relief from the current interest rates, the assumption to be used for 2006 Calendar Year plans is 3.95%. This represents a 1% drop from the December rate of 4.91% due to the expiration of temporary interest rate relief on December 31, 2005. This will drastically increase the calculated value of Vested Benefits, which in turn may cause many additional plans to be subject to the Variable Rate premium.
Beginning in 2006, there is a $1,250 per participant premium for 3 years that will apply to some plans after an undefunded plan is transfered to the PBGC.
For Multiemployer Plans (large union plans - see link) there is simply an $8 per participant premium (was $2.60 prior to 2005).
Maximum Guaranteed Benefit
The maximum guaranteed benefit rules are complex. The starting point is a maximum monthly benefit amount at age 65 that depends on the year the plan is terminated. For 2006, the maximum age 65 benefit is $3,971.59 per month, payable for the participant's lifetime only. In addition, the guaranteed benefit cannot exceed a participant's high 5-consecutive year average pay.
maximum benefit is reduced for benefits commencing at an earlier retirement age
maximum benefit is reduced for payments forms of payment that may continue after the participant's death (for a certain number of years or to the participant's spouse)
Benefits are generally paid as annuities. Lump Sums are available only for benefits worth up to $5,000.
In addition, recent increases in benefits are not immediately guaranteed--they are graded in over a number of years:
For non- Substantial Owners, increases in benefits are graded in at 20% per year, so that they are fully guaranteed (subject to the other limitations) after 5 years.
For Substantial Owners, increases in benefits are graded in over a period of 30 years. This is why it is highly unlikely that a Substantial Owner in a small plan would qualify for payment of any benefits from the PBGC other than the level of benefits that were actually funded by the plan assets.
It is because of the adjusted maximum guaranteed benefit limit that some participants of large plans taken over by the PBGC report drastic reductions in their benefit levels, such as receiving only 45 cents on the dollar. That is, their benefits have been reduced 55% from what they were expecting.