A pension plan is a defined benefit or defined contribution retirement plan. Typically, contributions are made to an employee's pension plan over the course of their life with a company, with benefit to be paid out after the employee retires or reaches a certain age. However, if the company freezes the pension plan, employees may stop earning benefits going forward. Employees may be left unsure where they stand with a frozen pension plan.
Pension plans are generally set up as a defined benefit plan or a defined contribution plan. A defined benefit plan promises a defined monthly benefit amount to the employee upon retirement, usually based on the employee's salary and years with the company. A defined contribution plan is funded by a specified contribution amount with benefits based on how the investments have performed over time.
When a company considers the costs associated with maintaining a pension too high, or the company runs out of money to fully fund the pension, they may freeze the pension plan. Freezing a pension plan may lead to the company eventually terminating the pension plan. A pension freeze can be categorized as a “soft freeze” or a “hard freeze.”
In a hard pension freeze, the company may terminate contributions to the employee's pension fund. Any amount of money in the pension fund will remain but there will be no additional contributions by the company. The pension benefits on retirement will be based on the pension factors in place at the time, including years with the company and salary. However, any future pay raises or time with the company may not be reflected in pension benefits.
With a soft freeze, the employer may factor in future salary increases but not factor in years of service with the company. The employer may also cap the salary increase amount that is used to determine the monthly pension benefit.
The impact of a pension plan freeze will depend on a number of factors, including the employee's age, years of service with the company, position in the company, and salary. For example, a long-term employee who is close to retirement may see very little change in their retirement benefits after a pension freeze. However, a new hire looking to a long-term commitment with the company may see a drastic change in their anticipated retirement benefits.
If a pension plan is terminated, in most cases, the employees will be given the option of a lump sum payout or annuity plan. Lump sum payouts can be rolled over into qualifying retirement plans, otherwise, the employee may be taxed on the payout. If the pension becomes insolvent, the Pension Benefit Guarantee Corporation will cover the employees up to a certain limit of their accrued benefits.
After a pension plan freeze, employees should evaluate their options and make plans for their own retirement. Employees who no longer have an employer-provided retirement plan should make sure they are investing in their personal future retirement through other individual retirement plans, including an IRA or Roth IRA. In some cases, an employer may offer another retirement benefit plan after freezing the pension plan, such as a 401(k) or 403(b). These are defined contribution plans that can provide additional retirement benefits based on the amount of money contributed and how the funds perform. However, defined contribution plans do not provide the guaranteed benefit payments of a defined benefit plan.
If you have any questions about pension plan freezes or managing a pension plan change, contact Butterfield Schechter LLP. We are San Diego County's largest firm focusing its law practice on employee benefits. Our firm can help your company establish employee benefit plans, maintain ERISA compliance, and represent your company in ERISA litigation. Contact our office today with any questions on how we can help you and your business succeed.