Defined Benefit Plans

A defined benefit pension plan promises you income in retirement. For example, your plan might pay you $100 per month from age 65 until death.

With a defined benefit plan, you’ll have a retirement income for the rest of your life and, if you have a spouse, for the rest of your spouse’s life. During your working years, your employer or union will tell you how much you’ll receive when you retire. You don’t have to worry about whether this money will run out or how it’s invested. The people overseeing your plan do this for you.

No. No law requires an employer to give workers a defined benefit plan—or any other retirement plan for that matter. However, some employers are required by a collective bargaining agreement with a union to provide a pension to their union workers.

A defined benefit plan promises you regular payments for life based on factors such your age, pay and years of service. Plan officials are responsible for making sure you receive what you’re promised.

Other retirement plans, called defined contribution plans, do not pay you a promised income for life. Instead, you and/or your employer put money into an account that, over time, will hopefully grow large enough to support you in retirement. Generally, you’re responsible for deciding how much you’ll put into the account, where to invest the money and when you’ll take it out of the account. The amount you get depends on how much money was put into the account and how well this money was invested. It is up to you to make sure you don’t run out of money.

The best practice is always to save additional money for retirement. When determining how much money you’ll need, make sure to consider:

• Your health before and after retirement
• When you want to retire
• Whether someone else, like a spouse, also depends on your retirement income
• What you want to do after retirement
• Where you want to live after retirement
• How long your retirement might last.

It isn’t easy to know exactly how much money you’ll need. Ask your benefits/HR department or fund office whether they have a worksheet or other tools that can help you decide how much money you’ll need and how much you should save to reach your retirement goals. Here is a toolkit to get you started.

It depends on two factors: your retirement age and how long you’ve worked for your employer or through your union. In most cases, you must have worked between 5 and 7 years. This is called vesting.

Vesting is a schedule that spells out when you’re entitled to your pension. Being vested, however, doesn’t mean you’ll be able to take money out of your plan any time you want. It only means you have a right to your pension at retirement age. Under federal law, there are two types of vesting. With cliff vesting, once you reach a certain amount of years worked (not more than 5), you’re 100% vested. With graduated vesting, you earn an increasing portion of your pension as the years pass (not more than 7).

A good place to start is your pension plan booklet, called the summary plan description (SPD). You’ll receive this automatically from your plan, either by mail or electronically. If the SPD doesn’t have the information you need, ask your benefits/HR department or fund office for a copy of the more detailed plan document.

Most defined benefit plans use a formula to figure out how much money you’ll receive when you retire. The formula is based on things like the number of years you were part of the plan, your pay and your age. Since benefits vary from plan to plan, ask your benefits/HR department or fund office to explain how your benefits are calculated. At least once every 3 years, you’ll receive an individual benefit statement that tells you what benefits you’ve earned so far and whether these benefits are vested.

How your pension is determined depends on who is sponsoring your plan. Some plans are set up by one employer. Decisions for these single-employer plans are made by (1) the employer or (2) negotiation between the employer and a union.

Some unions set up plans with many employers in the same trade or industry to provide their workers with pension benefits. These plans are called multiemployer plans. A collective bargaining agreement and other legal documents determine how much money each employer has to contribute to the plan for each worker. A group of trustees representing both the workers and the employers decides how the money will be invested and how much workers will receive at retirement. Decisions to change a plan or its benefits are usually made by the trustees, but there are some situations where benefits are part of the collective bargaining process.

Contact your benefits/HR department or fund office if you’re having a problem. Ask them to explain what’s happened and, if appropriate, to make a correction. If the problem isn’t resolved, ask them to give you the paperwork you need to file an appeal. The federal government has rules that your plan has to follow when there’s a disagreement.

• Once your initial claim for benefits is filed, the plan has 90 days to respond—180 days if the plan tells you it needs more time. If your claim is denied, your plan has to notify you in writing with a specific reason why it was denied and how you can file an appeal.
• Next, you have 60 days to request a review of your claim using your plan’s appeal procedures.
• The plan has another 60 days to review your appeal—120 days if it tells you it needs more time. By the end of this period, the plan must send you a written notice saying whether your appeal was granted or denied. If the appeal is denied, the notice must give you the reason, describe any additional appeal options you have and provide a statement regarding your rights to get a review of the decision in court.

You can’t be disciplined or fired for filing an appeal.

It depends. Federal law allows postponing pension payments after you’ve retired, but some plans may override this option. By delaying when you start getting your payments, the amount you receive will probably be higher. Any contributions your employer makes to your pension plan on your behalf for work you do after your plan’s normal retirement age might also increase your monthly payment.

You’re not at risk from investment losses with a defined benefit plan. Even if the investment market goes down, you’ll get your promised retirement payments. If your plan runs low on money to pay benefits, your employer is expected to contribute enough to close the gap, or the plan might change the way it invests. While a defined benefit plan might be forced to decrease the benefits you’ll earn in the future, it generally can’t reduce the benefits you’ve already earned. However, in rare cases of severe financial distress and under strict federal guidelines, the plan may be able to reduce benefits earned.

There are federal laws that allow for borrowing, but it is extremely rare. Most defined benefit plans do not allow you to borrow money from your plan.

Yes—the money you get from your plan at retirement is taxed as federal personal income. The money isn’t, however, subject to Social Security payroll tax. When it comes to state taxes, the rules vary. Most states tax your pension the same as any other income you receive. A few states don’t tax individual income—pension or otherwise. There are also a few states that exempt some or all pension benefits from state income tax.

You and your spouse can choose if you’d like to have pension payments continue after your death. If you both agree to choose this option, your pension payments will continue through both your lifetimes but will be lower than what you would have received to make up for paying benefits longer. Federal law requires that the payment amount must be at least half of what you would have received if you had chosen payments only for your lifetime.

If you want to receive benefits for your lifetime only and not for the life of your spouse, your monthly benefit will be higher. You and your spouse must both sign a form that says you’re giving up your rights to benefits for your spouse and that you both understand your pension payments will end when you die.

Yes. Your future pension benefits can be increased or decreased. Generally, the amount of benefits you’ve already earned can’t be changed. However, in rare cases of severe financial distress and under strict federal guidelines, the plan may be able to reduce benefits earned.

In some plans, pension payments aren’t adjusted for inflation after you retire. Over time, the purchasing power of your benefits may shrink considerably. This is one reason it’s a good idea to save some money on your own for the later years of your retirement. Some plans, however, offer a cost-of-living adjustment, or COLA. Ask your benefits/HR department or fund office whether your benefits will be adjusted for inflation after retirement.

You need to carefully consider all the pros and cons before making this decision. What’s best for you may be entirely different than what is right for someone else. Here are some reasons you might decide to take your money as a lump sum:

• You (and your spouse, if you have one) have poor health and don’t expect to receive many monthly payments before you die.
• You want to have immediate access to your money so you can use it any way you want.
• If you invest well, you might be able to have both the income you need and some left over to pass on to your beneficiaries.
• You want to delay using the money and paying taxes on it. With a monthly retirement payment, you’ll owe federal income tax on the money you receive. With a lump sum, you can roll your money into an Individual Retirement Account (IRA) and you won’t be taxed on the money until you take it out. The federal government usually requires you to start taking some money from your IRA no later than April 1 of the year after the calendar year you reach age 73. The Required Minimum Distribution age will increase to age 75 starting in 2033.  
  

On the other hand, many retirees have personally experienced the downsides of lump sums:

• You (and your spouse, if you have one) may live much longer than you expect.
• Having access to all your retirement money makes it easy to quickly spend it all.
• You need to decide how to invest and withdraw your money so you have enough to last the rest of your life. Even if you enjoy investing, there may be a time when you’re no longer willing or able to manage the money on your own.
• If you don’t invest the lump sum wisely or there’s a market crash, your money could be gone long before you are.
• Taking a lump sum without rolling it over to a tax-sheltered IRA can put you in a higher tax bracket for the year, leading to higher income taxes than you expected.

Some defined benefit plans are sponsored by a union/labor organization with many employers contributing to the same plan (this is called a multiemployer plan). If you remain with the same employer but transfer to a job not covered by the labor plan, your employer must give you vesting credit for the time you work even though your employer won’t be contributing to the plan on your behalf. If you get a job with another employer that contributes to the same multiemployer plan, you will continue earning benefits the same as if you were with your original employer. If you get a job on a project in another city or region, working for an employer that doesn’t contribute to your plan but instead to a different plan, you may be able to continue earning benefits in your original plan under a reciprocity agreement.

If you worked for an employer with its own plan (a single-employer plan), what happens next depends on whether you’re vested in that plan.

• If you’re not fully vested at the time you change jobs, you forfeit the portion of your pension that was not vested.
• If you’re fully vested but haven’t reached your plan’s normal retirement age, you’ll get benefits when you retire.

Check the vesting rules of your plan or talk to your benefits/HR department or fund office to find out exactly what would happen in your situation.

One of the great things about a defined benefit plan is that when the price of stocks goes down, you continue to get your pension payments. Those responsible for investing the plan’s money have to take the possibility of a market crash into consideration when they decide how to invest plan funds. If your plan runs low on money to pay benefits, your employer is expected to contribute enough to close the gap. While a defined benefit plan might be forced to decrease the benefits you’ll earn in the future, it generally can’t reduce the benefits you’ve already earned. However, in rare cases of severe financial distress and under strict federal guidelines, the plan may be able to reduce benefits earned.

If you stop working for an employer providing a defined benefit plan and then return, your future pension benefit will depend on whether you were vested in the plan before you left and how long you were gone.

• If you were partially or fully vested, you may be able to immediately start earning more benefits.
• If you weren’t even partially vested, you may be able to apply your previous work time toward your vesting requirement. However, plans often don’t recognize your previous work time if it has been longer than 10 years since you’ve worked there.

Because these rules can be different for every plan, it’s very important to read your plan booklet and talk to your benefits/HR department or fund office before you make any decisions.

If you’re part of a Reserve or National Guard unit called to active duty, federal law requires your employer to treat your time in the military as if you’ve been continuously employed. Your time served in the military doesn’t negatively impact eligibility, vesting or earning of benefits. You receive credit for time served when you return to work.

Time provided under the federal Family and Medical Leave Act (FMLA) can’t be considered a “break” in your service. That means you’ll vest in the same amount of time as if you hadn’t taken the leave. If the leave is unpaid, however, you might not earn additional pension benefits during this time, depending on your employer’s plan.

State law governs how the property owned by you and your spouse is divided—this includes the division of your retirement savings. If you and your spouse can’t agree on how to divide your pension, a state court will decide for you. The court may award some or all of your pension to you, your current spouse, a former spouse, children or other dependents.

Once a court makes a decision dividing your marital property, it issues a domestic relations order regarding the distribution of your pension. You need to give a copy of this order to your benefits/HR department or fund office. If the order complies with federal law, the payments are made as directed by the plan and the court. If the order does not comply with federal law or the terms of your plan document, the order will need to be revised.

If you owe money to people or businesses, your pension is generally safe from their claims. However, the IRS or your state department of revenue may place claims on your pension for unpaid taxes.

Some plans provide a disability benefit to workers who are no longer able to work due to illness or injury. Plans can define “disability” differently. Some plans consider a person disabled when they can no longer work in their usual trade or industry. Other plans consider a person disabled only when they can’t work for wages at any job at all. A plan can specify how long workers need to be covered by the plan before they’re eligible for disability benefits.

Each plan has its own rules as to what happens if you die before you retire. Some will pay a lump sum to your spouse or another beneficiary. Others allow beneficiaries to collect payments over a number of years. If you are not partially or fully vested at the time of your death, there might not be anything payable.

Many plans let workers retire before they reach the plan’s normal retirement age. For example, if a plan’s normal retirement age is 65, a plan might allow an early pension for retired workers between ages 55 and 64. To qualify for an early pension, you may need to have worked for your employer for a long period of time. Since early retirees start receiving benefits sooner, most plans reduce the monthly pension amount to take into consideration the extra years they’ll get payments.

If you return to work with the same employer, some plans have rules that stop your pension payments. Other plans have rules that allow retirees to work temporarily or for a limited number of hours without stopping pension payments. In some cases, retirees who go back to work for a former employer continue earning benefits. If you continue to work, but work fewer hours, you may be able to request that a portion of your pension be paid immediately to make up for the wages you no longer receive. The rules are different from one plan to another. Make sure to read your plan booklet and talk to your benefits/HR department or fund office before you make a decision to go back to work.

If you go back to work for a different employer, it generally will not affect your pension payments.

When two plans are merged, the rules of one or both plans may change how you earn future benefits. However, the benefits you’ve already earned generally can’t be reduced. You’ll receive a pension that is at least equal to the pension you would have received before the merger.

The federal government has laws to protect workers when a plan is ended. If you’re a current worker at the time the plan is terminated, you become fully (100%) vested in any benefits you’ve earned. This means you have the right to all benefits you’ve earned up to the time the plan is terminated. This rule applies even when a plan is only partially terminated—for example, an employer closes one plant or a division with a substantial percentage of workers losing their jobs.

A federal government agency, the Pension Benefit Guaranty Corporation (PBGC), guarantees payment of most private defined benefit plans. If your plan runs out of money, the PBGC pays your pension. However, the amount you receive from the PBGC may be less than what the plan had promised. The PBGC doesn’t cover plans offered by public (government) employers.

Most defined benefit plans are paid for (or funded) in full by employers. Plans must be funded ahead of time with contributions placed in a trust. Another option used by employers is the purchase of an insurance contract, called an annuity, that provides monthly payments for life.

While many defined benefit plans do not require employee contributions, some do. Contribution decisions depend on who sponsors your plan. If your plan is set up by one employer—a single employer plan—these decisions are made by (1) the employer or (2) negotiation between the employer and a union.

If you have a multiemployer plan that permits many employers in the same trade or industry to contribute to the same pension plan for their workers, a collective bargaining agreement and other legal documents state how much you and your employer must contribute to the plan.

In both cases, your promised future benefits are based on contributions plus investment earnings.

A federal government agency, the Pension Benefit Guaranty Corporation (PBGC), guarantees payment of most private defined benefit plans. If your plan runs out of money, the PBGC pays your pension. However, the amount you receive from the PBGC may be less than what the plan had promised. The PBGC doesn’t cover plans offered by public (government) employers.