From a retiree’s perspective, the biggest risk with defined benefit retirement is that you are at the mercy of your former employer. That could put your retirement at risk if the employer or its pension fund runs into trouble. The solution: The Pension Benefit Guaranty Corporation (PBGC), which was founded in 1974 and protects retirees if a pension plan becomes insolvent. As of 2019, the PBGC covers more than 26,000 individual pension plans. In turn, around 40 million American workers have insurance protection for their pension earnings.
What Is the Pension Benefit Guaranty Corporation (PBGC)?
When a defined benefit plan goes bankrupt, or when it is otherwise unable to continue making payments, the Pension Benefit Guaranty Corporation assumes its obligations. The PBGC makes payments in the pension plan’s stead, ensuring that the covered retirees won’t lose what is often their primary source of income. It’s a bit like the pension equivalent of the Federal Despot Insurance Corporation, which insures deposit accounts so that savers don’t have to worry about losing their money to a bank failure.
Employers who have retirement plans under PBGC coverage pay mandatory premiums that fund this insurance. The PBGC also collects whatever is left in any plans that it takes over. If a retirement plan still has some capital and investments, but not enough to make all of its payments, the PBGC will take over both its assets and its liabilities. As a result, taxpayers currently do not fund the PBGC whatsoever.
The PBGC was created by the federal government as part of the 1974 Employee Retirement Income Security Act (ERISA).
What Are The Limits of PBGC Insurance Coverage?
Most private-sector pension plans fall under PBGC coverage. However, it does not apply to the following:
- Government/military pensions
- Private retirement accounts, like IRAs and 401(k)s
- Religious institution pensions
- Small professional practice pensions (companies with less than 25 employees)
- Profit-sharing plans
- Employee stock ownership plans (ESOPs)
- Thrift savings plans
- Money purchase plans
PBGC coverage is not an unlimited plan. It only replaces a defined benefit plan up to a maximum amount. In 2019, that amount is $5,607.95 per month, or $67,295.40 per year. Any retiree who would have earned more than that under their pension will unfortunately face some loss in benefits.
The PBGC has rarely had to reduce retiree benefits. The limits are there to keep its premiums low. Additionally, these limits prevent employers from offering outrageously high pensions with the knowledge that the government will cover them.
Distress Terminations vs. Standard Terminations
If a company is unable to pay off its pension benefits, it can file a distress termination with the PBGC. To receive this status, the plan provider must prove that it and any affiliated companies are fully unable to pay plan participants what they’re owed.
Should the PBGC grant the company a distress termination, it will become the pension plan’s new trustee. This will allow it to pay current and future retirees exactly what they are entitled to. The PBGC will use a combination of its own assets and existing assets within the plan to pay participants.
While the PBGC was created to protect retirees against insolvent companies and bad investments, a company can also hand over its pension plan voluntarily. This process is known as a standard termination.
To complete a standard termination, the company must demonstrate that it has enough money in its fund to meet all obligations. This typically involves either purchasing a lifetime annuity for each qualifying retiree or finding a way to deliver the total value of the retiree’s pension plan in a lump sum. The PBGC will oversee this process and intervene if necessary.
Problems With the PBGC
In 2009, policy experts believed that the PBGC might itself soon become insolvent. This was in very large part because of the looming bankruptcy of the American auto industry. Due to the industry’s historic unionization and prosperity, it has assumed vast pension benefits. In fact, at one point General Motors was infamously spending more on retiree benefits than on steel.
Widespread bankruptcy would have shifted those retirement payments onto the PBGC’s books. This lead observers like the Brookings Institute to report that the agency could run deficits of $100 billion or more under these circumstances.
Fortunately that didn’t happen, though this hasn’t saved the PBGC from financial problems altogether. As the number of employers who run defined benefit plans has declined, the PBGC has steadily lost premiums. Yet, even while its income is shrinking, its responsibilities are growing thanks to ongoing retirements, the 2008 financial crisis and more.
While the PBGC has had its share of financial issues, it’s still there to protect you if the pension you’re counting on runs into trouble. Still, even if you’ve got a pension coming your way, it’s a good idea to build a nest egg of retirement savings that you can tap in addition to that fixed income. You can use a retirement calculator to see if you’re on track for a secure retirement, and it’s also a good idea to work with a financial advisor who specializes in retirement planning.
Tips for Retirement Planning
- Planning out your retirement income can be extremely difficult. You need to consider your income needs, including healthcare expenses; figure out how much money you’ll need to meet those needs; and then build an investing plan that gets you there. If you’d like some help, consider working with a financial advisor. SmartAsset’s free financial advisor matching tool consider your financial situation and goals to match you with up to three fiduciary advisors in your area.
- Although it shouldn’t be your only source of retirement income, Social Security can be a big help. If you’re curious about what you’ll earn in Social Security, check out our Social Security calculator.
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