What to Do If Your Pension Is Frozen or Terminated

The use of pension plans is declining. Many people are navigating what to do with their pension plans as they are frozen or terminated. In 2017, only 16% of the Fortune 500 companies offered a traditional pension plan to employees, compared to 59% in 1998. Among pharmaceutical companies the numbers are much better, with 50% of companies still offering pension plans.

The shift away from pension plans is obvious and ongoing. As more and more companies get rid of their pensions, it makes it easier for other companies to do the same. Companies used to offer a pension plan to employees to be competitive with other employers. This is no longer the case. (For more, see: How Do Pension Funds Work?)

Freezing and Terminating Pension Plans

Companies eliminate pension benefits to employees in two ways: freezing or terminating. Here is what those terms mean:

  • Freezing: When a pension plan is frozen it is closed to new employees and current employees may stop accruing benefits, but the plan continues to operate. You generally have to wait until retirement age to begin receiving benefits which would be either a lump-sum or a monthly annuity amount.
  • Termination: When a pension plan terminates, it stops operating. Employees participating in a pension when it is terminated are generally offered a monthly annuity payment during retirement or a lump-sum payment to be made at the time of the termination of the plan. In either case, participants will still receive a benefit and will not lose anything they’ve already earned to that point. They just won’t earn more benefits in the future.

What to Do if Your Employer Cuts Your Pension Plan

If your employer freezes or terminates its pension plan, you'll first want to reevaluate your retirement planning. If you were counting on your pension to provide a certain amount of income during retirement, you’ll need to adjust that assumption lower.

Employers often increase their 401(k) benefits when a pension is frozen, but it likely won’t make up fully for the impact of the reduced pension. You’ll need to save more during your working years to make up for the reduced pension income. Exactly how much you will need to save is one of the things that you’ll need to determine. Your 401(k) is your main retirement savings plan and it becomes even more important now. You’ll want to make sure it’s invested appropriately to meet your needs.

If you aren’t able to increase your savings, it may mean you’ll have to work a few more years than you had planned. Perhaps you had a big enough cushion in your retirement plan that the reduced pension won’t impact you too deeply. The point is, you won’t know what you need to change until you update your retirement plan to see where you are.

If you’ve never done any retirement planning, the event of your employer freezing or terminating its pension is a good time to start. (For more, see: The Demise of the Defined-Benefit Plan.)

Choosing Between Monthly Payments Or a Lump Sum

If your employer terminates your plan, you’ll have some additional decisions to make. That’s because your employer will give you the choice between taking monthly pension payments for life or receiving a lump-sum payment. The idea behind the lump-sum is that you can invest the money in an IRA and pay yourself a monthly income through systematic withdrawals during retirement.

This is a very important decision because you can’t change your mind. You’ll want to carefully weigh the pros and cons of each option.

Monthly Payment Considerations

  • Security: The monthly pension is guaranteed for your lifetime and, if you choose, your spouse's lifetime. This is true to the extent that the pension plan stays solvent and does not default. Assuming the pension plan remains in place, you do not have to worry about outliving your money.
  • Inflation: Most pensions do not have a cost of living adjustment. This means that the amount you receive today is the same amount you will receive for the rest of your life. It will not increase. This becomes a problem because things will cost more in the future. The longer you live, the less your monthly pension will buy. You have to have a plan for how you are going to deal with inflation because your monthly pension will not keep up.
  • Heirs: There is no benefit to your heirs. If you die early your spouse may continue to receive only 50% to 75% of your benefit. When your spouse dies, no other heirs will receive any benefit.
  • PBGC risk: The Pension Benefit Guaranty Corporation (PBGC) is the government agency that insures pension benefits. PBGC steps in when pension plans cannot pay promised benefits. There is a maximum benefit that the PBGC will pay, which means the benefit you receive from PBGC could be less than you would have received from your company pension.

Lump-Sum Considerations

  • Not guaranteed: If you invest the money poorly you could run out of money.
  • Inflation: With a lump sum, investments can be made to keep up with and exceed inflation so that your income and purchasing power can grow over time.
  • Heirs: If you die early and your spouse dies early, your heirs still receive any money that is left.
  • Control: You can invest the money as you want. You could potentially provide yourself a higher income than the monthly pension.
  • Flexibility: Invest the money how you want. Take withdrawals as you want, when you want.
  • Taxes: You can modify your withdrawals over time. You can temporarily stop withdrawals if you want, thus lowering your taxable income and allowing you to manage your tax strategy year-to-year.

Questions to Ask

The best strategy will depend on many variables in your situation. It's important to take into consideration the following questions when deciding which strategy will work best for you:

  • What is the present value of the future pension payments?
  • How long do I think I and my spouse will live?
  • What are my monthly income needs in retirement?
  • What other sources of income do I have for retirement?
  • What’s best for my situation?
  • How comfortable am I investing a lump sum?
  • How comfortable do I feel leaving the money in the pension plan?
  • Do I have heirs?
  • How important is flexibility in investments and tax planning to me?

Once you have the answers to these questions, you will have a better understanding of which type of payment plan will work best for your situation.

If your employer freezes or terminates your pension, it is important to update your financial plan and take this change into account. If you are given the choice between a monthly pension benefit and a lump-sum payment, there is no right answer. There are many factors that need to be considered for each individual person and the decision should be carefully made. (For more from this author, see: 2 Things You Need to Know About 401(k)s.)