IMPACT OF PENSION PLAN TERMINATIONS

U.S. Department of Labor Office of Inspector General

Audit Report

IMPACT OF PENSION PLAN TERMINATIONS

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This report reflects the findings of the Office of Inspector General at the time that the audit was issued. More current information may be available as a result of the resolution of this audit by the Department of Labor program agency and the auditee. For further information concerning the resolution of this report's findings, please contact the program agency

Report Title: Impact of Pension Plan Terminations

Report Number: 09-94-001-12-001

Issue Date: September 30, 1994

The Employee Retirement Income Security Act of 1974 (ERISA) is the principal law regulating qualified private pension and welfare benefit plans in the United States. ERISA was enacted to curb abuses in administering and managing the voluntary system for employee pension and welfare benefit plans and requires adequate disclosure of information to pension plan participants and their beneficiaries. The law established:

standards of conduct for plan managers in order to assure proper fiduciary controls;
funding requirements to protect participant vesting; and
a federally mandated insurance program, operated by the Pension Benefit Guarantee Corporation (PBGC), to safeguard pension benefits for workers when certain defined benefit pension plans are terminated.

The OIG performed a nationwide audit of pension plan terminations. The main objective of the audit was to answer several questions including:

Why are pension plans terminated?
What impact do pension plan terminations have on American workers?
What is the impact of the termination process on American workers?

According to the Plan Year (PY) 1990 Internal Revenue Service (IRS) Form 5500s, 60,859 pension plans were terminated involving 1.6 million participants and almost $27.6 billion in plan assets. Pension and Welfare Benefits Administration (PWBA) information indicates that during the same 1990 plan year, the U.S. had 712,000 active private pension plans with $1.8 trillion in assets, which increased to $2.5 trillion in 1992.

Plan Terminations

Since ERISA's establishment in 1974, Congress has passed other laws to strengthen funding requirements and provide additional protections to participants. The changes have limited plan contributions, reduced the accumulation of tax deferred contributions, or provided new types of pension plans, prompting some employers to change the type of pension plan offered or terminate all pension coverage. OIG interviewed plan sponsors and asked why their plans were terminated. Although sometimes more than one reason was given for terminating the pension plan, these are the three primary reasons given by 73 percent of the sponsors interviewed:

1. their desire to eliminate the administrative and cost burdens of the plans,
2. their reaction to tax law changes which reduced their tax benefits; and
3. normal changes in the business entity or a change in sponsors.

Because of tax law changes and the resulting increase in administrative costs, some of the plan sponsors believe that the tax benefit is no longer a sufficient reason to sponsor a qualified pension plan. When asked what would be the best way to encourage sponsors to maintain their pension plans, 77 percent stated that reducing burdensome administrative requirements, reducing regulations and providing employer incentives by changing tax laws would encourage continued plan sponsorship.

The OIG believes employers originally set up their qualified pension plans to provide retirement benefits, because the tax laws benefit them, and pension funding costs were acceptable. Without continued encouragement and incentives, plan sponsorship may decline leaving millions of American workers without adequate pension coverage.

Impact on Participants

Eighty-two percent of the participants interviewed stated the plan termination had no effect on them. However, only a few of the participants demonstrated they truly understood their pension plan and were concerned about losing pension coverage. Eighty- one percent of the participants received only a small dollar amount when the plan terminated, and they may have considered the loss of a small benefit as no loss. Whether the participants understood it or not, however, a pension plan termination is a real loss in terms of both present benefits and future income and means a loss of:

time accrued toward retirement if a replacement plan does not allow prior years of service to count toward vesting in a new plan or successor company's plan;
tax free accumulations if the distribution is not rolled over into another retirement vehicle;
PBGC guaranty obligation for defined benefit plans under Title IV of ERISA;
PBGC guaranty obligation when irrevocable commitments (annuity contracts) have been purchased to pay benefit liabilities; and
benefits to participants when they cannot be located when the plan terminates.

Another loss which is difficult to quantify is the possibility an individual must delay retirement until later than originally planned and/or experience a reduction in lifestyle at retirement because of a loss of pension benefits.

Asset Distribution

In the qualified terminated pension plans, 81 percent of the participants received eight percent of the benefits distributed which, if other resources are not ultimately available, would be inadequate to provide a meaningful pension. On the other hand, 19 percent of the participants received 92 percent of the benefits, more than $10,000 each, providing considerable assets toward future retirement.

In addition, some participants could not be located when the plan terminated, and they may never receive their promised benefit accrual under the terminated plan. Approximately $51.6 million in retirement funds are being held for 105,000 participants who were not located during the benefit distribution process. Some of these participants and/or their beneficiaries may never receive their accrued benefits.

Since retirement fund accumulations usually are related to the annual income and length of service, low wage earners and those with short employment periods have little potential for earning large retirement benefits. However, participants with large annual incomes and longer lengths of time in the plan, qualified for large amounts of retirement funds.

Trends

For the period prior to PY 1990, it appeared employers were terminating defined benefit plans and replacing them with defined contribution plans. Some participants felt the change benefitted them and others preferred the defined benefit plan. However, according to the May 1994 issue of the Employee Benefit Research Institute (ERBI) Notes, "Most recently, IRS statistics indicate that the net growth in defined contribution plans may be slowing. . .IRS determination letter statistics also indicate that the decline in the number of defined benefit plans may be flattening."

A desirable attribute of defined benefit plans is that they provide a future monthly benefit based on a formula, which includes factors for years of service and annual earnings. Most of the time, employers are totally responsible for funding these plans. When changing from a defined benefit plan covered under Title IV of ERISA, to a defined contribution plan, participants lose the PBGC Federal guaranty over pension assets.

Defined contribution plans generally provide for payments into an account in the name of the participant and at retirement the participant receives the contributions and earnings in the account. If it is a profit-sharing defined contribution plan, the employer decides how much, or if, to contribute each year. The defined contribution plans, in effect, shift the risk of investment gain or loss to the participant.

Conclusion

The audit indicated that ERISA provided reasonable protection for the funds in qualified pension plans. However, in the terminated plans we reviewed, most participants had only small amounts of funds while the majority of funds belonged to a very small number of participants.

The impact of terminations for most participants, especially those with low annual incomes, was receipt of only a modest amount of retirement resources and the loss of an ongoing plan which accumulated tax-deferred contributions and income. For some, the result was loss of a defined benefit plan and receipt of a defined contribution plan. For a few, the impact was receipt of very significant amounts of benefits.

The U.S. Government has a longstanding policy of granting tax incentives to employers providing pension coverage. Individual employees participating in a pension plan receive a deferral on income tax as their benefits accrue. The advantage of accumulating tax-deferred benefits is lost when plans terminate and the funds are not reinvested in similar retirement programs.

It is questionable whether or not the participants covered in our review understood or appreciated the need for retirement planning since 82 percent stated that pension plan termination had no effect on them. When asset distributions from the terminated plans are not reinvested, workers give up one of the major benefits of the current pension and tax laws which allow pre-tax dollars to accumulate into significant amounts of compounded tax- deferred retirement savings. In addition, workers lose the vested time

with the pension plan and normally have to re-start vesting requirements in a pension plan, if one is made available. As a result, some workers may not be able to retire with income security or may be forced to remain active in the labor force longer than they desire.

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