What to know when your defined benefit pension plan terminates
Defined benefit (DB) pension plans date back to the United States Revolutionary War¹ and continued to grow in popularity into the 1980s.² But since then, more and more companies are cutting DB plans from their benefit packages. Know your options for handling your benefit if your employer decides to do the same with your plan.
What’s the difference between terminating and freezing your DB plan?
Cutting DB plans often comes down to cost and can be further justified by the lack of competitive need—fewer employers are offering them, so companies aren’t at a disadvantage without them. If your company is getting rid of yours, the process starts by freezing your plan. After that, if they want to fully eliminate the plan, they’d take the additional step of terminating it altogether.
Freeze the plan
DB plans are typically frozen in one of two ways:
- Soft freeze: Newly hired employees can’t join the plan, but employees already in the plan may continue accumulating benefits.
- Hard freeze: Newly hired employees can’t join the plan (same as a soft freeze), and existing employees’ benefits don’t grow further.
The employer has flexibility when freezing the plan—they can unfreeze the plan in the future if they want. Employees in a frozen plan don’t have an immediate decision on handling their benefits—they can wait until retirement as they would if the plan was active (i.e., not frozen).
Terminate the plan
A DB plan termination is a permanent decision to end the plan’s operations, and the employer must distribute all money in the plan. The payout options for your plan will continue to be available and may already include a lump-sum option (your entire benefit is paid immediately). During the plan termination, you’ll likely be offered a lump-sum payment (even if it’s not an existing option) and be eligible to receive some form of annuity, often paid over the course of your life or your spouse and your combined lives.
Terminated DB plan payment option 1: take a lump-sum payment
A lump-sum payment is a one-time payout of your entire benefit amount, typically paid shortly after the plan terminates. You may be able to roll it over to another retirement account if you have one, such as a 401(k) plan or an individual retirement account (IRA). Rollovers may allow your money to maintain its tax-advantaged status until you want to withdraw your money in retirement.³
There are advantages and disadvantages to consider if taking a lump sum:
| Potential pros | Potential cons |
| You control all investment decisions | You no longer have a guaranteed income stream when you retire |
| Your investment returns may exceed inflation—the rate that prices for goods and services increases by | You're responsible for decision-making for a potentially large sum of money |
| You can ensure your full benefit is spent as you wish | You'll potentially pay taxes on the entire amount, depending on how you receive the lump-sum payment |
| You decide when and how much to withdraw and use, either from your bank account (if you didn't roll it over) or other retirement accounts you rolled the money over to |
Terminated DB plan payment option 2: receive annuity payments
Your other option is a form of an annuity—a series of guaranteed payments to you (usually monthly). You may be able to choose whether the payments last for a certain length of time (e.g., 20 years), the remainder of your life, or the remainder of your spouse’s life. There are many types of annuities with varying features, so check your plan documents to see which options are available to you.
Many people envision regular annuity payments when thinking about the benefits of a DB pension plan. But, like lump-sum payments, there are pros and cons to consider:
| Potential pros | Potential cons |
| You receive guaranteed income | Most annuities aren't adjusted for inflation, so your money can lose purchasing power over time |
| You don't have to worry about managing a large sum of money; instead, this is the responsibility of the insurance company making your annuity payments | If your plan terminates, your employer is required to transfer your annuity to an insurance company. When this happens, your money is no longer covered by the Pension Benefit Guaranty Corporation (PBGC), the federal agency responsible for insuring DB plans. Your benefit payments now depend on the financial health of the selected insurance company (subject to its state guaranty association requirements and protections). |
| Aside from choosing an annuity that pays your spouse after you pass away, you won't be able to leave money to your loved ones | |
| You may receive less than the value of the lump sum if you pass away prematurely |
Deciding which payment option is suitable for you
Figuring out what to do with your DB plan benefit if your plan terminates can be a difficult decision. Are you comfortable making investment decisions and withdrawing money on your terms? If so, then a lump-sum payment may make sense. Or would you rather receive a guaranteed income in retirement through an annuity payment?
Consider your overall financial situation before choosing. You can always consult with a financial professional for an informed second opinion.
1 “Revolutionary War Pension Records and Patterns of American Mobility, 1780–1830,” The U.S. National Archives and Records Administration, 1984. 2 “A Visual Depiction of the Shift from Defined Benefit (DB) to Defined Contribution (DC) Pension Plans in the Private Sector,” Congressional Research Service, 12/27/21. 3 There are advantages and disadvantages to all rollover options. You are encouraged to review your options to determine if staying in a retirement plan, rolling over to an IRA, or another option is best for you.
Important disclosures
Prior to establishing a defined benefit plan, including a cash balance plan, plan sponsors should also consider factors such as, but not limited to, the plan’s funding requirements and their impact on the company’s fiscal position, the investments chosen for the plan and their potential influence on the contributions required, and the federal rules that govern this type of plan. Cash balance plan investment losses may increase contributions and incur higher administration costs because the services of an actuary will be required. Minimum contributions may be required, and the plan will need to pay annual premiums to Pension Benefit Guaranty Corporation to guarantee benefits.
The content of this document is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made.
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