Termination of a Plan

Definition

Termination of a plan describes the process of discontinuing a pension plan offered to employees by an employer. There are two primary ways in which a pension plan can be terminated: standard termination and distress termination.

Standard Termination

A standard termination occurs when a pension plan is terminated with sufficient assets to cover all owed benefits. In this scenario, the plan sponsor has to ensure that all retirement benefits are fully funded. The sponsor can achieve this by:

Purchasing Annuities: Buying annuities from an insurance company to satisfy the remaining benefit obligations.
Paying Lump Sums: Providing lump sum payments directly to plan participants to fulfill owed benefits.

Distress Termination

A distress termination is primarily used in situations of severe financial distress, often linked to bankruptcy. This form of termination can only be pursued if the business faces significant financial hardships that render the continuation of the plan unsustainable.

Examples

Standard Termination Example: A company that decides to terminate its pension plan because it is switching to a different type of retirement benefit plan ensures that all accrued benefits are covered either by purchasing annuities or paying out the owed benefits in lump sums to its employees.
Distress Termination Example: A corporation filing for Chapter 11 bankruptcy determines it cannot afford to maintain its pension plan and seeks a distress termination to relieve itself of future financial obligations towards the plan.

Frequently Asked Questions (FAQs)

What is a standard termination?
- A standard termination is the process of ending a pension plan when the plan has enough funds to cover all accrued benefits, usually done through purchasing annuities or paying lump sums.
What constitutes a distress termination?
- A distress termination occurs due to significant financial hardship, where the sponsor determines it is no longer feasible to maintain the pension plan, often associated with bankruptcy proceedings.
Can a distress termination happen without bankruptcy?
- Yes, while it is usually associated with bankruptcy, a distress termination can also occur due to severe financial difficulties even without a formal bankruptcy filing.
What happens to the benefits when a standard termination occurs?
- During a standard termination, all accrued benefits must be paid in full, either through purchased annuities or lump sum payments to plan participants.
Are there regulatory approvals required for plan termination?
- Yes, the Pension Benefit Guaranty Corporation (PBGC) must be notified and, in some cases, approval is necessary for termination processes to ensure compliance with regulatory requirements.

Pension Benefit Guaranty Corporation (PBGC): A federal agency that oversees the protection of pension benefits in private-sector pension plans.
Annuity: A financial product that provides a fixed stream of payments over time, purchased by an insurance company on behalf of the pension plan sponsor.
Chapter 11 Bankruptcy: A form of bankruptcy that involves the reorganization of a debtor’s business affairs and assets.
Lump Sum Payment: A one-time payment made to pension plan participants instead of recurring payments.
Plan Sponsor: An employer or organization that offers a pension plan to its employees.

Online References

Suggested Books for Further Studies

“The Pension Answer Book” by Stephen J. Krass
“Pension Finance: Putting the Risks and Costs of Defined Benefit Plans Back Under Your Control” by Dirk J. Broeders and Anja D. C. Martijn
“Pensions Explained: Why defining benefits pays” by Michael Orszag and John W.R. Phillips

Fundamentals of Termination of a Plan: Business Law Basics Quiz

### Does a standard termination require the pension plan to be fully funded? - [x] Yes, the plan must have enough money to fully fund all benefits. - [ ] No, the plan can terminate with partial funding. - [ ] Only a partial amount is needed if approved by PBGC. - [ ] Funding level is irrelevant in standard termination. > **Explanation:** A standard termination can occur only if there are sufficient funds to cover all accrued benefits. ### What primary methods can be used to fully fund a standard termination? - [x] Purchase annuities and pay lump sums - [ ] Borrow funds from a bank - [ ] Rely on future business earnings - [ ] Apply for government grants > **Explanation:** The required benefits in a standard termination can be met by purchasing annuities from an insurance company or by paying lump sums to the plan participants. ### What typically triggers a distress termination? - [ ] Voluntary decision by the sponsor - [x] Business necessity owing to financial distress - [ ] High management fees - [ ] Change in ownership > **Explanation:** A distress termination usually happens due to significant financial hardships necessitating the termination, often linked to situations like bankruptcy. ### Which federal agency oversees the termination of pension plans? - [ ] Internal Revenue Service (IRS) - [x] Pension Benefit Guaranty Corporation (PBGC) - [ ] Securities and Exchange Commission (SEC) - [ ] Federal Insurance Office (FIO) > **Explanation:** The PBGC is responsible for regulating and overseeing the termination processes to ensure pension plan members' benefits are protected. ### Can lump sum payments be used in both standard and distress terminations? - [x] Yes - [ ] No, only in standard termination - [ ] No, only in distress termination - [ ] It depends on PBGC's decision > **Explanation:** Lump sum payments can be employed in both types of terminations to meet the owed benefits to plan participants. ### In a standard termination, who selects the insurance company for purchasing annuities? - [ ] The plan participants - [x] The plan sponsor - [ ] PBGC - [ ] The Department of Labor > **Explanation:** The plan sponsor is responsible for selecting and purchasing annuities from an insurance company to fund the benefits during a standard termination. ### How does the PBGC get involved in a distress termination? - [ ] It provides financial assistance - [ ] It takes over the plan completely - [x] It ensures compliance with specific requirements - [ ] It offers reorganization plans > **Explanation:** The PBGC ensures that the distress termination complies with legal and regulatory requirements to protect the interests of the pension plan members. ### For a distress termination, does the business need PBGC approval? - [x] Yes - [ ] No - [ ] It depends on the size of the business - [ ] Only if the assets are below a certain threshold > **Explanation:** PBGC approval is generally required to proceed with a distress termination to ensure that the termination occurs under legitimate financial distress conditions. ### What is an annuity in the context of pension plan termination? - [ ] A lump sum payment - [x] A stream of fixed payments over time - [ ] A type of stock option - [ ] A loan product > **Explanation:** An annuity is a financial product that provides a fixed stream of payments over time, thus helping to fund the benefits owed upon plan termination. ### When filing for bankruptcy, which pension plan termination is usually pursued? - [ ] Standard termination - [x] Distress termination - [ ] Regular payout termination - [ ] Emergency termination > **Explanation:** A distress termination is usually pursued during bankruptcy due to the significant financial distress and inability to sustain the pension plan.

Thank you for exploring our detailed guide on the termination of a plan and engaging with our informative quiz questions. Keep building your expertise in business law and financial planning!