You may have heard of the Pension Benefit Guaranty Corporation (“PBGC”) but might not truly understand how it works. This comes as no surprise.
In substance, the PBGC serves as a safety net. It guarantees certain benefits up to specified limits set by law. It collects insurance premiums from the companies who sponsor the plans and invests those funds to support its operations.
Luckily for small business owners, most companies are exempt. But you still must understand the rules.
How does the PBGC Work?
The PBGC was established by the Employee Retirement Income Security Act of 1974 (ERISA) in the United States. Its primary role is to protect the retirement incomes of employees who are enrolled in company sponsored defined benefit plans.
The PBGC essentially functions as a form of “insurance” for these pension plans. It will step in to provide benefit payments if a covered plan becomes runs out of money or is terminated with insufficient cash to meet the employee benefits.
If a covered plan fails, the PBGC takes over the plan administration and pays benefits to the participants. Thus, ensuring they receive at least a basic level of retirement income.
As such, the PBGC plays a vital role in safeguarding the retirement security of millions of Americans by providing a backstop in the event of pension plan failures. Its mission is to ensure that workers and retirees receive the pension benefits they have earned over their years of service.
PBGC Exemptions
PBGC covers all defined benefit plans. Only those plans meant for substantial owners are exempted from this coverage. Including even one, not notable employee eliminates a plan from qualifying for the exemption.
- A substantial owner meets the following requirements;
- 100% ownership of the unincorporated trade or business
- Direct or indirect ownership of 10% or more of a capital interest in a partnership
- Direct or indirect ownership of 10% or more of profit interest in a partnership
- Own 10% or more voting rights of a corporation
- Own 10% or more of a corporation’s stock value
The ownership attribution rules mainly used to determine controlled groups also apply when ascertaining the stock ownership. Under these rules, stock owned by an owner also belongs to their spouse. Therefore, the owner-only exemption will apply if all participants are substantial owners or their spouses. Children of a significant owner are not attributed to stock ownership. Including them in a benefit plan eliminates the plan from PBGC coverage exemption.
Different plans may also have rules that may change a plan’s reporting or testing requirements but do not specify the PBGC coverage exemption. Some plans are exempted from filing Form 5500 or prefer to file Form 5500-EZ compared to Form 5500-SF or the standard Form 5500. Filing Form 5500-EZ requires that:
- The plan covers the 100% owner of the unincorporated or incorporated business or only the partners in a partnership.
- The plan may include the business owner’s spouse or partners’ spouses.
- No other employee is covered.
Filing Form 5500-EZ does not require ownership of more than 10% of the employer compared to PBGC’s substantial owner exemption. This means that not all eligible plans to file Form 5500-EZ qualify to be exempted from PBGC coverage.
Non-discriminatory testing also considers a 5% ownership of an employer as a Highly Compensated Employee (HCE). PBGC coverage exemption requires a 10% ownership. Therefore, it is not enough for a defined benefit plan covering all HCEs to claim an exemption.
Suppose a PBGC-covered plan terminates without enough assets to distribute to all beneficiaries. In that case, PBGC allows the majority owner to waive a portion of his benefits to be distributed to other participants for their exclusive benefit.
A majority owner, in this case, owns 50% or more of the employer, which is different from the 100% ownership requirement when determining a substantial owner for PBGC coverage exemption.
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Final Thoughts
In conclusion, the Pension Benefit Guaranty Corporation (PBGC) stands as a vital safeguard for the retirement security of millions of workers and retirees across the United States. By providing a form of insurance for private-sector defined benefit pension plans, the PBGC ensures that individuals receive at least a basic level of pension benefits.
Moreover, the PBGC’s role extends beyond mere financial protection—it also contributes to the stability of the pension system and the broader economy. By stepping in to support troubled pension plans and prevent widespread losses among retirees, the PBGC helps maintain confidence in the retirement system, encourages participation in employer-sponsored pension plans, and fosters a sense of trust in the private retirement sector.
As such, the PBGC plays a pivotal role in upholding the social contract between employers and employees, ensuring that workers can retire with dignity and security, thus underscoring its indispensable importance in the fabric of America’s retirement landscape.
