What is Distress Termination?

by Investing School on December 3, 2012

No employee wants to hear that their company is involved in a Distress Termination. This process involves decreasing an employee base in relation to the company’s benefit plan. It occurs when the benefit plan can’t cover the expenses associated with paying the employees earned benefits.

This type of situation most often occurs when a company folds or when it is trying to avoid closing. Another circumstance may be an inability to pay debts without the termination. Once the benefit plan is terminated all the activities of the plan end as well. That means no more benefits accrue and vesting ends.

For the employees who have invested in the benefits plan this can be a real nightmare. The company must demonstrate that it cannot remain viable unless they terminate the pension plan. The pension plan may have become too expensive to maintain for a variety of reasons; for example: fewer employees are participating or the company may be reorganizing for bankruptcy.

Fortunately, the Employee Retirement Income Security Act of 1974 offers protection for pensions which are privately held. Through the Pension Benefit Guaranty Corporation benefits are paid to those individuals who hold accounts in failed pension plans.

Needless to say the PBGC does not look favorably on such terminations. When a plan terminates in this fashion the PBGC takes over all of the plan assets and assumes the responsibility for any liabilities. A company who wishes to make use of a distress termination undergoes significant scrutiny. However, if the choice is between bankruptcy or termination of the pension plan, keeping the company open is often considered the better solution.

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