BETHLEHEM, Pa. (Reuters) - Bethlehem Steel Corp. said on Monday the U.S. Pension Benefit Guaranty Corp. would terminate its pension plan, dealing a blow to the company's efforts to restructure and complete a potential buyout.

The action comes as Bethlehem, which filed for Chapter 11 bankruptcy protection last October, is in talks to be acquired by International Steel Group (ISG). Bethlehem, like its peers, is weighed down by worker retirement costs.

Bethlehem's potential buyer is backed by New York buyout firm W.L. Ross & Co, which has bought the assets of other bankrupt steelmakers.

"We haven't made any decisions as yet on anything. We haven't quite finished our regular due diligence to begin with. But this is a new, wildcat negative factor," said Wilbur Ross, chairman of W.L. Ross & Co.

Under an exclusivity period, ISG still has three weeks to look at Bethlehem's financial accounts and facilities before it considers making an offer.

The consolidation is also supported by the United Steelworkers of America (USWA).

"This premature termination deals a serious blow to the potential recovery by the creditors of Bethlehem Steel Corp., one of the most important of which is the PBGC," Bethlehem Chairman and Chief Executive Robert S. "Steve" Miller said in a statement.

"Given the significant underfunding of our pension plan, this action by the PBGC is not unexpected," Miller said.

However, Miller said he was still "very disappointed" by the action because the company had not missed any scheduled contributions to the funds. He said the company would attempt to amend the timing of the plan termination, which is expected to be announced on Dec. 18.

The PBGC is a federal insurer of pension plans. PBGC said on Monday it was terminating the pension plan as a way of taking it over.

"The PBGC's insurance guarantees will protect the basic pension benefits of Bethlehem Steel workers," PBGC said in a prepared statement. "Retirees will continue to receive their monthly checks without interruption, and other employees will receive benefits when they are eligible to retire."

Miller, who was Chrysler's chief negotiator for the automaker's rescue in the 1980s, said Bethlehem expects its talks with ISG to conclude as planned around Jan. 6.

On Monday, Ross said his firm would make a decision by the January deadline. But he claimed that the steelworkers would now get "drastically reduced" pensions, making it more expensive for his firm to buy them out as part of a potential restructuring and takeover offer.

"The cost of all that will skyrocket now," Ross said.

Bethlehem's pension and healthcare deficits are about $3 billion each. The company has said its plants are generating cash -- just not enough to deal with the legacy costs.

"Legacy costs" -- pension plan and healthcare debts -- that were borne by Bethlehem and other steelmakers have been a main hurdle as a shrinking industry left them paying far more for ex-employees and dependents than for current workers.

USWA said on Monday they were also disappointed by the PGBC's action.

"Since Bethlehem declared Chapter 11, we have been working diligently with management to restructure the company," said Tom Conway, the chief USWA negotiator.

"The PBGC's action denied us the opportunity of granting shutdown pensions to workers who are reduced from the workforce as a result of the restructuring," he said.

ISG has acquired the assets of bankrupt steelmakers LTV and the smaller Acme. ISG reopened LTV mills under an interim agreement with the steelworkers reducing employee costs and streamlining staffing -- a model for an ISG-Bethlehem merger, Miller says.

Bethlehem is also pursuing a "stand-alone" track to make it an attractive partner if the ISG merger fails.

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