You likely chose to freeze your defined benefit (DB) plan for a variety of reasons – cost of capital, volatility of contributions, balance sheet impact – but have you considered what comes next?
There are two primary options:
- Terminate the plan and pay all the benefits in full – which most likely has higher expected costs but lower long-term market risk.
- Maintain the frozen plan – which most likely has lower expected costs but comes with a higher risk.
Some plan sponsors choose to sponsor a DB plan even after it is frozen, but most have an end goal to terminate it. A solid strategy is key to terminating your plan in an efficient and cost effective way. There are generally three steps to developing an effective termination strategy:
1. Evaluate the cost of termination. Why:
- To determine how long it may take to have funding in place to cover the cost.
- To develop a timeline for termination and determine how quickly you may be able to terminate.
2. Evaluate several funding strategies. Why:
- To pick a strategy that best fits your needs and will work within your timeframe.
3. Evaluate the outcome of various asset allocation strategies. Why:
- To assess possible costs and the volatility of these costs, several strategies should be evaluated, including the current asset allocation. There are two common asset allocation strategies. These are:
- Traditional static asset allocation, such as a 60% allocation to equity investment options and a 40% allocation to fixed income investment options. Many DB plans use static asset allocation.
- Dynamic asset allocation, which links the plan’s asset allocation to its funded status. Dynamic asset allocation can be especially effective for hard-frozen DB plans.
These three steps help address the importance of considering both sides of the funded status: liabilities and assets. Doing so promotes the development of a strategy that allows the plan sponsor to move the hard-frozen plan toward termination in a cost-efficient, timely manner. In my next blog, I’ll be discussing these three steps in more detail.
In addition to blogging here, I also tweet regularly about DB topics of interest. Click to follow me on Twitter- @scottruba.
Asset allocation/diversification does not guarantee a profit or protect against a loss. Use of dynamic asset allocation does not guarantee improvement in plan funding status nor the timing of any improvement.
Insurance products and plan administrative services are provided by Principal Life Insurance Company a member of the Principal Financial Group® (The Principal®), Des Moines, IA 50392.