From Frozen to Terminated—Final Risk Transfer

My last post discussed step two in the defined benefit (DB) plan termination process. Now it’s time to look at the final step of a hard-frozen DB plan termination—the final risk transfer.

This involves paying out plan benefits to participants in order to satisfy the liabilities associated with the pension plan. Generally, there are two methods a plan sponsor can use:

Option 1 – Lump sum payments

Many terminating DB plans offer the option of a lump sum payment to participants who are not yet receiving benefits.

  • Pro. This method typically costs less than purchasing an annuity (option two).  However, many participants who take this option roll over their lump sum into their employer’s 401(k) plan.
  • Con. There is a risk that the participant will mismanage the funds, potentially resulting in less available income in retirement.

Option 2 – Purchase a guaranteed annuity from an insurance company

With this option, the plan sponsor uses plan assets to buy an annuity contract that transfers the pension liability to the insurance company. Then, as the participants reach retirement age, the insurance company pays them their monthly benefit payments via the annuity contract.

  • Pro. Allows participants the same annuity payment options that were otherwise available under the plan. This helps ensure retirement income to participants.
  • Con. This option may be more expensive than the lump sum option due to the risk the insurance company takes.

Additional steps

Once the annuity purchases and lump sum distributions (if applicable) have been made, the plan sponsor has a few remaining responsibilities to ensure a successful plan termination. Those include:

  • Pension Benefit Guaranty Corporation (PBGC) Form 501
  • Post-distribution certification
  • Treatment of excess retirement funds (if applicable)
  • Final Form 5500

It’s in the details

Termination of a hard-frozen DB plan requires more than just a well-planned investment and funding strategy.  The execution of the termination strategy and compliance with all the governmental filings and requirements are critical to a successful plan termination.

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Affiliation Disclosures

The subject matter in this communication is provided with the understanding that The Principal® is not rendering legal, accounting, or tax advice.  You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.

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.