Most DB plan sponsors that freeze their plan want to terminate it completely someday.
Terminating the plan allows plan sponsors to:
- Pay plan participants the benefit they have earned.
- Eliminate the liability that they have had to manage as part of the plan.
There are a lot of moving pieces leading up to a DB plan termination including:
- Administrative tasks (such as participant notices, election forms, government filings, etc.),
- Plan document amendments,
- Annuity purchase decisions,
- Protecting the plan’s funding status (which is so critical to maintain during this process).
Since this is my final blog in my “So You’ve Frozen Your DB plan – Now what?” series, I’m wondering if you are humming any songs in your head yet? Any guesses on what song I’m connecting these blogs to? I’ll give you two hints. Hint #1 – Sir Paul wrote it.
As I’ve been discussing, there are generally three steps a plan sponsor can consider when winding down their frozen defined benefit (DB) plan (that’s your #2 hint!). Today, I’d like to discuss the third step – develop an asset allocation strategy.
In my past few blogs, I’ve been discussing some of the strategies that Defined Benefit (DB) plan sponsors can consider in order to terminate their plan. There are generally three steps a plan sponsor can take. Today, I’d like to discuss the second step – develop a funding strategy.
Step 2 – Develop a funding strategy
After a plan sponsor has an understanding of what the cost to terminate the DB plan will be, the next step is to look at the available funding strategies for achieving this.
There are generally three steps to terminate a defined benefit (DB) plan. Today, let’s take a look at the first step– evaluating the cost.
Step 1– Evaluating the cost of terminating a DB plan
The cost to terminate a DB plan is generally more than the cost to fully fund a hard frozen plan. Many plan sponsors don’t realize this. A common question I hear is “My plan is 100% funded under IRS rules. Why isn’t it sufficiently funded to terminate?” Sponsors may also not have made minimum required contributions for some time which could leave them under the impression their plan is funded enough to terminate it.
Different rules apply when determining plan termination liability. Plan sponsors can incorrectly assume if their plan is 100% funded from an ongoing perspective they are at the point that they can terminate the plan with no additional cost.
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.
What may be done at any time will be done at no time.
– Scottish Proverb
Plan sponsors utilizing an unbundled service arrangement may be unintentional procrastinators without even knowing it. Let me explain.
Bundling has benefits. If you’ve followed my last few posts, you’ve seen how bundling a defined benefit (DB) plan with one service provider can mean cost and time savings, increased oversight and better overall service for the plan sponsor. Another advantage of bundling is eliminating a significant risk most plan sponsors may not even be aware of – the “Harriet factor”. Read more