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.
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.
I know what you’re thinking. First Kenny Rogers and now the Rolling Stones? Why does this guy keep quoting 1980s songs and relating them to defined benefit (DB) plans?
Well, there were two things I did during my summer nights as a teenager growing up in the ’80s that left a lifelong impact on me – listening to music and dreaming about DB plans. Didn’t we all? More on this later….
Anyway, in my last post, I introduced the idea of dynamic asset allocation (DAA) as a DB plan risk management strategy. This strategy works particularly well with hard frozen DB plans.