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.