Stop waiting on interest rates to manage DB risk and volatility!
What if a plan sponsor could take steps to help minimize costs and control volatility in their defined benefit (DB) plan regardless of the interest rate?
A recent paper published by Principal Financial Group® says it can be possible. (PDF: 694 KB)
It’s a common belief that interest rates have nowhere to go but up. And because bond investments typically go down in value when interest rates go up, plan sponsors may be avoiding investments in bonds in favor of other options. As the duration – that is, the length of the maturity of the bond – extends longer, the larger the decline in the bond investment will likely be if interest rates increase. So plan sponsors that invest in bonds have generally been sticking to shorter duration bond investments.
If a plan sponsor feels interest rates will go up, should they avoid bonds – and in particular longer duration investments? According to this article, that is not necessarily the case. Read more
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.
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.