Data: Not an Infinite Problem; there is an Endgame
If the recent glut of superhero movies has taught us anything, it is that with great power comes great responsibility. Most pension plan fiduciaries tend to focus their responsibilities on plan assets. They exercise their power by monitoring asset performance, investment fees, and service provider expenses. These fiduciaries also have the responsibility to maintain the data and the liabilities associated with that data. They have the power to tap into the savings lurking in the shadows of the plan’s data. Most pension plans update data once a year, by taking the prior year’s data and modifying it for any changes that may have occurred during the plan year. However, over the years, data updates can slip through the cracks, and the data degrades.
Denial – My Data is Perfect
Every superhero has a weakness and data degradation is kryptonite for plan sponsors. Pension plans have always had missing participants or incomplete information. Participants and their beneficiaries often continue to be included in counts and liabilities long after they have passed away. Accrued benefits are not always accurate, forms of payment are frequently misreported, dummy Social Security numbers are used, and it’s not uncommon for dates of birth and even gender to be incorrectly reported. Unfortunately, the most common response by plan sponsors and administrators has been to ignore the problem. However, fiduciaries should tackle these issues head on and see data as a strategic opportunity to create savings for the pension plan.
Garbage in, Garbage out
Fiduciaries and pension committee members, with their powers combined, are making important business decisions based on this underlying data. These important business decisions include how much to contribute, what benefits to provide, and whether to freeze or even terminate the plan. To make the best business decisions possible, pension plan data must be complete, accurate, and easily accessible, especially in this era of heightened Department of Labor (DOL) and Internal Revenue Service (IRS) scrutiny. Government audits and potential litigation can be expensive and time consuming. Prematurely freezing or missing a strategic opportunity to terminate or de-risk the pension plan could have costly consequences, for the pension plan, its participants, and the plan sponsor.
Money, Plain and Simple
As the data decays over time, the pension plan could be carrying excess liability which can lead to increased pension accounting expense, higher than necessary funding requirements and, most painfully, excess PBGC premiums. PBGC premiums continue to soar faster than a speeding bullet, and currently range from $80 per person to $621 per person (for plans subject to the PBGC variable cap). The PBGC variable-rate premium now stands at 4.3% of the plan’s funding shortfall. For every $1,000 removed via data cleanup, the plan could save an additional $43 per year. Removing extra participants can save real money.
The Biggest Opportunity: TVs!
Terminated vested participants (TVs) can be the most challenging class of participants to monitor. TVs are vested participants who have terminated from the company, but have not yet commenced receipt of their pension benefit. In many instances, they may not be eligible to commence until years in the future (often no earlier than age 55 or 65). It can be difficult to keep in contact with these TVs, especially those who terminated early in their working career. Though the TVs have a responsibility to keep the pension plan informed of their location, often the participant forgets they even had a vested benefit with the plan, and do not inform the plan sponsor of their current address. A myriad of issues can arise. Here are 3 key areas:
- Benefit Gets Bigger:
Being unable to locate or communicate with terminated vested participants can lead to benefits commencing after their normal retirement date. In those instances, most of the time, the monthly benefit must be actuarially increased to reflect interest and mortality. These adjustments can increase the annual benefit 10% or more per year! It is much easier and cheaper to commence benefits on time and not have to provide such increases for any delays in payment.
A 65 year old terminated vested participant is due $100 per month. The lump sum value would be $16,000. But he doesn’t come forward to collect. 6 years later, he is tracked down to commence, since he is at his Required Minimum Distribution (RMD) date. Now he must be paid $220 per month, or a lump sum of $30,000. The $16,000 that could have been paid at 65 would need to return over 11% per year to accumulate into $30,000 at 71.
- Rules Get Broken:
You could also have issues with terminated vested participants beyond their RMD date. Participants must commence benefits by the April 1st following the year they reach 70½. This plan failure can lead to taxation issues for the participant as well as potential qualification issues for the pension plan. It opens the plan up to legal issues as well as increased expenses for corrective actions.
A terminated vested participant is well beyond his RMD date. This is an error that could lead to plan disqualification. More likely, the “fix” will be to go through the IRS’ Voluntary Compliance System. Forms must be completed (estimated to be 10 hours of time, per the IRS instructions) and a user fee of $1,500- $3,500 must be paid to the IRS. The participant owes a 50% excise tax on any required RMD amounts that were not timely paid, though the filing with the IRS does allow for a request (often granted) that the excise tax be waived.
- Money Gets Wasted:
Aside from not informing the plan of address changes, the plan may also not be informed when these participants pass away. Unlike with retirees, there is no monthly check to be stopped, and next of kin may have no idea that the participant was ever entitled to a pension. Generally, the spouse of a deceased TV will be entitled to a death benefit from the plan, however the plan may not know whether or not the participant was married, who the spouse is, or how to contact him/her. Some plans even call for death benefits to be paid to the beneficiary of a non-married participant. Tracking down the spouse/beneficiary of a deceased TV gets more difficult as time passes.
A terminated vested participant passes away unexpectedly at age 40. The plans administration procedures would not call for the Plan to attempt to contact this participant about his benefit until he is nearing age 65. As a result, this participant could be valued for 25 years in the actuarial valuation, resulting in higher accounting expense, minimum required contributions, and PBGC premiums. In an extreme case, PBGC premiums could be $600+ per year for these 25 years, resulting in over $15,000 being paid to the PBGC for a participant who is no longer due a benefit.
These problems can add up quickly. A handful of participants over 65, plus a few over age 70 ½ plus another handful who have unknowingly died could drive annual cost well over $10,000. Plans with thousands of TVs can add another 0 to that number.
Most plans are either Hard Frozen (no more accruals) or Soft Frozen (no more new participants). These plans should be thinking about terminating in the future. Plan termination could be closer than they think once all the potential data savings have been recorded. Conversely, with these savings, sponsors could have too much money in the plan with “trapped surplus”, subject to asset reversion excise taxes at plan termination.
In order to enact a plan termination, the data needs to be pristine for all of the participants. Certified accrued benefits and the historical pieces of data, such as salaries and years of service will be needed. Searches must be conducted for missing participants, and correct addresses obtained for as many participants as possible. There are many other steps that can and should be taken to clean up data prior to plan termination. If you wait to clean it all up once you’ve decided to terminate the plan, it may be too late, costing the plan, and its sponsor, time and money.
Let’s Get Started
A good data consultant can navigate you through the entire data scrubbing process and make sure you maximize all of the potential savings available to the pension plan. An initial data assessment from the consultant should be able to give you a report of the current status of the data quality. Payment registers should be cross referenced against the current pension plan data for retirees and beneficiaries. Death audits should be run for all terminated vested participants, retirees, and their beneficiaries. Locator services need to be utilized to track down missing participants (or potentially their beneficiaries) and the most current addresses. Hard copies of participant data information should be converted to electronic files. Each pension plan is unique and faces different challenges based on their historical data quality. As a result, additional plan specific processes may be necessary.
As time marches on, the data is constantly changing, but you want to have the most accurate, complete, and easily accessible data possible. Sponsors have the power to clean up the data. While the process may not be fun, the rewards can be large. Lower PBGC premiums, cleaner administration, and accelerated terminations await the sponsors who address these problems today, while future headaches and unnecessary expenditures await those who delay. If you’d like to be a plan sponsor superhero and take care of these data problems now River and Mercantile knows the right course of action and can help you prevent these data problems from recurring. We would be happy to discuss these issues further if you have any questions.