Is Your Defined Benefit Plan Ready for Termination?
Part 1 – Getting to the End
As the saying goes, “All good things must come to an end.”
For a defined benefit pension plan that is closed to new participants, or has frozen benefit accruals, the “End” is settling its liabilities in a plan termination. Most plan sponsors understand the general contours of a plan termination – some combination of lump sums to participants and a transfer of remaining liabilities to an insurance provider, with some participant notices, government filings, and perhaps a big contribution made along the way. The challenge facing plan sponsors is understanding not the “what” of plan termination but the “when” and the “how” – when termination will occur, and how to prepare for it. In other words: what do frozen plan sponsors need to do to make “the End” a good one?
In a series of posts, we’ll be digging into four critical areas that plan sponsors need to assess so they can plan for a smooth plan termination, i.e. a good “End”.
First, what is the plan’s funded status on a plan termination basis? The cost of terminating the plan is different from the accounting or funding bases sponsors wrestle with each year. Understanding the true cost to terminate is critical to knowing how close you are to “the End”.
Second, how much funded status risk does the plan carry? Every defined benefit plan faces a myriad of risks that can affect the funded status, including changing interest rates, volatile investment markets, demographics, and regulatory changes. These risks provide opportunity to sponsors of ongoing plans. But, as a plan nears full funding, these risks need to be reduced and eventually eliminated. Otherwise, sudden changes in interest rates or investment markets can set you back years on the road to termination.
Third, is the plan administration clean? Defined benefit administration is complicated and includes many facets (e.g. forms, notifications, and plan documents). These facets will all come under scrutiny by the regulatory agencies as part of the plan termination. Almost all plans have some minor issue that needs to be addressed. These minor issues generally don’t impact ongoing plan operations, but they can create major headaches if they not addressed until the plan termination process has begun. Meanwhile, major issues can stop a plan termination in its tracks.
Fourth, is the data complete? There is a lot of data needed to go through a termination. Ideally, plan sponsors will have all the pieces (e.g. pay and service histories) that were used to calculate benefits, complete census information, beneficiary data and every participant’s current address. Compiling any missing information will take a lot of time and effort; this work should be done well before starting the termination process.
Join us next week as we dive deeper into the first area: the plan’s funded status.
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