Employers have been killing off defined pension plans for years now.
Nearly 60 percent of companies surveyed early this year said they have either frozen accruals for all participants or closed their defined benefit plans to new entrants. Many more are likely to do the same within the next two years, the survey of senior corporate financial executives by Prudential Financial Inc. and CFO Research Services found.
So, how easy is it to terminate a defined benefit plan?
According to the experts, it’s definitely not something that can just happen overnight.
Companies (and especially governments) can’t just decide one day that they want to close down their plans. There are steps they must follow so the process goes smoothly and plan participants feel the least amount of pain.
Here are nine, compiled from BenefitPro.com interviews with a couple of leading thinkers:
Plan ahead. Darlene Finzer, a principal of employee plan audit services at Rea & Associates, says a standard termination takes four to six months, as long as there are no delays. For bigger plans, it could take six to 18 months to process a normal plan termination. Part of that process involves applying to the IRS for a determination ruling. It could take up to a year to receive that approval.
Build a good team. Finzer recommends that plan sponsors hire a good ERISA attorney, financial advisor and an actuary or accountant to help them decide whether a plan termination is the best option for them. “I think it is important to have those individuals in place. They can bring a unique, much-needed aspect to making sure your plan termination goes smoothly and according to how the plan sponsor would like it to happen,” she said.
Fill out the paperwork. It isn’t just the IRS that needs to be informed you want to terminate your defined benefit plan. The Pension Benefit Guaranty Corp. also needs to be involved and, if your organization deals with employee unions, the unions themselves and the Department of Labor also need to be involved in the termination process. When plan sponsors decide to terminate their plan, they need to make sure their plan documents are updated to reflect the different options they will offer plan participants. If, for instance, a plan doesn’t offer lump sum distributions but wants to offer that option as part of the plan termination, the plan documents need to be amended to reflect that change, Finzer said.
Know your funding level. Before a pension plan can be terminated, plan sponsors need to know where they stand. Is the plan fully funded, underfunded or overfunded? Different steps must be followed depending on the funded status of the plan. Pension plans must be fully funded at the time of termination, so it makes a difference in the termination timeline whether a plan needs to sink millions of dollars into the plan before it can be terminated. That may include de-risking strategies like freezing a plan to new employees, which takes time. Over-funding creates its own set of problems, not the least of which is determining where that extra money should go and giving Uncle Sam its share of it, said Jeff Schapel, vice president and manager of actuarial consulting for CBIZ Retirement Plan Services in Cleveland, Ohio. That said, it is much easier to start the termination process with a fully funded plan.
Do the math. See if plan termination will save your organization money in the long run. As an actuary that handles lots of pension plans, Schapel said that what usually trips up plan sponsors is the immediate financial hit a balance sheet takes when a pension plan is terminated. “When you terminate your plan you have to use the PBGC rates. They decide what interest rates to calculate lump sums,” he said. Plan sponsors also must determine whether they want to offer their participants lump sum payouts or purchase annuities for them.
Another item that plan sponsors don’t think about is how they’ve been carrying their pension liabilities on their balance sheet through unrecognized losses. If they decide to terminate the plan, they have to “recognize all those losses at once,” Schapel said.
If a $100 million plan had $50 million in unrecognized losses on its books, it would have to recognize that, he said. It is difficult to prepare the board or shareholders for that financial impact.
Re-examine your investment strategy. If your plan is terminating, you don’t want to leave the assets sitting in high-risk investments while you move through the termination process, Schapel said. The market could drop drastically while you are waiting to terminate, creating huge losses for the plan.
He recommends evaluating a plan’s investment strategy before the termination process even begins.
Lee Topley, managing director of the retirement plan consulting group at Unified Trust Co., recommends that once plan sponsors get approval to terminate their plan, they sell their high-risk investments and move that money into something safer, like a money-market fund.
Follow the PBGC’s plan termination timeline. Plan sponsors do not want to try and terminate their plan without going through the PBGC’s outlined process, Finzer said. There is actual termination paperwork that needs to be filed with the PBGC. There also are some great tips and all of the forms that would be required to be filed throughout the termination process on the PBGC website.
“My advice is look at that information, what forms are required and follow the timeline the PBGC has in place because if (plan sponsors) miss some of those pieces or some of those timelines, they might have to start the process over,” she said.
Finzer recommends putting together a termination calendar that spells out exactly when each document needs to be filed and when notices need to be sent out to participants.
Come up with a replacement plan. While plan termination is happening, it’s a good idea for companies to consider what they will replace their pension plan with. If the company isn’t filing for bankruptcy, but just trying to get pension debt off its books, it is a good idea to see whether a 401(k) plan or other option is right for their participants, Schapel said.
Retain paperwork associated with the plan termination. Plan sponsors need to retain any records pertaining to the pension plan termination process for at least two years, said Finzer. That includes valuations, trust reports and participant distribution paperwork. The PBGC can come in and audit plan terminations up to two years after they happen, she said. The PBGC will audit any plan termination that involves more than 300 participants. For those with fewer participants, the PBGC will just choose which plans to audit at random.