Category Archives: Defined benefit

Preparing a pension plan termination

The process of terminating a defined benefit (DB) plan is lengthy, time consuming, and costly. An actuary, trust custodian, attorney, trustee, and investment advisor can assist with many of the duties. In this DB Digest article, Milliman’s Stephanie Sorenson discusses the multiple tasks that plan administrators must accomplish in preparation for a plan termination.

Here’s an excerpt:

Data
It is important to review and validate the participant data. Quality data is critical to the termination process. Insurer quotes will reflect the accuracy, actual or perceived, of the data provided to them.

Also the Pension Benefit Guaranty Corporation (PBGC) requires that the plan sponsor maintain the participant and plan data for six years after plan termination (the date on which PBGC Form 501 is filed). The data should be gathered during the plan termination process and remain accessible during the six-year period.

Does the data have valid identification numbers for all participants? Does the data contain valid dates of birth, hire, participation, and termination? If not, review employment records and update.

Does the data include addresses for all participants and beneficiaries? Are the addresses valid? Do any participants reside outside the United States? Many notices are required to be sent during the termination process. An address and death search for all inactive participants may be prudent.
Verifying addresses prior to termination can save time and frustration.

Have all of the accrued benefits been calculated and certified? If yes, does the data include the information that was used to calculate the stored accrued benefit? During the termination process, a Notice of Plan Benefits will need to be supplied to all participants. This notice is required to provide the personal data used to calculate the participant’s accrued benefit along with a statement requesting that the participant correct any information they believe to be incorrect. If the plan has frozen accrued benefits but the calculation data is not available, the best available data must be provided to the participant on the Notice of Plan Benefits along with a statement giving the participant the opportunity to provide the missing data.

If benefits are not calculated and certified, does the data contain all of the information necessary to calculate the benefits? Final benefits will need to be calculated, not estimated, for all participants.

Data is fluid and constantly changes. Participants move, die, quit, get married/divorced, and retire during the termination process. Ensuring and maintaining accurate data is key to preparing for a plan termination.

Pension funded status comes almost full circle at 2016 year-end

Wadia_ZorastMilliman today released the results of its latest Pension Funding Index (PFI), which analyzes the 100 largest U.S. corporate pension plans. In December, the funded status for these pension plans improved by $13 billion due to robust investment returns of 1.17%, and the funded ratio increased from 80.3% to 81.0% to close out the year. Overall, interest rate declines characterized 2016, with the end of August marking the lowest discount rate (at 3.32%) in the PFI’s 16-year history. Since that point and coincident with the conclusion of the U.S. presidential election, interest rates have steadily increased.

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Last year was a rollercoaster of a year, but we’re ending up nearly where we started – with a funded ratio of 81.0%. Going into 2017, rumors of potential multiple interest rate hikes by the Federal Reserve have plan sponsors and pension practitioners closely watching market activity. If interest rates continue to climb, the funded ratio could make some major gains.

Looking forward, under an optimistic forecast with rising interest rates (reaching 4.59% by the end of 2017 and 5.19% by the end of 2018) and asset gains (11.2% annual returns), the funded ratio would climb to 93% by the end of 2017 and 106% by the end of 2018. Under a pessimistic forecast (3.39% discount rate at the end of 2017 and 2.79% by the end of 2018 and 3.2% annual returns), the funded ratio would decline to 74% by the end of 2017 and 68% by the end of 2018.

An executive survival guide for tax-exempt employers sentenced to Section 457

Pizzano-DominickThis blog is part of a 12-part series entitled “The nonqualified deferred compensation plan (NDCP) dirty dozen: An administrative guide to avoiding 12 traps.” To read the introduction to the series, click here.

By the time executives of the corporate world-at-large experienced the first full-fledged legislative lockdown of their nonqualified deferred compensations, when the American Jobs Creation Act of 2004 instituted Internal Revenue Code (IRC) Section 409A, most of their counterparts in the tax-exempt sector had already been long used to having such benefits confined. Many years earlier, the Tax Reform Act of 1986 (TRA 86) sentenced these benefits to the custody of IRC Section 457, generally effective for taxable years beginning after December 31, 1986. The problem is that even as we approach the 30th anniversary of this sentence, Section 457 applicability and compliance still remain sources of confusion and frustration for many not-for-profit employers as they seek to provide significant executive compensation programs.

Tax-exempt employers, not employees
When not-for-profit organizations hire key decision-makers from the “for-profit” world, these organizations frequently find individuals desiring deferred compensation benefits similar to those offered by their former employers. Unfortunately, too often the tax-exempt organization complies and implements a plan that, while perfectly in compliance with the tax laws governing similar plans sponsored by corporations in the for-profit sector, does not comply with the more restrictive limitations applicable to most not-for-profit entities. If the Internal Revenue Service (IRS) discovers such a plan during an audit of the individual or the organization, the employer’s good intentions could result in extremely adverse tax consequences for the executive.

The deliberations that led to the 457 sentence
Why are tax-exempt employers subject to stricter limits than their for-profit counterparts? Because the IRS gives these organizations a pass come tax time, they cannot afford to offer the same charity to their employees. The IRS does not mind if executives of taxable entities defer as much as 100% of their compensation because, while the opportunity to tax this pay is generally deferred until the funds are distributed, the plan sponsor’s ability to take a tax deduction on such amounts is similarly delayed, thereby creating a vital trade-off that enables the U.S. Department of the Treasury to view these arrangements as tax-neutral. In contrast, tax-exempt employers have no tax deductions that can be deferred and thus no trade-off to offset the Treasury’s loss of current tax revenue incurred by their employees’ deferrals of compensation. Because tax-exempt entities as non-taxpayers are not concerned with deductibility of compensation, unless it involves unrelated trade or business income, there would be no incentive for them to limit their employees’ deferrals on their own if Section 457 did not exist.

Applicability of Section 457: Not all tax-exempts are treated equally

Free from Section 457: No separation of Church and the Feds: Originally sentenced to Section 457 by TRA 86 with the other tax-exempts, NDCPs maintained by churches and qualified church-controlled organizations (QCCOs) were paroled in 1988, when the Technical and Miscellaneous Revenue Act exempted this congregation of plans from the application of Section 457 (however, a nursing home or hospital that is associated with a church, but which is not itself a church or a QCCO, would be covered by Section 457 if it is a tax-exempt entity). The only other NDCPs granted Section 457 immunity are those established by the federal government or any agency or instrumentality thereof; although this should not be too surprising given that the creation of these rules as well as determining who must comply with them is, after all, a federal function.

Those sentenced to Section 457: The states, cities, towns, and the rest of the tax-exempts: If an employer is an entity that is a state or local government or a tax-exempt entity other than those described in the preceding paragraph, any NDCP it establishes must comply with Section 457. Plans of states and local governments have been subject to Section 457 from its creation in 1978; however, because the rules governing these arrangements are more similar to those covering qualified plans (e.g., all employees—not just executives—participate, and plan assets must be held in a separate trust for the exclusive benefit of participants), the remainder of this blog will focus on the rules applicable to the nongovernmental tax-exempts sentenced to 457.

What are the terms of a Section 457 sentence?
While a 457 sentence is mandatory, in the sense that it is levied based on the employer’s status, tax-exempt employers do have considerable discretion over the manner in which they choose to serve this sentence: a 457(b) plan (aka an eligible 457 plan), a 457(f) plan (aka an ineligible plan), or concurrently using both. The following chart reveals their major differences:

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After the election: What’s ahead for corporate pension liabilities and funded status?

vaag_m_vanessaperry_h_alanNow that the presidential election is behind us, much of the political uncertainty that existed prior to the election has subsided, but uncertainty about the investment markets remains high. Interest rates spiked upward after the election and have continued moving higher. U.S. equity prices also spiked upward and have continued climbing. Now that we’re into December, plan sponsors are trying to gauge the impact of these recent events on end-of-year pension plan assets and liabilities. The longer-term impact of the Trump victory, however, is more difficult to predict.

President-elect Trump’s plans for corporate tax cuts, infrastructure spending, and deregulation are cited as some of the factors driving interest rates and expected inflation higher. The yield on the 10-year U.S. Treasury bond has increased about 50 basis points (0.50%) since the election, while the yield on the 10-year U.S. Treasury Inflation-Protected (TIP) bond has increased about 30 basis points (0.30%). The difference between the two yields, known as “breakeven inflation,” is a measure of inflation expectations. By this measure, expected average inflation over the next 10 years has increased by about 20 basis points (0.20%) since the election.

High-quality corporate bond yields—the basis for pension discount rates for accounting disclosure purposes—have increased by about 35 basis points (0.35%) since the election. If these yields remain at this level through the end of the year, plan sponsors could benefit from a drop of several percentage points in the value of their pension obligations (since the election), although yields are still below where they were at year-end 2015.

The Federal Open Market Committee (FOMC) is widely expected to raise its federal funds target interest rate when it meets this week. This would be the first increase since December 2015. It’s too early to predict whether this will be a single increase or the first of many increases over the next couple of years. If the Fed raises its target rate several more times, this could help support the recent spike in longer rates and possibly contribute to additional increases.

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Corporate pension funded status sees largest improvement of 2016, gaining $71 billion in November

Wadia_ZorastMilliman has released the results of its latest Pension Funding Index (PFI), which analyzes the 100 largest U.S. corporate pension plans. In November, the funded status for these pension plans experienced its largest increase of the year, improving by $71 billion, primarily due to interest rate gains that reduced the deficit for the Milliman 100 plans to $340 billion. The funded ratio for these plans climbed sharply, increasing three percentage points from 77.2% to 80.3%.

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While plan sponsors are pleased with the third straight month of funded status improvement, all eyes are on interest rates as we near the December 30 measurement date. Discount rates have climbed 66 basis points since their record low in August, now the question is whether we’ll see interest rates climb above 4% by year’s end.

Looking forward, under an optimistic forecast with rising interest rates (reaching 4.63% by the end of 2017 and 5.23% by the end of 2018) and asset gains (11.2% annual returns), the funded ratio would climb to 93% by the end of 2017 and 106% by the end of 2018. Under a pessimistic forecast (3.33% discount rate at the end of 2017 and 2.73% by the end of 2018 and 3.2% annual returns), the funded ratio would decline to 73% by the end of 2017 and 66% by the end of 2018.

Public pension plans’ funded status improves in Q3

Sielman-BeckyMilliman today released the third-quarter results of its Public Pension Funding Index, which consists of the nation’s 100 largest public defined benefit pension plans. As of September 30, the funded ratio of these plans rose to 71.0%, up from 69.8% at the end of June. The funded status improved by $48 billion, the result of an estimated $86 billion increase in plan assets thanks to relatively healthy investment returns of 3.5% for the quarter.

While investment returns were healthier than expected, our Milliman 100 plans experienced a wide range of returns, from an estimated low of 1.33% to a high of 4.37%. Bond funds and commodities generally fared poorly, after having done well in the second quarter. It’s yet to be seen whether they will rebound as we close out the year.

The Milliman 100 PPFI total pension liability (TPL) increased from $4.583 trillion at the end of Q2 to an estimated $4.620 trillion at the end of Q3. The TPL is expected to grow modestly over time as interest on the TPL and the accrual of new benefits outpaces the benefits paid to retirees.

To view the Milliman 100 Public Pension Funding Index, click here. To receive regular updates of Milliman’s pension funding analysis, email us.