A spin-off of a single-employer defined benefit (DB) pension plan is a complicated transaction, with an end result of one plan split into two or more DB plans. The objective of federal rules governing spin-offs is that participants should be no worse off with respect to the security of their accrued benefits immediately following the spin-off, compared with benefits that would have been received if the plan had been terminated immediately prior to the spin-off.
A change in business circumstances might be one reason a plan sponsor would consider a spin-off. For example, if a portion of the participants in a single-employer DB plan are sold to another company, the buyer and seller might agree that the assets and liabilities of the affected DB plan participants be spun-off into a new plan that becomes the responsibility of the buyer.
Another reason a plan sponsor might consider a spin-off would be for risk management purposes. Many plan sponsors today are interested in transferring the responsibility for pension liabilities to either participants by a lump-sum distribution or to an insurance carrier by an annuity purchase. That interest is due to various uncertainties that will affect the ultimate cost of the pension liabilities (e.g., investment performance, liability interest rates, participant mortality, legislative changes, pension insurance premium charges). A plan sponsor in an ongoing pension plan is generally not allowed to transfer the responsibilities for the liabilities of active participants unless the plan is being terminated. If the assets and liabilities related to active participants are spun off into a new separate plan, that plan can then be terminated with the liability responsibility transferred as described above.
The Pension Benefit Guarantee Corporation (PBGC) is the federal agency responsible for the insurance of unfunded pension liabilities. In the case of an underfunded pension plan termination, the amount of the shortfall covered by the PBGC is dependent on the PBGC’s rules on how liabilities are categorized, with certain lower-priority liabilities not insured by the PBGC. If 3% or more of plan assets are spun-off into a new plan, a complicated actuarial calculation must be done to determine the assets allocated to each plan, based on PBGC liability categorization rules for underfunded plan terminations. Also, a Form 5310-A must be filed with the Internal Revenue Service (IRS) at least 30 days prior to the effective date of the spin-off.
If less than 3% of plan assets are spun off into a new plan, the Form 5310-A filing is not required. Also, the actuarial calculation becomes much simpler because the assets allocated to the smaller plan are just equal to the present value of its liabilities rather than determined by the above rules for larger spin-offs.
In summary, given the complexities of the requirements for implementing a single-employer DB plan spin-off, a plan sponsor may wish to discuss the proposed spin-off with the plan actuary and legal counsel before proceeding.