Tag Archives: single-employer retirement plans

Year-end compliance issues for single-employer retirement plans

By year-end 2014, sponsors of calendar-year single-employer retirement plans must act on necessary and discretionary amendments and perform a range of administrative procedures to ensure compliance with statutory and regulatory requirements. This Client Action Bulletin looks at key areas that such employers and sponsors of defined benefit (DB) or defined contribution (DC) plans should address by December 31, 2014.

PBGC premium increases in the federal budget agreement

The U.S. Congress has approved and sent to the president a federal budget agreement that includes an increase in the annual premiums that sponsors of single-employer defined benefit plans pay to the Pension Benefit Guaranty Corporation (PBGC) to insure the plans in the event of a plan termination. The budget agreement, which the president will sign, includes no changes to the PBGC premiums for multiemployer pension plans. The budget accord’s PBGC provisions are effective for plan years beginning after December 31, 2013. This Client Action Bulletin offers more perspective.

Year-end compliance issues for single-employer retirement plans

By year-end 2013, sponsors of calendar-year single-employer retirement plans must act on necessary and discretionary amendments and perform a range of administrative procedures to ensure compliance with statutory and regulatory requirements. This Client Action Bulletin looks at key areas that such employers and sponsors of defined benefit (DB) or defined contribution (DC) plans should address by December 31, 2013.

Considerations for pension sponsors before freezing/phasing-out a single employer DB plan

Kamenir-JeffBased on some recent survey information, reports on the demise of pension plans have been greatly exaggerated. A survey that I conducted in 2012 on Milliman single employer defined benefit (DB) pension plans, showed that about 50% of the plans were still accruing benefits for at least some participants. In addition, a Bureau of Labor Statistics National Compensation Survey in March 2012 indicated that 68% of private industry DB plans covering nonunion workers are still accruing benefits. Even if these survey results are flawed, it is clear that not all DB plans have frozen benefit accruals. Therefore, for many plan sponsors, the decision of how to maintain an ongoing accrual DB plan is still relevant.

The four scenarios that the plan sponsor of an ongoing accrual DB plan would most likely be considering are:

1. Maintain the DB plan as is with no changes.
2. Freeze all benefit accruals followed by a plan termination.
3. Freeze all benefit accruals without an immediate plan termination.
4. Maintain ongoing accruals for only current participants with no new participants.

The advantages and disadvantages of each scenario from a plan sponsor perspective are summarized below.

Maintain DB plan as is: Advantages
A DB plan is the best vehicle for providing monthly lifetime income to participants because it is not subject to mortality and investment risk. With defined contribution (DC) plans, participants must figure out on their own how to make their account balances last a lifetime.

For active participants, DB plan benefits can automatically adjust for inflation under a final average pay benefit formula. For retired participants, that can be accomplished with an automatic cost-of-living feature.

In many ways DB plans are more flexible in design than DC plans. DB plans can offer features such as early retirement windows, ongoing subsidized early retirement benefits, and supplemental monthly benefits to Social Security or Medicare retirement age, providing participants the opportunity to retire early. DB plans can easily be amended to update past service benefit accruals by a benefit formula improvement.

As with DC plans, DB plans can be easily amended to reduce future benefit accruals.

Maintain DB plan as is: Disadvantages
Managing the cost volatility (funding and pension accounting) that is primarily related to unpredictable investment performance and liability interest rate changes remains the biggest challenge facing any DB plan. Plan sponsors should discuss possible policies and strategies with their actuaries and investment consultants to help reduce cost volatility.

Pension Benefit Guaranty Corporation (PBGC) premium rates, both flat and variable, will be increasing under the Moving Ahead for Progress in the 21st Century (MAP-21) legislation passed in 2012. This is a plan expense that only provides a benefit to the plan sponsor in the unlikely event of a distress plan termination.

Freeze all benefit accruals/plan termination: Advantages
The plan sponsor no longer needs to be concerned about cost volatility issues.

In a plan termination situation, unlike an ongoing plan situation, active participants can be offered immediate access to the lump sum value of their accrued benefit.

Freeze all benefit accruals/plan termination: Disadvantages
The plan sponsor must commit to the plan termination process, which has many steps and stringent deadlines. In conjunction with the plan termination, the plan sponsor will need to locate all terminated vested participants and may need to cleanse data to accurately determine accrued benefits for active and terminated vested participants.

The recent low interest rate environment has increased the cost of settling liabilities (lump sums and annuity purchases).

The plan sponsor in a “standard” plan termination will typically need to make a significant immediate contribution in order to fully fund plan termination liabilities.

Most plan sponsors decide to design some type of replacement for the frozen DB plan benefit accruals, typically through new DC plan contributions. This is a time-consuming process with lots of necessary participant communications. Many times, special transitional DC plan contributions are considered for long-service DB plan participants who are most adversely affected by the benefit freeze.

Special curtailment and settlement pension accounting calculations will be required, resulting in the immediate recognition of unrecognized pension accounting losses.

Freeze all benefit accruals/deferred plan termination: Advantages
In comparison to an immediate plan termination, the plan sponsor can hope for a prospective higher interest rate environment in order to reduce the cost of settling plan termination liabilities. In addition, the plan sponsor can start gradually funding for plan termination liability, rather than having to immediately make a large contribution, and special settlement accounting is deferred.

Freeze all benefit accruals/deferred plan termination: Disadvantages
In comparison to an immediate plan termination, communications to active participants will be more difficult because they will not have immediate access to their frozen DB plan benefits. In addition, the plan sponsor will still need to annually maintain the DB plan, which entails management of cost volatility and annual payment of PBGC premiums.

As with an immediate plan termination, the plan sponsor will still need to go through a process to determine a replacement for the frozen DB plan accruals and special curtailment accounting is still immediately required.

Maintain ongoing accruals for only current participants: Advantages
The plan sponsor is able to keep the “promise” made to current participants at their hire that they could count on receiving retirement income for all company service from a DB plan.

Maintain ongoing accruals for only current participants: Disadvantages
In comparison to maintaining a DB plan for both current and new participants, the plan sponsor will need to monitor minimum coverage nondiscrimination requirements because all employees will no longer be covered under the DB plan. In addition, as fewer and fewer current participants accrue benefits from the DB plan because of eventual termination or retirement, the plan sponsor will also need to monitor minimum participation nondiscrimination requirements.

In comparison to a freeze of all benefit accruals, it will take much longer to see any significant DB plan cost reductions.

In conclusion, the plan sponsor should give consideration to all of the above presented issues before deciding to make significant changes to its ongoing accrual single employer DB plan.

Funding strategies and policies for single-employer defined benefit pension plans

As far as determining the funded status of a defined benefit (DB) pension plan, many factors are out of the control of the plan actuary, such as investment performance, liability interest rates, and how much a plan sponsor is able to contribute to the plan. However, the actuary can discuss with the plan sponsor possible funding strategies and policies designed to maintain the funded status of a fully funded plan or to improve the funded status of an underfunded plan.

In general, the discussion can be broken down into three possible scenarios. If a plan is fully funded, the plan sponsor should consider ways to stabilize annual costs to avoid the possibility of becoming an underfunded plan. If a plan is underfunded, the plan sponsor can consider ways to stabilize annual costs and then commit to making contributions gradually over time to bring the plan to fully funded status. Alternatively, a plan sponsor can subject an underfunded plan to annual cost volatility with an equity-based investment allocation in the hope of bringing the plan to fully funded status through a combination of favorable investment performance and contributions.

Some cost stabilization strategies that can be considered are liability-driven investment (LDI) tactics or a change to a more conservative investment allocation that is much less based on equities. In an LDI strategy, the plan’s investment allocation is changed to primarily fixed income with the objective of plan assets and plan liabilities moving in tandem as liability interest rates rise and fall. In a more conservative investment strategy (e.g., an allocation of 35% equities and 65% fixed income), annual costs are more stable, which is due to less investment risk related to a low equity allocation.

One possible funding policy to consider is annual contributions in the amount needed to hit a given Pension Protection Act of 2006 (PPA) funding target (e.g., at least 80% to avoid benefit restrictions for the current year). Another funding policy to consider is having the actuary determine an annual contribution amount projected to meet a plan sponsor’s funded status goal (e.g., become 100% funded by the year 2017).

A plan sponsor can choose to combine any of the above strategies and policies to meet its goals. Reviewing long-term cost projections is suggested when considering any new strategy and/or policy.

Finally, plan sponsors need to be careful about taking full advantage of any type of legislative funding relief—e.g., Moving Ahead for Progress in the 21st Century (MAP-21) funding relief legislation passed during 2012—because later this may result in much higher minimum funding requirements. Therefore, plan sponsors should consider making higher-than-required contributions despite the availability of funding relief.

IRS extends deadline to adopt amendment restricting pension benefit

The Internal Revenue Service (IRS) has again extended the deadline for single-employer defined benefit retirement plan sponsors to amend their plans to comply with the restrictions on benefit accruals and optional benefit payment forms for underfunded plans, as required by tax code section 436. IRS Notice 2012-70 also extends the period during which such an amendment is eligible for relief from the anti-cutback requirements of tax code section 411(d)(6).

Under the new IRS notice, plan sponsors have until the latest of the following dates to adopt an interim amendment to comply with one of the benefit restrictions requirement:

• The last day of the first plan year that begins on or after January 1, 2013 (i.e., December 31, 2013, for a calendar-year plan)
• The last day of the plan year for which section 436 is first effective for the plan
• The due date (including extensions) of the employer’s tax return for the tax year that contains the first day of the plan year for which section 436 is first effective for the plan

The new notice extends the deadlines the IRS provided in last year’s Notice 2011-96, which included dates similar to those above, except that the year 2012 was used in the first listed item.

Note: Milliman’s Client Action Bulletin (CAB) 12-8, Year-End Compliance Issues for Single-Employer Retirement Plans, stated that a plan amendment for benefit restrictions was necessary by December 31, 2012. The IRS’s new guidance was subsequently released and thus supersedes the information contained in the CAB.

For additional information about the IRS’s extended deadline to amend a plan for funding-based benefit limitations, please contact your Milliman consultant.