Steps to Prepare for a DB Plan Termination

Colleen Lowmiller, a consultant with Findley, said during a webcast hosted by the firm that defined benefit (DB) plan terminations usually take 12 to 18 months.

There are goals and deadlines during the process, and if a plan sponsor hits a roadblock, it can stop the termination process. However, when the issue has been addressed, the sponsor will have to start the process all over again. For this reason, Lowmiller said DB plan sponsors should assess their readiness well ahead of time. She suggested designating a project team with clear responsibilities and firm deadlines.

“Use the time when the plan is well-funded to be ready to go,” she told webinar attendees.

Financial preparedness

Larry Scherer, managing consultant at Findley, said financial preparedness is important. The DB plan must first be frozen in order for benefit accruals to stop. This is because benefit calculations should not be estimates, they should be certified by the plan’s actuary as final, explained Alan Pennington, senior consultant at Findley.

According to Scherer, financial preparedness for a DB plan termination considers asset returns, employer contributions and interest rates. He said plan sponsors should understand economic conditions and that what the market will do to a plan’s funded status is always a moving target. For example, whether interest rates are high or low will affect a plan’s funded status.

Scherer suggested using a liability-driven investing (LDI) strategy to reduce portfolio risk as the plan’s funded status improves. He said the goal is to maintain funded status. “You don’t want to be overfunded, because there will be excise taxes on assets returned to the plan sponsor,” he told webinar attendees. “On the other hand, if a plan has recognized losses, there will be a settlement cost on its financial statement.”

As for employer contributions, Scherer recommended having a funding policy. DB plan sponsors need to decide what they can afford to put in the plan based on minimum required contributions, whether they should set contributions or adjust them every year, and whether they want to borrow to fund, weighing that against whether market conditions will help close any funding gap.

DB plan sponsors may decrease their liabilities, and perhaps some of the funding gap, by taking risk transfer actions, such as offering a lump-sum window to terminated, vested participants or purchasing an annuity for retirees, he said.

According to Scherer, plan sponsors should monitor their plan’s funded status as conditions change and do some forecasting. They may need to make changes to asset allocation or contributions.

Data and benefit design preparation

Having complete and accurate employee data will be essential for benefit calculations, as well as the notice of plan termination, said Pennington.

DB plan sponsors should make sure they have vesting correct for each employee, have correct addresses, correct Social Security numbers and have minimal missing participants. He added that plan sponsors should create good documentation of the steps taken to find missing participants. Pennington said the Pension Benefit Guaranty Corporation (PBGC) is auditing all plan terminations of plans with more than 300 members, and it is randomly selecting for audit plans with 300 members or less.

In addition, if it has been a while since the plan sponsor filed for an IRS determination letter, it may want to do that before starting the plan termination process. Pennington said it is not required, but can be prudent so the IRS can sign off that the plan is up to date.

Before terminating a DB plan, plan sponsors may want to design replacement benefits—for example, a defined contribution (DC) plan—to make sure employees still have the ability to prepare for a secure retirement, Pennington said. In addition, if the DB plan does not currently allow lump-sum distributions, the plan sponsor may want to amend it to allow them, as lump sums can be less expensive than annuities. He added that if a plan sponsor decides to allow for lump-sum distributions, it should make sure the new retirement plan will allow for rollovers from the DB plan.

Preparing communications

Miriam Batke, a consultant at Findley, told webinar attendees an important aspect of a DB plan termination is effective communications. Plan sponsors need to consider the timing, message and to whom communications will be delivered. Communications need to go to participants, retirees, active employees not in the plan and union representation, if applicable.

Required communications include a Notice of Intent to Terminate, a Notice of State Guaranty Association Coverage of Annuities, a Notice to Interested Parties for IRS filings, a Notice of Plan Benefits and benefit election forms.

Plan sponsors should communicate information to employees about the replacement retirement plan. Batke also suggested plan sponsors make sure participants are aware of how their decisions—whether to take a lump sum, whether to participate in the replacement plan—will affect their retirement readiness.

“Early communications about changes will help increase employee understanding and can reduce questions during benefit elections time,” she said. She added that it may take weeks or even months to develop a strategy for communications.