Powerful Insights from Interactive Forecasting of Defined Benefit Pension Plan Results

With the current volatility in long-term bond rates and in the investment market, plan sponsors should examine the impact of the market on the future of their defined benefit pension plan.

The market downturn due to COVID-19 severely impacted the funded status of defined benefit pension plans, and the ramifications could project out many years into the future.

Challenge

Financial experts at any organization will agree that one of the problems with defined benefit pension plans is the volatility of cash funding requirements due to the sensitivity of the plan measurements to changes in the market. Many plan sponsors seek strategies to keep cash requirements as level as possible.

The difficulty for many stakeholders at organizations that sponsor defined benefit pension plans lies in understanding how the various factors are interrelated so that there is confidence in decisions made to improve the defined benefit pension plan’s financial position.

The following case study illustrates the power of interactive modeling on understanding the extent that different variables, like cash contributions, long-term bond rates, and asset returns, affect the future outlook for the defined benefit pension plan.

Case Study

The plan sponsor of a frozen defined benefit pension plan has been closely following the funded status of the plan. Based on annual forecasts, they developed a strategy with their actuary to contribute $5 million per year to be well enough funded to consider a plan termination in seven years.

Powerful Insights from Interactive Forecasting of Defined Benefit Pension Plan Results

The market downturn due to COVID-19 significantly changed this forecast. The actuary updated the current forecast to recognize the decrease in the market value of assets, lower bond rates for valuing liabilities, and lower expected rate of return for 2020 and 2021.

The updated forecast showed that the required contributions were no longer level and more than doubled compared to their original strategy due to overriding minimum funding rules, and the plan termination time horizon had extended to twelve years.

Solution

The plan sponsor worked with their actuary and asset advisor to model various “what if” situations quickly using an interactive modeling tool. Visually seeing the impact of future changes in the various economic variables on the defined benefit pension plan, helped to develop an approach for usage of available cash and to formulate next steps to monitor the defined benefit plan’s financial position.

Powerful Insights from Interactive Forecasting of Defined Benefit Pension Plan Results

Interactive Forecasting Results

Different variables were changed in several variations of the projections, and some great information was obtained:

  • If looking at contributions alone and trying to achieve level amounts, doubling the contributions to $10 million only shortens the plan termination funding time horizon to eleven years.
  • When considering level contributions of $7.5 million, there are a few years in the projection period when those contributions are not enough, but the plan termination funding time horizon remains at twelve years, and they would have saved some cash, especially in the short term.
  • If contributions are increased to $7.5 million, AND there is some economic recovery in 2021, then level contributions can be achieved.

Instead of needing to (somewhat blindly) decide to double contributions and to continue that for the foreseeable future, the interactive forecast showed that even a modest economic recovery has more of a long-term effect on the defined benefit pension plan’s results and plan termination time horizon than large additional cash contributions alone. Increasing planned contributions somewhat, and regrouping and using the interactive forecasting tool with updates periodically is the best short-term strategy for them.

Without the interactive tool, it would not have been apparent that waiting for some economic recovery was the right approach for now. It also would not have been clear that contributing higher amounts (within reason) in the hopes of getting things back on track actually does nothing to achieve that goal. That kind of insight is valuable when working on organization-wide approaches for allocation of cash, while also being responsible about trying to put future strategies like defined benefit pension plan termination back on track.

To discuss interactive projections for a defined benefit pension plan, plan sponsors should reach out to their actuary. Alternatively, contact Colleen Lowmiller in the form below, and with just a little information, Findley’s actuaries can put together interactive forecasting information to assist with strategy sessions.

Published on August 27, 2020

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Coronavirus Market Volatility and Pension Plan Contributions

The Coronavirus (COVID-19) pandemic’s impact on your family, friends and economy continues to unfold daily. Interest rates are down, and the equity markets are depressed and have been highly volatile. This economic situation will cause revenues of many plan sponsors to stagnate, which will drain cash reserves, and likely lead to layoffs. This is another “perfect storm” for the pension plan, which if the markets don’t normalize, will lead to much higher required pension contributions in the upcoming year. 

When revenues drop significantly, organizations will struggle to meet current and future funding obligations, as well as pay for essential plan operation services.

Seeking Federal Relief

Congress continues to work on additional funding relief and has recently released several changes impacting defined benefit plans.  However, additional relief measures may be contained in possible Phase 4 coronavirus legislation by early April. This relief will likely delay the impact of the current economic situation and allow plan sponsors to make lower contributions than they would have otherwise, but it likely will not permit sponsors to eliminate their long-term obligations. In other words, it will delay the impact of the current market conditions in hopes that the market will rebound after the coronavirus is under control. 

The Consequences for Late Contributions

If at all possible, plan sponsors will want to adhere to the required deadlines for contributions, both the quarterly requirements and any additional amount required by the final due date (8-1/2 months after the end of the plan year). This table shows the consequences for delayed quarterly contributions:

Contribution TimingPenalties
Less than 30 days lateInterest penalty at effective rate plus 5%
More than 30 days lateInterest penalty at effective rate plus 5%
Notification to PBGC**
More than 60 days lateInterest penalty at effective rate plus 5%
Notification to PBGC (due once contribution at least 30 days late)**
Notification to all plan participants

*Approximately 10% payable to the Trust as additional required contributions
**Generally, there is a waiver of the notification for late or missed quarterly contributions if the plan has less than 100 participants.  However, regardless of the size of the plan, the PBGC must be notified if a final minimum required contribution is missed.

Plan sponsors must meet the total required plan year contribution by the final due date, which is 8-1/2 months after the end of the plan year. There is no grace period for this contribution. Organizations that miss this deadline will experience:

  • Disclosure of an unpaid minimum on the U.S. Department of Labor’s Form 5500
  • Interest and penalties beginning immediately
  • An excise tax of 10% of the missed contribution, which is payable on the due date of the final contribution (for plans with a calendar plan year, the deadline for the final 2019 plan year contribution is September 15, 2020 and the deadline for the final 2020 plan year contributions is September 15, 2021), with interest accruing until paid. This tax is paid to the IRS and cannot be paid from plan assets.

Funding Waiver Requests

Organizations that experience temporary business hardship due to the Coronavirus’s (COVID-19) impact on the economy may consider applying to the Internal Revenue Service (IRS) for a funding waiver. However, under current law, it is generally cost prohibitive for smaller plans. The IRS user fee is approximately $30,000, which does not include the cost to prepare the request. Also, the waiver does not eliminate the required contribution, but merely allows you to amortize the payment over five years.

The application process for a funding waiver is onerous as organizations must provide extensive information about the company’s financial condition, the pension plan, as well as share details about executive compensation arrangements. In addition, notifications of the waiver request must be sent to plan participants, and the company must consider comments they receive from participants. The IRS also coordinates with the PBGC as it reviews funding waiver requests, seeking analysis and recommendations from the PBGC.

Maintaining Pension Plan Operations

For organizations whose cash flow is being dramatically impacted by the steps being implemented to fight the coronavirus, there are ways to continue essential services of the plan. Fees for most plan operations can be paid from plan assets. Essential services of the plan include:

  • Initiating new retirements or payments to beneficiaries
  • Paying lump sum benefits
  • PBGC insurance premiums
  • Plan audits
  • ERISA counsel services including plan documents and amendments
  • Government form filings
  • Actuarial counseling services
managing pension plan operations during coronavirus market volatility

It’s important to remember that this is a one-year deferral of the cash expense since fees paid from plan assets are generally added to the following year’s minimum required cash contribution. Consult with your ERISA counsel about paying any fees from plan assets as services that are essential to the employer, but not the plan, are generally not payable from plan assets.

Other Ways to Reduce Contributions?

For plan sponsors who deposited contributions in excess of minimum requirements in the past, a prefunding balance or a carryover balance may be available to be used to offset all, or a portion of, a future contribution requirement. A formal election to create or add to the prefunding balance must be made, and there still may be time to do this related to last year’s contribution.  

Plan sponsors with cash flow concerns may consider options of freezing benefits or reducing benefits in order to reduce future contributions. If participants are currently earning new benefits (i.e., your plan is not currently frozen) an organization may be able to amend the plan to eliminate (i.e. freeze) or reduce benefits before they are earned in 2020.

This may not eliminate the required contribution for 2020, but it will reduce it by the value of the benefits that were expected to be earned. However, in order to freeze or reduce the current year’s benefit, the organization must amend the plan before any participant completes the required number of hours during the plan year (typically 1,000 hours, but varies by plan design). 

Freezing or reducing plan benefits requires a plan amendment and a participant notification. Plans with at least 100 participants require at least a 45-day notice before benefits can be reduced or eliminated. Plans with less than 100 participants only require at least a 15-day notice period. For plan sponsors who are considering reducing 2020 plan year benefits, time is of the essence to amend your plan and distribute the proper notification within the timing guidelines.

Eliminating or reducing plan benefits is a tough decision. There are issues other than cash contributions to consider before making a move, including possible financial statement impact (i.e., ASC715 curtailment expense, if applicable) and human resource/employee relations implications.

Questions regarding contribution options for your defined benefit pension plan, contact the Findley consultant you normally work with, or Keith Nichols at KeithNichols@findley.com or 724.933.0631 or Wesley Wickenheiser at Wesley.Wickenheiser@findley.com or 502.253.4625

Published March 26, 2020

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2020 Defined Benefit Plan Compliance Calendar

Calendar Plan Year & Calendar Employer Tax Year*

defined benefits plan compliance calendar 2020 January through June
defined benefits plan compliance calendar 2020 July through December

January 2020  

15   Due date to make fourth required quarterly contribution for 2019 plan year

31   Last day to file Form 945 to report withheld federal income tax from distributions

31   Last day to furnish Form 1099-R to recipients of distributions during 2019 calendar year

February 2020

28   Last day to file Form 1096 and Form 1099-R on paper with the IRS

March 2020

31   Last day to file Form 1099-R electronically with the IRS

31   Deadline for enrolled actuary to issue AFTAP certification for current year to avoid presumption for benefit restrictions (if applicable)

April 2020

01   Presumed AFTAP takes effect unless and until enrolled actuary issues certification of AFTAP for current plan year (if applicable).

01   Last day to pay initial required minimum distributions to applicable plan participants

15   Due date to make first required quarterly contribution for 2020 plan year

15   Last day to file financial and actuarial information under ERISA section 4010 with PBGC (if applicable)

15   Last day for C corporation employer plan sponsors to make contributions and take tax deduction for 2019 without corporate tax return extension

15   Last day to furnish Annual Funding Notice (for plans covered by PBGC that have more than 100 participants)

May 2020

01   Last day to provide notice of benefit restrictions, if restrictions are applicable as of April 1, 2020

July 2020

31   Due date to make second required quarterly contribution for 2020 plan year

31   Last day to furnish Summary of Material Modifications (SMM) to participants and beneficiaries receiving benefits

31   Last day to file Form 5500 for 2019 without extension.

31   Last day to file Form 8955-SSA without extension

31   Last day to provide a notice to terminated vested participants describing deferred vested retirement benefits (in conjunction with Form 8955-SSA)

31   (or the day Form 5500 is filed, if earlier) – Last day to furnish Annual Funding Notice (for PBGC covered plans with 100 or fewer participants without extension)

31   Last day (unextended deadline) to file Form 5330 and pay excise tax on nondeductible contributions and prohibited transactions (if applicable)

September 2020

15   Last day to pay balance of remaining required contributions for 2019 plan year to satisfy minimum funding requirements.

30   Last day to furnish Summary Annual Report to participants and beneficiaries (for non-PBGC covered plans)

30   Last day for enrolled actuary to issue AFTAP certification for current plan year

October 2020

01   If enrolled actuary does not issue AFTAP certification for plan year, then AFTAP for the plan year is presumed to be less than 60 percent and plan will be subject to applicable benefit restrictions.

15   Last day to file Form 5500 (with extension)

15   Last date to file Form 8955-SSA (with extension)

15   Last day to provide a notice to terminated vested participants describing deferred vested retirement benefits (in conjunction with Form 8955-SSA)

15   Due date to make third required quarterly contribution for 2020 plan year

15   Last day to file PBGC comprehensive PBGC premium filing and pay premiums due (for plans covered by PBGC)

31   Last day to provide notice of benefit restrictions, if restrictions are applicable as of October 1, 2020

December 2020

15   Last day (with extension) to furnish Summary Annual Report (for non-PBGC covered plans)

31   Last day for enrolled actuary to issue a certification of the specific AFTAP for current year if a range certification was previously issued

31   Last day for plan sponsors to adopt discretionary plan amendments that would be effective for the current plan year

*This calendar is designed to provide a general overview of certain key compliance dates and is not meant to indicate all possible compliance dates that may affect your plan.

© 2020 Findley • All rights reserved

If you would like more specific information about each compliance item, you may review or print the calendar below.

Print 2020 Detailed Benefit Plan Compliance Calendar

Interested in other compliance calendars?

Defined Contribution

Health & Welfare

Impact of Historic Interest Rate Decline on Defined Benefit Plans

How will defined benefit pension plans be impacted by historic year-to-year interest rate declines? The U.S. has experienced over a 100 basis point decrease on 30-year treasury rates and significant decreases across treasury bonds of all durations from year-to-year. After a slight uptick in rates during the fourth quarter of 2019, interest rates have plummeted in the first quarter of 2020. The low interest rate environment, coupled with recent volatility in the market arising from concerns over the Coronavirus, has pension plan sponsors, CFOs, and actuaries alike, taking an in-depth look at the financial impact.

Historic Interest Rate Decline on Defined Benefit Plans and options to consider.

How Will Your Company be Impacted by Historic Interest Rate Decline?

Under U.S. GAAP and International Accounting Standards, pension liabilities are typically valued using a yield curve of corporate bond rates (which have a high correlation to Treasury bond rates) to discount projected benefit payments. Current analysis shows that the average discount rate has decreased approximately 100 basis points from the prior year using this methodology.

Due to the long-term benefit structure of pension plans, their liabilities produce higher duration values than other debt-like commitments, that are particularly sensitive to movement in long-term interest rates. The general rule of thumb is for each 1% decrease in interest rates, the liability increases by a percentage equal to the duration (and vice versa). The chart below, produced using Findley’s Liability Index, shows the percentage increase in liabilities for plan’s with varying duration values since the beginning of 2019.

Pension Liability Index Results - 2/29/2020

Assuming all other plan assumptions are realized, the larger liability value caused by the decrease in discount rates will drive up the pension expense and cause a significant increase in the company’s other comprehensive income, reflecting negatively on the company’s financial statements.

Considerable Growth in Lump Sum Payment Value and PBGC Liabilities

Additional consequences of low treasury bond rates include growth in the value of lump sum payments and PBGC liabilities. Minimum lump sum amounts must be computed using interest rates prescribed by the IRS in IRC 417(e)(3) which are based on current corporate bond yields. PBGC liabilities are also determined using these rates (standard method) or a 24-month average of those rates (alternative method). For calendar year plans, lump sums paid out during 2020 will likely be 10-20% higher for participants in the 60-65 age group, than those paid out in 2019. For younger participants, the increase will be even more prominent.

In addition, if the plan is using the standard method to determine their PBGC liability, there will be a corresponding increase in the liability used to compute the plan’s PBGC premium. In 2020, there will be a 4.5% fee for each dollar the plan is underfunded on a PBGC basis. Depending on the size and funding level of the plan, the spike in PBGC liability may correspond to a significant increase in the PBGC premium amount.

What If We Want to Terminate our Pension Plan in the Near Future?

For companies that are contemplating defined benefit pension plan termination, there will be a significant increase in the cost of annuity purchases from this time last year. The actual cost difference depends on plan-specific information; however, an increase of 15-25% from this time last year would not be out of line with the current market. This can be particularly problematic for companies who have already started the plan termination process. Due to the current regulatory structure of defined benefit pension plan terminations, companies must begin the process months before the annuity contract is purchased. The decision to terminate is based on estimated annuity prices which could be significantly different than those in effect at the time of purchase.

Actions You Can Take to Mitigate the Financial Impact

Contributions to the plan in excess of the mandatory required amount will help offset rising PBGC premiums since the premium is based on the underfunded amount, not the total liability. Additional contributions would also help offset the increase in pension expense.

The best advice we can offer at this time is to discuss these implications internally and with your service providers. Begin a dialogue with your investment advisors about the potential need to re-evaluate the current strategy due to market conditions. Contact your plan’s actuary to get estimated financial impacts so you can plan and budget accordingly. If your plan has recently begun the plan termination process, you may need to reconvene with decision-makers to make sure this strategy is still economically viable.

Questions? For more information, you can utilize Findley’s Pension Indicator to track the funded status of a variety of plan types each month. To learn more about how this historic interest rate decline may impact your plan specifically contact your Findley consultant, or Adam Russo at adam.russo@findley.com or 724.933.0639.

Published on March 3, 2020

© 2020 Findley. All Rights Reserved.

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Required Distributions to Pension Plan Beneficiaries

Plan administrators are likely familiar with the Required Minimum Distribution (RMDs) rules with regard to pension plan participants, but, similar rules apply to beneficiaries of deceased non-retired participants as well.  When a pension plan participant dies prior to retirement, the pre-retirement death provisions of the pension plan will dictate the amount and timing of the benefit payment to a beneficiary.  IRS regulations set the minimum timing for when pension payments must be made, but the pension plan document may require a more stringent timeframe.

Spouse beneficiaries can usually defer receipt of their benefit until December 31 of the year the participant would have attained age 70 ½.  However, non-spouse beneficiaries may not defer payment that long. Payment of death benefits to a non-spouse beneficiary must satisfy either the five-year rule or the life expectancy rule.

Five-Year Rule and Required Distributions

The five-year rule requires that the death benefit be completely distributed no later than December 31 of the 5th calendar year following the participant’s death.  For example, if a participant dies in 2019, the non-spouse death benefit must be distributed no later than December 31, 2024.  Payments may be made in multiple intervals or installments (if the pension plan provides) or paid in one lump sum as long as the entire benefit is fully distributed within this five-year timeframe.

Life Expectancy Rule and Required Distributions

The life expectancy rule allows for required distributions to be made over the life or life expectancy of the designated beneficiary.  To qualify under this rule, pension payments must begin no later than December 31 of the year following the year of death.  For example, if the participant dies in 2019, the non-spouse beneficiary must begin receipt of annuity payments under this rule no later than December 31, 2020.

The life expectancy rule can be calculated using two methods: the account balance method or the annuity distribution method.  The account balance method requires dividing an account balance (or the present value of the participant’s accrued benefit) by the life expectancy factor as prescribed in published IRS life expectancy tables.  The annuity distribution method allows for the pension benefit to be paid as an annuity over the life of the beneficiary.  The annuity can also be paid over a certain period as long as the time period does not extend beyond the beneficiary’s single life expectancy.

This article is intended to provide a brief and general overview of the timing requirements for paying death benefits from a qualified pension retirement plan.  The rules regarding the amounts and timing of payments to beneficiaries can be complex.  Internal Revenue Code section 401(a)(9) and associated regulations provide the minimum requirements for distributing participant benefits as well as death benefits from a qualified plan.  It is important to remember to review the pension plan’s provisions with regard to pre-retirement death benefits as the plan may require distributions to begin earlier than the law requires.

Questions? Contact the Findley consultant you normally work with, or contact Lisa Tomlin at 336.271.2089 or Lisa.Tomlin@findley.com.

Published December 2, 2019

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Pension Strategy Driver – 2020 PBGC Premium Rates Announced

For many sponsors of single-employer pension plans, the minimum cash funding requirement is no longer the most important number discussed with their actuaries every year. Instead, pension plan sponsors have shifted their focus to managing their PBGC premiums.

PBGC Premium Rates Chart 2007-2020. Flat-Rate vs. Variable-Rate

PBGC Premiums Defined

The PBGC premium is essentially a tax paid to a government agency to cover required insurance for the plan and the participant benefits in the event that the plan sponsor goes bankrupt. The annual premium is calculated in two parts – the flat-rate premium and the variable-rate premium – and is subject to a premium cap.

The flat-rate premium is calculated as a rate per person.

The PBGC variable-rate premium is an amount that each plan sponsor pays based on the underfunded status of its plan.

The variable-rate premium cap is a maximum amount that a plan sponsor of a significantly underfunded plan has to pay. It is calculated based on the number of participants in the plan. There are other caps that apply for small plans.

2020 Premiums Announced

For 2020, the flat-rate premium amount is $83 per person. This is 168% higher than the rate of $31 per person at the beginning of this decade.

For 2020, the variable-rate premium has jumped to $45 per $1,000 of the underfunded amount. Up until 2013, that rate was $9 per $1,000. That amounts to a 400% increase in just seven years.

The cap for 2020 is $561 per person; which means for a 10,000-life plan, the maximum PBGC variable premium is $5,610,000.

Therefore, the PBGC premium for a 10,000-life plan at the premium cap would total $6,440,000.

More information about various strategies to manage PBGC premiums can be found here: Managing PBGC Premiums: There is More Than One Lever.

More information regarding PBGC’s Current and Historical Premium Rates can be found on the PBGC’s website link above.

Questions? Contact the Findley consultant you normally work with, or contact Colleen Lowmiller at colleen.lowmiller@findley.com, 216.875.1913.

Published October 29, 2019

© 2019 Findley. All Rights Reserved.

Minimum Participation Rule Puts Pension Benefits at Risk

Almost all pension plans are subject to certain compliance tests that are outlined by the IRS. The compliance requirements are in place to make sure that if a plan sponsor’s contributions to a pension plan are deductible for tax purposes, then the pension plan’s benefits must not be designed too heavily in favor of the highest paid employees. One set of compliance rules for most pension plans are the minimum participation requirements. As some defined benefit pension plans continue operating, these rules are causing compliance concerns.

Minimum Participation Rule Details

Under Internal Revenue Code (IRC) Section 401(a)(26), a defined benefit pension plan must benefit a minimum of

  • 50 employees or
  • 40% of the employees of the employer.

If the pension plan is not benefiting any highly compensated employees (HCEs), it automatically satisfies the rule.

HCE is generally determined as an individual earning more than a specified dollar threshold established by the IRS for the prior year. This dollar limit is $125,000 based on 2019 earnings to determine HCEs for the 2020 year. All others are considered non-highly compensated employees (NHCEs).

Unintended Consequences

Today, many pension plans have been “partially frozen” for years, which means they have benefits accruing only for a specified group of employees. As time passes and ordinary turnover and retirement occur, the number of employees that accrue benefits in these defined benefit pension plans is decreasing.

Although the original purpose was to provide “meaningful” benefits to employees across the plan sponsor’s organization, these requirements are now causing accruals to be shut off as some plans approach and fall below the minimum threshold of employees accruing benefits.

For the affected employees, it comes at a time close to retirement age when their promised pensions, by design, would be accumulating at the highest rates, and defined contribution style benefits, like 401k plans, can’t realistically replace all lost future accruals.

Potential Strategies

Do Nothing and Wait

  • We can hope that legislative relief will be passed to eliminate the participation issues. However, Congress has considered addressing these issues over the last 5 to 7 years, and no movement towards enacting relief rules has been seen yet.

Merge Pension Plans

  • This provides immediate relief to minimum participation issues.
  • It could be a temporary solution if the benefits are also partially frozen across the combined defined benefit pension plan. Review the demographics to project how long this solution will last when weighing the advantages of this strategy for your situation.

Open the Pension Plan

  • Reopen the pension plan to additional participants. (Yes, this could make sense!)
  • More employees will be benefiting and eliminate minimum participation rule issues.
  • New plan participants can receive a different formula (something similar to the current plan formula but reduced, cash balance formula, variable annuity formula, etc.)
  • Consider if recruiting or employee retention issues can be reduced or alleviated by designing new pension benefits for targeted employee groups.
  • This can be designed to help bridge the time until the potentially affected employees reach retirement age.
  • Watch the mix of HCEs and NHCEs because the additional pension benefit design still needs to satisfy other IRS coverage, nondiscrimination, and design-based compliance rules.

Freeze Remaining Pension Benefits

  • The freeze can be for all participants or only for current and future HCEs.
  • Replacement benefits can be provided to address employee retention and retirement readiness issues.
    • Provide projected lost benefits as cash payment(s).
    • Executive employees can have some or all lost benefits replaced in a nonqualified deferred compensation plan or other executive compensation arrangement.
    • Design partial replacement benefits in a 401k plan.
  • Consider the impact of the pension plan freeze on other sponsored benefit plans. For example, are there benefits that are automatically available, or not available, based upon whether an employee is accruing benefits in the pension plan?
  • Curtailment accounting rules are triggered which may require an additional one-time expense to be recognized through income in the year of the benefit freeze.

In Perspective

There are many valid business reasons that explain why a plan sponsor would want to stop pension accruals for everyone except a specified group. We know the IRS rules were not intended to cause the loss of benefits for employees late in their careers. Regardless, several pension plan sponsors are at the point where their partially frozen pension plans are close to becoming noncompliant. While we continue to wait for legislative relief for this issue (that may never come), if you sponsor a partially frozen pension plan, you should determine when this will become an issue for you. Begin discussing possible strategies, and have an approach in place well ahead of time to minimize the disruption to your organization as much as possible.

Questions? Contact the Findley consultant you normally work with, or contact Colleen Lowmiller at colleen.lowmiller@findley.com, 216.875.1913.

Published October 28, 2019

© 2019 Findley. All Rights Reserved.

GE pension changes: should my company be looking to do the same?

On October 7, General Electric (GE) announced a series of decisions around their salaried pension plan:

  • For participants continuing to accrue benefits, further accruals will be stopped at the end of 2020. (New employees hired after 2011 were not eligible for the pension plan.)
  • A lump sum buy-out proposal to 100,000 terminated but not yet retired participants will be offered.
  • Benefits in a supplemental plan for certain executives will also freeze.

Inevitably, whenever one of the largest pension plans in the country makes an announcement like this, it can cause executives at other companies to question if a similar decision makes sense for their plan.  The action item here most germane to other plan sponsors, and the focus of the remainder of this article, will be to focus on the middle bullet point.  Offering lump sums to non-retired, terminated participants has become a popular strategy among pension plan sponsors the last couple years as a way to reduce headcount without paying a premium to an insurance company to off-load the obligations.

Lump Sum Cashouts Defined

A Lump Sum Cashout program occurs when a defined benefit pension plan amends its plan to allow terminated vested participants to take a lump sum payment of their benefit and be cashed out of the plan entirely. The program is typically offered as a one-time window.  Plans generally may offer this type of program only if their IRS funded percentage is at least 80% both before and after the program is implemented.

Many pension plans have offered, or at least considered, Lump Sum Cashout programs over the last several years to minimize their financial risk. Plan sponsors that have implemented these programs have been rewarded with significant cash savings as well as risk reduction.

Advantages of Implementing Lump Sum Cashout Today

1. Improved Funded Status

An advantage of the current interest rate environment is that lump sums will be less than most other liability measurements related to the plan. Employers will be paying benefits to participants using a value less than the balance sheet entries being carried for those benefits in most cases. These lower lump sum payments will then help employers improve the funded status of the plan in addition to de-risking or reducing the future risk.

2. PBGC Premium Savings

The most significant benefit of offering a Lump Sum Cashout Program is the Pension Benefit Guaranty Corporation (PBGC) premium savings. The PBGC continues to increase the annual premiums that pension plans are required to pay to protect the benefits of their participants in the pension plan. The per participant portion of the premium (flat-rate) is now up to an $80 payment per participant in 2019. This is more than a 200% increase since 2012. The variable rate portion of the premium is up to $43 per $1,000 underfunded which is an increase of almost 500% since 2012.

These rates are expected to continue to grow with inflation each year. Therefore it is ideal for pension plan sponsors to reduce their participant count sooner rather than later so they can save on these future premiums. In total, some pension plan sponsors could see annual PBGC premium savings of over $600 for each participant who takes a lump sum distribution.

Other Considerations When Planning for a Lump Sum Cashout

There are some concerns that pension plan sponsors will also want to consider such as:

  • Potential increases to contribution requirements;
  • One-time accounting charges that could be triggered;
  • Potential increase to annuity purchase pricing upon pension plan termination. Note that a permanent lump sum feature may increase pension plan termination annuity pricing and cause some insurers to decline to bid.

The pension plan’s actuary should be consulted so they can properly evaluate the impact of offering such a program.

Some pension plan sponsors use lump sum cashouts as part of their pension plan termination preparation strategy. This Findley article provides tips to map your route to pension plan termination readiness. Already have a frozen plan and been considering a termination in the near future? For a complete A-Z walkthrough, check out our guide below.

Questions? Contact the Findley consultant you normally work with, or contact Amy Gentile at amy.gentile@findley.com, 216.875.1933 or Matt Klein at matt.klein@findley.com 216-875-1938.

Published on October 8, 2019

© 2019 Findley. All Rights Reserved.

Pension Financial Impact of Record Low Treasury Bond Rates

Featured

How will defined benefit pension plans fare as a result of the 30-year U.S. Treasury bond rates falling below 2.00% for the first time in U.S. history? This 100 basis point drop from the beginning of the year and the fact that U.S. Treasury bond rates of all durations are down significantly from the beginning of the year, have pension plan sponsors, CFOs, and actuaries alike, taking an in-depth look at the financial impact.

How Will Record Low Treasury Bond Rates Impact Your Company’s Defined Benefit Plan?

Due to the long-term benefit structure of pension plans, their liabilities produce high duration values that are particularly sensitive to movement in long-term interest rates. For instance, a standard frozen pension plan may have a duration of 12 which indicates that a decrease in the discount rate of 100 basis points would produce a 12% increase in liabilities. 

Under U.S. GAAP and International Accounting Standards, pension liabilities are typically valued using a yield curve of corporate bond rates (which have high correlation to treasury bond rates) to discount projected benefit payments. Current analysis shows that the average discount rate has decreased over 100 basis points from the beginning of the year using this methodology. Assuming all other plan assumptions are realized, the larger liability value caused by the decrease in discount rates will drive up the pension expense and cause a significant increase in the company’s other comprehensive income, reflecting negatively on the company’s financial statements. 

Pension Financial Impact of Record Low Treasury Bond Rates

What If We Want to Terminate our Pension Plan in the Near Future?

For companies that are contemplating defined benefit pension plan termination, there will also be a significant increase in the cost of annuity purchases. The actual cost difference depends on plan-specific information; however, an increase of 10-20% from the beginning of the year would not be out of line with the current market. This can be particularly problematic for companies who have already started the plan termination process. Due to the current regulatory structure of defined benefit pension plan terminations, companies must begin the process months before the annuity contract is purchased. Their decision to terminate is based on estimated annuity prices which could be significantly different than those in effect at the time of purchase.

Consider Growth in Lump Sum Payment Value and PBGC Liabilities

Additional consequences of record low treasury bond rates include growth in the value of lump sum payments and PBGC liabilities. Minimum lump sum amounts must be computed using interest rates prescribed by the IRS in IRC 417(e)(3) which are based on current corporate bond yields. PBGC liabilities are also determined using these rates (standard method) or a 24-month average of those rates (alternative method). If current interest rates hold, lump sums paid out during 2020 will likely be 10-15% higher than those paid out in 2019 for similarly situated participants. In addition, there would be a corresponding increase in the liability used to compute the plan’s PBGC premium. In 2020, there will be an estimated 4.5% fee for each dollar the plan is underfunded on a PBGC basis. Depending on the size and funding level of the plan, the spike in PBGC liability may correspond to a significant increase in the PBGC premium amount.

Actions You Can Take to Mitigate the 2020 Financial Impact

There is potential to help mitigate the financial impact for 2020 by taking action now. Since lump sum payments are projected to increase significantly in 2020, offering a lump sum window to terminated vested or retired participants during 2019 could be a cost effective way to reduce the overall liability of the plan.

Contributions to the plan in excess of the mandatory required amount will help offset rising PBGC premiums since the premium is based on the underfunded amount, not the total liability. Additional contributions would also help offset the increase in pension expense.

The best advice we can offer at this time is to discuss these implications internally and with your service providers. Begin a dialogue with your investment advisors about the potential need to re-evaluate the current strategy due to market conditions. Contact your plan’s actuary to get estimated financial impacts so you can plan and budget accordingly. If your plan has recently begun the plan termination process, you may need to reconvene with decision-makers to make sure this strategy is still economically viable.

Questions? For more information, you can utilize Findley’s Pension Indicator to track the funded status of a variety of plan types each month. To learn more about how falling interest rates may impact your plan specifically contact your Findley consultant or Adam Russo at adam.russo@findley.com or 216-875-1949.

Published on August 22, 2019

© 2019 Findley. All Rights Reserved.

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Three Compelling Reasons to Consider Pension Plan Mergers

If you have more than one pension plan you are administering, consider a pension plan merger to potentially reduce plan administrative, Pension Benefit Guarantee Corporation (PBGC), and future plan termination fees. Sound too good to be true? Read on.

While the total number of pension plans may have dwindled over the past few decades, several companies still sponsor not only one, but multiple pension plans for participants within their organization. Most typically this is the result of a decision made years ago when the retirement plans were created or acquired – either to intentionally separate participants with different benefit formulas such as Hourly Plans for union employees earning a service related benefit, Salaried Plans for employees earning a pay related benefit, or as a result of an acquisition where the plans benefitting employees are not original employees of the parent company.

While there may have been reason to keep the plans separate in the past, it might be time to reevaluate and consider whether a pension plan merger might be beneficial.

“It might be time to reevaluate and consider whether a pension plan merger might be beneficial.”

What is a Pension Plan Merger?

A pension plan merger is the consolidation of one or more pension plans into a single, previously existing pension plan. 

Consider Company X who maintains 3 pension plans: 

  • Plan A benefits all Hourly, union employees
  • Plan B benefits all Salaried employees
  • Plan C benefits all participants acquired by Company Y

A pension plan merger is the transfer of all retirement plan assets and liabilities from Plans A and/or Plan B into Plan C (or some other similar combination) and as a result, Plan A and/or Plan B would cease to exist.

Pension Plan Merger Example

Going forward, annual requirements remain only for the consolidated plan. Because the merger cannot violate anti-cutback rules, there is no negative impact to the retirement plan participants. Protected benefits such as accrued and early retirement benefits, subsidies, and optional forms of benefits cannot be reduced.

Why Should We Consider Merging Pension Plans?

Reason #1 : Reduced Administrative Fees

Each qualified pension plan has several annual requirements, regardless of size. Combining plans can reduce total administrative fees by minimizing the redundancy of the annual actuarial, audit, and trustee work:

  • Annual valuations: Funding, accounting, and ASC 960
  • Government reporting: IRS Form 5500 and PBGC filings
  • Participant notices: Annual funding notices
  • Annual audit: Plan audit for ASC 960 and financial accounting audit
  • Trustee reports

Merging plans can streamline many processes, reducing fees for these services compared to operating separately.

Reason #2 : Potential PBGC Savings

Plan sponsors with both an underfunded and overfunded plan can reduce PBGC premiums by sharing the excess retirement plan assets of an overfunded plan with one that is underfunded. Annual premiums are due to the PBGC (Pension Benefit Guarantee Corporation) for protection of participant benefits in the event the plan sponsor is unable to fulfill their pension promises. Plans that are fully funded pay only a flat rate premium based on headcount. Underfunded plans pay an additional variable rate premium (VRP) based on the total unfunded liability for the plan (capped by participant). Merging an underfunded and overfunded plan can create a combined fully funded plan, eliminating the variable portion of the cost or premium due to the PBGC as shown:

Consider Company X who maintains 2 pension plans: 

  • Plan A has 580 Hourly participants with a PBGC shortfall of $10 million as of 1/1/2019
  • Plan B has 1,160 Hourly participants with a PBGC excess of $10 million as of 1/1/2019
  • Plan A merges into Plan B with 1,740 participants and no shortfall as of 1/1/2019
Impact of Pension Plan Merger on PBGC Premiums

By merging Plan A into Plan B, the shortfall is eliminated and PBGC premiums due are dramatically reduced with considerable financial impact.

Reason #3 : Plan Termination on the Horizon

Similar to the administrative savings of merging two ongoing pension plans, there will likely be reduced fees related to the process at termination. The final step in distributing retirement plan assets will be the agreement between the insurance company taking over the responsibility for all future benefit payments of remaining participants. Merging plans will consolidate the transaction and increase the number of participants affected, potentially resulting in annuity purchase cost savings to offset the underfunded liability  at final distribution. If plan termination is on the horizon, especially for two small to mid-size pension plans, a plan merger may prove to be a valuable first step with potential positive financial impact.

We Want to Merge our Pension Plans…Now What?

In most scenarios, the process is fairly straightforward. There will be a few adjustments required to the valuation process in the first year, but going forward will operate as usual. Participants will be notified of the change, but there will be no difference to the way that their benefits are calculated or administered.  

The plan sponsor will also be required to do the following:

  • Execute a plan amendment describing the plan merger
  • Modify the plan document to reflect the new consolidated plan
  • File Form 5310-A with the IRS no later than 30 days prior to the merger

Regardless of the size of the plan, a plan merger may be a step in the right direction toward simplifying the administration and cutting costs for many organizations sponsoring more than one pension plan.  Merging multiple pension plans is most often one example in the pension world where less is more. Finally, there are instances where a merger may result in increased costs (PBGC premiums) or may present other challenges.

Each situation is unique so don’t make any assumptions without consulting your actuary. And don’t overlook the importance of a communications strategy to inform participants of any changes which take place.

Questions? For more information, contact the Findley consultant you normally work with, or contact Debbie Sichko at debbie.sichko@findley.com, 216.875.1930.

Published on August 15, 2019

© 2019 Findley. All Rights Reserved.

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