Not very long ago (In Confero Issue 14), we provided tips on getting ready to terminate your defined benefit plan. This was driven by an expressed interest by many plan sponsors in how to prepare for and initiate a plan termination. Despite this interest, there really haven’t been many significant plan terminations. I think this lack of action was driven by the underfunding that remained after the effects of financial risks and costs. Despite the best of intentions, plans remained underfunded. Elsewhere in this issue is a discussion of the risks involved and how to mitigate those risks (“How to De-risk the De-risking Process”). Taken together with the checklist here, you should be able to prepare for a plan termination and not be surprised by unexpected risks along the way.
The termination of a defined benefit pension plan (both traditional and cash balance) can be a difficult, costly, and time-consuming process. Typically, there are many parties involved in completing the termination, including the plan sponsor, and many advisors (actuary, attorney, accountant, investment advisor, and trustee), as well as the IRS and the PBGC. The termination process requires communications to interested parties, and filings of information with the IRS and the PBGC. For plan terminations, interested parties are defined as all present employees with accrued benefits, all former employees with vested benefits, and all beneficiaries of deceased former employees currently receiving benefits under the plan.
All of these communications and filings must be completed in accordance with strict guidelines regarding timing, form and content. These requirements are briefly summarized in the chart that follows. All of these requirements are detailed in guidance from the IRS and the PBGC. Despite the numerous requirements, this may not be the most difficult part for most plan sponsors (other than for the fees involved), since the responsibility for preparing and completing the paperwork is often delegated to professional advisors.
The pretermination planning might be the most challenging aspect of the entire process, but careful preparation will make the entire process more manageable. There aren’t any detailed instructions or guidelines, and the process requires a great deal of judgment from HR and finance, and may entail significant costs.
The initial review is generally financially driven.
Why do you want to terminate the plan? Costs too volatile? Contributions and expense levels unacceptable? Too great a liability on the balance sheet? Plan not appreciated or understood by participants? Or is it a little of each?
Can you afford to terminate the plan? You must look at your funding level. Termination of a plan generally entails lump sums or annuities, both of which may have a cost higher than the liability you have already considered for funding and accounting. If this liability for termination exceeds plan assets, you must develop a funding strategy to cover the shortfall. Termination can’t be completed until the plan is fully funded.
On termination of a plan any unrecognized losses on the balance sheet must be recognized. Are you and your board prepared for this?
Can you withstand plan-asset volatility during the termination process? Consider implementing a risk-reduction plan to avoid an unexpected shortfall in funding.
Are there any assets that may be difficult to liquidate?
The termination process is data-dependent.
How good is your data? If you have missing participants, missing addresses or questionable data, now is the time to start a cleanup process. Data errors will delay that process.
How will benefits and options be calculated? Consider an automated process if there are material benefit-calculation fees. It may be worth considering a change if your current administrator can’t automate the process.
Do you need a replacement plan?
Benefit adequacy may be a necessary consideration. If your employees can’t afford to retire, what will the impact be on your costs (Consider advancement opportunities for younger staff as well as medical costs.)?
If the plan termination isn’t being driven by financial considerations, can you get desired results from improving or implementing another plan (like your 401(k))? Which plan design will satisfy both your cost constraints and employee-benefit adequacy needs?
Communications and Advice.
Besides the required employee notices and communications, consider what else may be desirable for public relations or for changes to other benefit programs.
If the termination will give participants a number of distribution options, as well as potential changes to other plans, consider providing financial advice or education. If advice is given, you must select a fiduciary. Do you have a process to do that?
Selection of advisors to help with the termination decisions and required filings:
You may already have advisors in place. These advisors include your ERISA attorney, actuary, accountant, investment advisor, and other financial advisors. Each should be evaluated for their ability to assist with the plan termination process.
If annuities will be offered, you must evaluate the carriers involved. Who is qualified to evaluate those carriers, and how many will be included in the bidding process? Who will conduct the bidding?
Get estimates of the fees involved. Competitive bidding can greatly reduce fees.
Completing a plan termination is complex, time-consuming, and challenging. However, careful pretermination planning and engaging qualified advisors will make the process manageable and help you achieve the desired financial results. Because the process takes place over an extended period of time, involves advisors from many specialties, and internal resources from HR and finance, consider engaging an advisor to help manage the process and manage the other vendors/advisors involved.