When defined benefit pension plans come up in conversation (that’s what we ERISA folks do when we get together), it’s usually about the decline of traditional pension plans and the increase in of cash balance plans. Frozen pension plans are rarely included.
They should be since they are a significant part of the retirement plan universe. At last count, there were approximately 7,800 plans covering 5.5 million employees with $317 billion in assets.
What exactly is a “frozen pension plan”? Generally speaking, it’s a defined benefit plan that has:
- Ceased benefit accruals for all employees, or
- Accrues benefits for existing participants, but is closed to new entrants
As an aside, the later may have compliance issues with respect to Minimum Coverage, Minimum Participation, and Top-Heavy requirements under the Internal Revenue Code.
But both types of frozen pension plans have one thing in common. Although benefit accruals have ceased or there are no new participants, the cost of maintaining the plan continues. Service providers are still required, e.g., actuaries, third party administrators, accountants, attorneys, investment managers, and recordkeepers.
Expenses inherent to the plan itself also continue. It’s substantial increases in two of those expense items that are making frozen pension plans high maintenance – and all pension plans for that matter.
First, PBGC Premium Increases
Defined benefit plan sponsors experienced back to back PBGC premiums in 2012 as part of the Moving Ahead for Progress in the 21st Century Act (MAP-21) and in 2013 as part of the Bipartisan Budget Act of 2013 that was signed into law on December 26, 2013. This legislation significantly increases both the flat-rate and variable-rate single employer PBGC premiums.
These premiums to which employers have to pay each year to the PBGC are comprised of two portions:
- Flat-Rate
- Variable-Rate
The flat-rate portion is determined by multiplying the flat premium rate by the number of participants in the plan. One estimate I’ve seen show the future PBGC flat–rate premiums could be a significant percentage of the present value of that participant’s benefit payments.
For example, the present value of future PBGC flat -rate premiums would be about $1,800 for a 40 year old participant, assuming 5% interest and 3% inflation indexing.
That’s the “then”. But in the “now”, it’s the variable-rate premium that will make it make it much more expensive for employers than in the past. The variable rate premium is that portion of the PBGC premium that is based on the amount of a plan’s unfunded vested benefits (“UVB”), or the difference between plan assets and liabilities.
Take the example of a frozen pension plan covering 50 participants that is $500,000 underfunded. This employer will see their PBGC premiums increase from $6,600 in 2013, to $9,450 in 2014, to $14,850 this year, and to $14,850 next year – 168% increase in 4 years.
Second, New Mortality Tables
The Society of Actuaries has issued a new set of mortality tables that recognizes longer lifespans. Longer lifespans means retirement benefits are paid longer. Because mortality is a key assumption in measuring pension obligations, the new set of mortality tables could significantly increase pension liabilities.
The IRS has the authority under the Pension Protection Act of 2006 (“PPA”) to prescribe mortality rates used in the calculation of funding liabilities. The PPA requires a review of the mandated mortality tables for at least every 10 years. Since actuaries are currently using a 2000 mortality table adjusted for expected mortality improvements, the IRS could require the use of the new tables next year for both funding requirements and lump distributions.
What will be the impact? Projections I’ve seen indicate that
- Plan liabilities could increase 6% to 8%, and
- Depending on participant age and retirement date, lump sum distributions could increase from 7% to 15%.
So what should employers with frozen pension plans be thinking about now? Certainly consider terminating the plan, or if not financially feasible now consider alternative strategies to get a better handle on their retirement plan expenses. What those strategies are and how they play out in a frozen pension plan are beyond the scope of this blog post, but will be discussed soon.