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Ending a Defined Benefit Plan Takes Shutdown Strategy, Experts Say

Before a plan can be terminated, it needs to have all the funds necessary to pay benefits to employees. Once that happens, plan sponsors can start the process of shutting down the plan.

May 9, 2012

There isn’t an application yet for terminating a defined benefit plan, but there is plenty of guidance.

“There are enough plan sponsors with frozen [defined benefit] plans who want out,” says Mike Clark, a consulting actuary in Principal Financial Group’s Pittsburgh office. “There is a desire for simplicity and guidance to get to the endpoint.”

Principal is one of several firms with road maps for plan sponsors looking to terminate their defined benefit plans. Principal broke its “how to” into two phases: “Best Practices for Building a Termination Strategy” and “Winding Down Your Hard-Frozen Defined Benefit Plan.”

Before a plan can be terminated, it needs to have all the funds necessary to pay benefits to employees. Once that happens, plan sponsors can start the process of shutting down the plan.

A large part of the second phase is helping participants know about the choices they will need to make, says Cathy Toner, senior manager in the strategic retirement consulting group at Vanguard Group Inc., which also offers plan shutdown guidance. When the plan terminates, it is important participants understand the difference between the freeze and the shutdown.

“They’ve already heard the tough news about the plan freezing,” Toner says. Participants “should understand they are no longer accruing benefits.”

For several years, more plan sponsors have been joining the trend of opening defined contribution plans and freezing defined benefit plans. According to data from consulting firm Towers Watson & Co., since 1998, 42 of today’s Fortune 100 companies have frozen or closed their defined benefit plans.

Freezing a plan doesn’t mean everything stops. A “soft freeze” is typically not open to new employees, but existing participants still accumulate benefits. A “hard freeze” or “close” is when new hires can’t join and benefit increases for existing participants stop.

Terminating the defined benefit plan is the next step. The final phase of a 2006 federal law that determines the calculation used to exit participants from the plan comes into effect this year. The new interest rate used to calculate participants’ payouts when terminating a plan will make it more affordable for plan sponsors, experts say.

Participants typically get two choices in a termination: receive a lump-sum or an annuity payment. It can be a tough for some participants to figure out which option works best, Toner says.

Last year, the Valley Forge, Pennsylvania-based investment company launched Vanguard Pension Reinvestment Services, a program designed to help participants of terminated defined benefit plans make better decisions about their retirement money.

“It may be the biggest chunk of money they’ll ever get, so it’s important for [participants] to make the best decision for their situation,” Toner says. “Most people need a little help.”

Patty Kujawa is a freelance writer based in Milwaukee. Comment below or email editors@workforce.com.