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Sunday, September 21, 2014

For Your Benefit – Savitz Summer 2010 Newsletter

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My Defined Benefit Plan is Frozen – Now What?

Over the past decade a significant number of plan sponsors have “frozen” their defined benefit plans – meaning, although the plan has not been “terminated”, employees are no longer earning benefit accruals in connection with continued service. Rather, all accrued benefits are locked and frozen.

In many cases, the primary driver behind a plan freeze is related to costs – more specifically, an attempt to mitigate future financial risk and volatility. In some cases, perhaps a secondary goal is to reduce the effort associated with operating the plan. However, it is important for sponsors of frozen defined benefit plans to remember that a frozen plan cannot be ignored – it must be managed – and must continue to comply with pension laws and regulations. In short, think: “freeze and operate”, rather than “freeze and forget”!

The following are some considerations that employers who sponsor a frozen defined benefit plan – or who are considering a plan freeze -- should keep bright on their radar screen.

Plan Documents, Notices and Filings

Unfortunately, freezing a plan provides no exemption from keeping the plan document current, issuing timely notices to plan participants, or submitting annual plan filings to the government (e.g. Form 5500). While some of the complexity associated with these efforts may be reduced – for example, the volume of future plan amendments may be reduced – there is still considerable effort required with keeping the plan in compliance with emerging regulations, issuing various participant notices and filing accurate annual government submissions.

Funding and Investments

In keeping with the above theme, it is important to remember that freezing a plan does not relieve the plan sponsor of responsibility for the plan’s funding and investment strategy. While financial risks and volatility may be mitigated by the freeze, they are by no means eliminated. An annual actuarial valuation is still required. Further, the plan sponsor should continue to work closely with the plan actuary and investment professionals in devising an appropriate funding and investment strategy, including a process for evaluating these strategies periodically to ensure they are keeping current with changing business, regulatory and economic conditions. Even though a plan is frozen, the plan’s funded status and contribution requirements are still a function of shifting economic conditions (e.g. interest rates), plan investment performance, retirement and mortality experience, government regulations and other factors. Therefore, a thoughtful and attentive approach to plan funding and investing is still very much in order.

Ongoing Benefits Administration

Just because the accrued benefit is frozen, future service still matters. For instance, if an employee is not vested at the plan freeze date, post-freeze service still counts for vesting purposes. Similarly, post-freeze service may also count for purposes of retirement eligibility, early retirement subsidies, and other benefit eligibility purposes. For these reasons, post-freeze service and separation dates must typically still be tracked. In addition, ongoing retiree deaths, scheduled retiree benefit changes, and new retirements must be managed. In fact, when a participant steps forward to retire, even though the accrued benefit is pre-calculated and frozen, additional calculations may still need to be performed at that time -- such as early retirement benefits and optional payment forms (possibly including a lump sum calculation).

Data Audit

The plan freeze is an opportune time to perform a final data review for current employees. This will enable the calculation and communication of “final” accrued benefits. For instance, depending on the plan formula, each employee’s service history, compensation history and birthdates should be subject to a final review. At the time of plan termination, the PBGC will require the plan administrator to provide each participant with a detailed accounting of the data used to determine their final accrued benefit. It is easier to perform a final data verification now than it will upon a future plan termination. The same is true for future retirees should the plan continue. For example, consider the current 40-year old participant who will need to have this verification done 20+ years from now when he or she steps forward to retire! For similar reasons, it is also a good time to review and finalize the data and accrued benefits for former employees who have a vested accrued benefit.

In short, while freezing a defined benefit plan reduces some future uncertainties and cost volatility, it does not eliminate the need for plan sponsors to carefully govern and operate their plan. In some cases, the effort and costs associated with actuarial valuations and benefits administration may be reduced. In addition, certain “simplifying” investment strategies – such as immunization or maybe even annuitization – may be appropriate for some frozen plans. A plan sponsor may even choose to put the frozen plan on a path toward potential future termination. But until such time that a plan is actually terminated, even a frozen plan requires significant plan sponsor care and attention.

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