DB Plan Termination

[Guest JimJ]

Background - Client A currently has DB plan and would like to terminate the plan and start a 401(k). Their current actuary has told them that the termination process is between 18-26 months and they will not be able to provide the funding liability nor their cost until well into the process. I am not very familiar with DB plans and assumed much like a DC plan that once a sponsor decides to terminate that the hard cost can be determined up front. I also believed that once the process began and accruals have ceased the funding liability could be determined.

My questions are this:

What is the typical time frame to terminate a DB plan?

How soon into the process should the employer know what liability they have to terminate the plan? Including the actuaries cost.

What is the basic process for terminating a DB plan?

Thank you for your help and responses.

JimJ

[Blinky the 3-eyed Fish]

I am assuming this plan is covered by the PBGC. I will also assume the plan sponsor will submit the plan to the IRS for a determination letter. With those assumptions the time frame should be as follows:

http://www.pbgc.gov/forms/500_NEWI.PDF (go to page 3)

As you can see it is not 18-26 months to get all this done.

As for your other questions: When the valuation can be done to determine the final contribution depends on whether the valuation date is at the beginning or end of the year. If it is the end of the year, the actual final valuation cannot be done until the last day of the last plan year or the last day of the plan year in which the plan terminated (if earlier).

The actuary should be able to ballpark costs for you before the process starts. Although, from experience, different plans have different issues that may require more or less time than another. Also, the IRS or PBGC could always request items that would also add to the time.

[david rigby]

Probably the other fact (not explicitly stated) is that the DB plan is underfunded on a termination liability basis. Thus, the employer will make a contribution for whatever amount is required to bring that funding up to 100%. If my assumption is above, the actuary is correct in implying that the liabililty for that amount cannot be determined yet, because the amount will depend on several factors. These include such mundane items as data corrections. However, the most crucial issue is twofold: when will the benefits be distributed? and what will be the interest rate required to value these benefits? It is difficult to answer the second until you are reasonably certain of the first.

Another factor that could affect the ultimate plan liability is whether the plan will distribute its requirements via purchase of annuities or via direct distribution to participants. If the former, no insurance company will give a price quote far in advance (my experience is that price quotes expire at the end of the day). If the latter, then my comments above about interest rate apply.

Blinky is correct about being able to obtain a "ball park" estimate, but if the time frame is 12 months (or so) in the future, then more than one estimate might be in order.

[mbozek]

There are two ways of determining termination costs for a DB plan: on a current basis and a termination basis. Plans can be fully funded on a current basis (e.g., no contributions can be made) because the plan assumes an interest rate of 7.5% is needed to pay all plan benefits and the plan's actual return is in excess of this rate. But If the plan is terminated then the interest rate used to determine the present value used of the benefits drops to the PBGC rate for 30 yr bonds (which has recently been changed) which could be say 5.5%. This requires more assets and could result in the plan being under funded if all benefits are paid in cash. If annuities are purchased the interest rate may increase to 6.0% which will require less assets since the higher the interest rate the lower the present value needed to fund benefits necessary to terminate the plan. If the plan does not have sufficient assets at the time the termination is approved the employer will be required to contribute additional assets to pay out all accrued benefits.

[Guest JimJ]

Thank you all for your reply. Is there any other information I can provide to make this easier to answer. Currently the sponsor wants to do the following.

1) Terminate the DB plan as soon as possible, and begin a DC plan.

2) Pay all part's out of the DB and allow them to roll money into the DC plan.

3) Find out an approx. cost and timeframe to move forward with the DB termination.

4) Find out what liability they will have for funding. (I understand that certain items are required to make this a definite number. But, can certain assumptions by the actuary take place and allow them to provide a good estimate?)

Are these unreasonable requests to ask the current provider to supply? Are there too many variables to accomplish this request? Thanks again. JimJ

[MGB]

That is certainly reasonable except one thing...item 2.

Some participants may request an annuity instead of a cashout. Finding insurance companies to bid on a small number of people (and/or small amounts - although you can force it if the value is less than $5000) is probably the most time consuming and difficult steps in the termination process. If everyone chooses against the annuity option, then the process will be much smoother and should go very quickly.

The best approach is to freeze the DB immediately and start up the DC. Whenever the DB actually gets terminated is of no consequence except to determine the date of the payouts. Freezing is a different step than terminating.

[Guest JimJ]

Can you explain the freezing approach in a little more detail?

[david rigby]

MGB is correct about recommending a freeze. In fact, whenever a client considers a plan termination, I also recommend they freeze as well. A plan freeze is exactly what it sounds like: a simple plan amendment stating that no benefits will accrue after a certain date. Note that this date must be in the future and you must notify participants in advance (often referred to as the "204h notice").

A good freeze amendment will include several things, such as freezing service, freezing benefit accrual, and freezing plan participation. This might sound redundant, and it sometimes is, but not always. Therefore, I suggest you do it anyway to remove any possibility of interpretation otherwise.

One important difference between termination and freezing a DB plan is that the former requires 100% vesting, while the latter does not. Therefore, if you freeze and then terminate it in a later plan year, you may have some participants terminate non-vested prior to the plan termination date. The dollars involved may not be significant, but it can save some.

I notice that we are in the same state. If you need any specific help in this area, please email me.

[Guest merlin]

WRT freezing benefits, also bear in mind that the freeze does not cease the minimum accrual in a top heavy plan.If your db plan is t/h you might want to include in your termination amendments a coordinating article transferring the minimum to the dc plan.

[mwyatt]

One slight point on the vesting issue wrt the "freezing" of benefit accruals. Full vesting would be required if plan is fully funded; if plan is underfunded at time of freeze can continue with regular vesting schedule. See this thread for further info on impact of freeze:

http://benefitslink.com/boards/index.php?showtopic=5561

My quote from DOL is a few items down.

[david rigby]

If your plan is properly designed, it will probably include a statement that excess assets revert to the employer upon plan termination. This might not be what you want, but you can always change that at time of termination. However, you cannot change the other way.

Therefore, assuming this provision is in your plan, the fact set in the referenced IRS reg does not apply, and a freeze will not result in 100% vesting.

[David]

Regarding top-heavy minimum accruals, note that EGTRRA exempts frozen plans from the top-heavy minimum accrual rules.

[Guest merlin]

Agreed that EGTRRA removes the requirement for frozen db plans to give the minimum, but until your plan is amended to remove it the obligation is still there. But I have a related question. The db minimum was always considered the more valuable accrual,hence the multiple ways of meeting minimum in the dc side of a db/dc combination. Have these rules gone by the boards with EGTRRA? It would seem so. Any comments?

[AndyH]

Merlin, are you sure about the top heavy requirement remaining for a frozen plan until the plan is amended for EGTRRA?

What is your basis for saying that?

I would think that most freeze notices either freeze without differentiation of the types of accruals, or the freeze notices cease accruals except as may be required under section ___ of the plan, or section ___ of the Code.

Maybe in the second case you might have a point, but otherwise I'm not sure I'd agree.

[Guest merlin]

Andy,see 1.416-1 Q&A T-5. I don't think referencing IRC 416 in your freeze notice will suffice.

As for the second point, I don't think you can delete the db minimum "in operation". You still have to run the plan in accordance with its terms, even if those terms are now more restrictive than the law requires.

[AndyH]

I'll take a look at that, but note that Notice 2001-42 gives you until 5/31/02 (3/31/02 if the plan uses elapsed time) to amend to change the top heavy rules in a DB plan without causing a cutback, on the basis that the top heavy benefit does not accrue until somebody works 1,000 hours.

So even if you are right, it seems clear that there is time to remedy it.

p.s. I looked at T-5. There's nothing new there. My opinion is unchanged. I think it depends upon the language in the freeze notice and amendment.

Other opinions?

[Guest merlin]

I agree with your first point. There is time to make the amendment . My point is that there must be an amendment, rather than just removing the minimum in operation.

As for your p.s.,are we both saying the same thing differently? The minimum continues to accrue until the plan is terminated,even if the regular plan accrual is frozen,right?

[Guest nikomendy]

just to remphasize that those participants whose accured present values are greater than or equal to $5000, MUST BE GIVEN CHOICE of annuity.

It is immaterial whether this is 5 or 5000, they must be given the choice.

Furthermore, "quick quotes" are fine-- but ultimately the insurer chosen must be approved by dol as a part of the normal termination, and the identity of this insurer must be provided to participants. I noted this- as one of the notes above alluded to "how much easier" the process might be if all participants were only to be given lump sums; maybe true, but as stated above-LUMP SUMS cannot just be forced for those whose accured values exceed or equal $5000.

[david rigby]

To be a bit more precise, a distribution can be "forced" when the plan terminates, whether or not the amount is greater than $5000. If greater than that amount, then the participant might have some choice about the form in which it is received.

- If the plan termination offers a lump sum, then the participant can choose an annuity, in which case the plan will be forced to purchase that annuity on the commercial market.

- Alternatively, the plan termination might be accomplished thru the purchase of annuities for all employees, in which case nobody gets a choice.

[Guest nikomendy]

Better stated-- but bottom line is that vested participants (with present values greater than $5000), always have the annuity option; either as the only option or as a choice versus a lump sum.

Have several questions on the annuities:

plan being normally terminated, allowed/s participants a range of j&s factors- from none up to 100% (with appropriate reductions) for higher j&s factors. Participants in pay status-selected these varying ranges- and receive their payouts on a monthly basis. Assuming the plan which is being terminated is fully funded:

(a) does the pay period of the annuity, have to match the terminating plans' pay period ? or for example could the annuities provide payouts only on a semi-annual basis etc. ?

(B) On a per retiree- basis - does the provided annnuity from the commercial carrier- have to match the j&s factor selected and received by the retiree under terms of the plan being terminated ? Or can these participants just be provided 50% J&s factors with their provided annuities ?

© Under what circumstances can the value of the provided annuity be less than participant is already receiving ?

(d) plan being terminated has an early retirement provision for those 55 or older, and a normal plan age of 65. There are some early retirees as well as those 65 or older. Can the termination process be used to defeat 411(d) of the code... and value the purchased annuities based only on a age 65 basis- e.g. a "slick way to cutback" the pre-65 retirees ?

Regulations in Sept of 2000 relaxed considerabley the optional forms of benefit in DC plans but seemed to not allow these for db plans.

[david rigby]

I think:

(a) Yes. To pay the benefit less frequently would be contrary to what the plan says. To amend the plan in that manner would (likely) violate 411(d)(6). To amend the plan to be more generous is probably permitted, but possibly irrelevant.

(B) See (a).

© If the participant is receiving an annuity form of distribution, the value of the annuity is irrelevant. If that participant has an option to receive a lump sum, then that lump sum (as well as any other optional forms) should comply with the terms of the plan.

(d) I doubt it. Those who are eligible for early retirement (likely) would be entitled to elect an early retirement annuity under the plan. The value of that participant's lump sum option (if available) may or may not reflect any early retirement subsidy, depending on the terms of the plan and prior administrative practice.