Defined Benefit vs. Defined Contribution - the armwrestling continues!

[Guest Franklin Evans]

There is standard language for plan terminations in documents, but I've been away from those details too long to remember.

I will remind you that a Defined Benefit trust is held by the plan sponsor for the payment of benefits. A DB plan's assets "belong", if that's even the right term, to the contributing employer(s).

I was there, at ground zero, during the big deals that reaped so much cash from rich pension plans, back in the late 80's. That was an aberration that was quickly quashed (excess reversion taxes, etc.) The bottom line, pun intended, was and ever shall be tax shelters and write-offs for corporations. Giving benefits to workers is still second place.

[Guest Lorne Dauenhauer]

I disagree that providing benefits to workers comes in "second place." While the plan sponsor certainly has to frame many plan decisions in a business context, employers generally establish qualified retirement plans with a dual purpose: to provide for their employees' retirement and to compete for and retain quality employees.

Next: I remind you that as is the case with any assets held in trust, the "legal" owner is the plan sponsor, while the "equitable" owners remain the plan participants. I believe that the current ownership interpretation of "excess" assets is that any assets in excess of the plan's liabilities remain the property of the employer -- both in legal and equitable titles. Any and all assets necessary to provide benefits for participants certainly do not belong to the employer.

Lastly, there is no "standard" termination language that I'm aware of. That said, it is arguably better (from the plan sponsor's perspective) to draft the plan document with 'reversion' language which can be amended to allow for an allocation of those assets upon termination. It might not be possible to go in the reverse direction, for fear of violating the anti-cutback rules. There are contingencies, e.g. bankruptcy, that might call for reversion rather than allocation, and it is best left to the plan sponsor to have a choice rather than be stuck with the allocation option alone.

[This message has been edited by Lorne Dauenhauer (edited 03-29-2000).]

[david rigby]

To Lorne, there is extremely common language in plan documents that addresses plan termination. This is what the "standard" reference meant.

To Lorne and Frank, if you know what is good for you, stay away from this message thread.

[This message has been edited by pax (edited 03-29-2000).]

[Guest Franklin Evans]

To pax and any who might wonder, I am the moderator for this message board, and any difficulties concerning decorum and courtesy on this message board should be brought to my direct attention, and failing a timely response to Dave Baker.

Lorne, I ask you to take my comments with a grain of salt, and I'll readily confess that I am more than a bit cynical.

I started my career in pension admin in 1976, and two months into my on-the-job training I was asked for my opinion about certain regs... the chief actuary, the documents attorney and my supervisor were ready to give up and needed a fresh perspective. Since then, I've had the privilege to work directly with several experts in the field, but the common attitude has been (in my experience) that if you don't like the weather now, wait for the next session of Congress. If you complain about proposed and temporary regs now, think about what it must have been like just two years after ERISA was passed.

My comment about the bottom line, without the cynicism, is still an important thing to consider. Most employers would not have qualified plans were it not for the corporate tax deduction and their ability to design plans that give their top executives the best possible benefit. There are certainly other important aspects, such as employee morale and retention, but for most small employers (again, in my experience) these remain secondary considerations.

My current focus is business requirements and software design. I continue to see evidence that my early cynicism remains justified. As we say in cyberspace, YMMV (your mileage may vary).

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[John A]

My 3/29 post was intended to relate to the link provided: http://www.bergen.com/region/pensionc200003284.htm

The link seems to indicate that the New Jersey legislature believes that a $2 billion surplus in the police and firefighters pension fund should be used to 1) provide a more generous early retirement benefit, 2) reduce the contributions of town and city governments (making money available for property tax relief), 3) reduce the withholding requirement for pension payments for current employees.

Any thoughts on New Jersey's actions?

Some excerpts from this link:

The New Jersey legislature approved a bill that pays the tab for a controversial measure signed in January that allows police and firefighters to retire after 20 years with pensions equal to half their salaries.

The measure covers the cost of the new benefit and further reduces what towns must pay the state for existing pension benefits by tapping part of a $2 billion surplus piling up in the state Police and Firemen's Retirement System. The surplus is the result of the sharp growth in the value of stocks held by the pension funds.

Such a maneuver allows towns and county governments to skip thousands of dollars in pension payments that they would have otherwise been required to pay by April 1. That money can now be used to ease property tax pressures by allowing officials to pay down debt or address rising costs for municipal services.

Municipal and county governments have avoided paying their portion of the pension bills for employees who are not police or firefighters since the passage of the 1997 pension bond act, which pumped $2.76 billion in bond proceeds into the state pension systems.

And earlier this year, Whitman signed legislation that reduced the size of the pension payment withheld from local and state government employees' paychecks.

[Guest Franklin Evans]

Thank you to John for the link and summary.

New Jersey's action to reduce future contributions is an example of a good parallel to a private-sector plan sponsor adjusting its annual contribution because of minimum funding amortization credits from unusual investment experience. The difference is that a corporation makes this type of decision routinely, and based on the advice of a pension actuary, and a government must do it by legislation, debate, and political compromise... and maybe on the advice of a pension actuary, but not always.

[sarcasm] Now, I ask you, is that any way to run a business? [/sarcasm]

[This message has been edited by Franklin Evans (edited 03-30-2000).]

[John A]

http://www.nasra.org/level2/dbvsdc.html

Some selected excerpts from this link, which is directly on topic to DB vs. DC:

DB vs. DC - Who Rules?

An Interview with Leslie Finertie (Towers Perrin)

Defined Benefit vs. Defined Contribution retirement systems is one of the "hottest" topics in public sector retirement systems. The vast majority of public retirement systems are DC, which may explain the many apparent misconceptions about DB.

The 1997 PENDAT Survey indicated that the median employer retirement contribution to a DB plan for general employees was between 10 and 14 percent of covered payroll. What might be the comparable contribution to a DC plan?

Finertie: Studies show if you try to keep employees whole when they transfer from a DB to a DC plan, contributions have to increase by 50 percent or more of payroll for employees over age 40. Or, with the same contribution rate to a DC plan, the average investment return needs to increase to 15 percent or more, annually for life.

Recent studies show that about half of terminating employees eligible for a lump sum spend that money rather than roll it over for retirement. It's hard for a 30-year-old to realize that if they spend the $5,000 to $10,000 they've saved so far, it will make a big impact on their retirement account in 30 years.

Many public retirement system directors have expressed the fear that a substantial number of people under a DC plan will end up at the age of normal retirement without an adequate benefit to supplement Social Security. Is this a valid concern?

Finertie: Everyone should be concerned about the adequacy of retirement benefits for employees switching to DC plans. Social Security alone may not keep retirees out of poverty. So, employees may need to work well into their 60s to accrue enough benefits in a DC plan. Individuals may look at the large DC account balance and retire at age 50 or 55 thinking they have enough money. But what if they run out of funds by about age 65 when Social Security payments begin? Will they be in good enough health to go back to work after being retired for 10 years or longer? Who will pick up the shortfall when these retirees can cover their own living expenses?

Do you think that DB vs DC will continue to be a big public sector issue in the coming years?

Finertie: The DB vs DC debate will rage on. So many organizations marketing 401(k) and similar types of DC plans will continue to focus on their advantages. DBs will continue to remain difficult to understand. And, we will continue to have generational differences with younger employees preferring DCs because of their portability. Also, as employers begin to need employees to work for more years because of the emerging skilled labor shortage, employers may want DCs which don't encourage early retirement because they don't include early retirement subsidies.

[jlf]

To Lorne and Franklin: I was not referring to plan termination in my posted question of March 29, 2000. My question refers to a fully funded and on-going DB plan. I look forward to your informed replies.

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yes

[Guest Lorne Dauenhauer]

jlf (and Franklin -- feel free to chime in here): the only way for a DB plan to "distribute its surplus" is when the plan terminates.

DB plans are precluded from allowing distributions to participants while they are still employed (unless the participant has reached the plan's definition of normal or early retirement age).

Certainly, a DB plan could use up its surplus by making the benefit formula "richer", but this isn't a good thing to do in the long run, as you are promising to pay benefits far, far in the future based on your past investment performance. Not the smartest thing to do.

Alternatively, the DB plan could offer an early retirement incentive plan by giving enhanced early retirement benefits to a select group of employees, but none of these are the same as "distributing surplus".

Franklin: I can appreciate your perspective on small employers' plans. As for another perspective on the bottom line, if it weren't for the tax breaks provided by Congress, the private pension leg of the "three legged stool" would be very, very short indeed.

[jlf]

To clarify: NJ is not using the entire $2.3 billion surplus in the police and firefighters pension fund to improve benefits for police and fire personnel. It is using just $45 million of it. JohnA, I'm sure you recognize this. I just did not want to leave it chance. jlf

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yes

[jlf]

I refer you to my post of 2-9-00.

The non-response is deafening. jlf

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yes

[John A]

quote:

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Originally posted by jlf:

To clarify: NJ is not using the entire $2.3 billion surplus in the police and firefighters pension fund to improve benefits for police and fire personnel. It is using just $45 million of it. JohnA, I'm sure you recognize this. I just did not want to leave it chance. jlf

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jlf, yes I recognize that the surplus is not being used entirely to improve benefits and I thought my post and the link indicated other uses for the surplus. That was what prompted the initial question of "Who owns the surplus?" Perhaps the question should have been, "What is the best policy when a surplus occurs - should it always be used 100% to improve benefits, should it be used to reduce current employer contributions, should it be used to reduce current employee contributions, should it be saved as a "rainy day" amount if investment experience turns sour, if a government plan - should the government be able to tap into the surplus for other governmental needs, etc., etc., etc. Should the existence of the surplus be credited to wise investing of the employer, favorable economic conditions due to a well-run government, dumb luck, overcontributions from employer and/or employee, etc.? In the private pension world,the government's answer when a plan terminates is to give an employer this approximate choice: 1) give the entire surplus to existing participants at time of plan termination, 2) give participants some of it, employer can keep some of it, and we the government will take some of it in taxes.

In the private pension world for an on-going plan, a high enough surplus generally prevents the employer from making any further tax-deductible contributions and about the only way the employer may be able to continue making tax-deductible contributions would be to improve benefits. I'm not trying to provide a right answer re: surplus asset policies - I'm just raising the issue of surplus asset policies in light of New Jersey's actions.

I thought it was interesting that some groups feared that if the entire surplus had been used to improve benefits for police and firefighters, some cities would have faced the possiblity of having no police or firefighters since they all would have retired. There was some fear that even the existing improvement might lead to shortages of police and firefighters.

[ishi]

Very interesting and massive thread.

I wonder what the pro-DC group is thinking now, given the current prolonged market downturn. Theory versus reality ...

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Ishi

[Guest Brian4]

What the pro-DC group is now thinking is a good question.

It is interesting how the thread stopped around the market peak in Spring 2000.