COLA Ends on Plan Termination?

[John314]

I am working with a single employer pension plan that is looking to terminate their plan. The plan is PBGC covered and will be terminating as part of a standard termination. The plan provides for an annual post-retirement COLA based on CPI and capped at 4.0%. I know that typically a COLA such as this is considered part of the accrued benefit and cannot be amended out. The catch is that the definition of the COLA in the plan document states that the COLA will cease on plan termination. As best I can tell this language has always been in the document and they have received FDLs. I will be pointing them to their attorney for a final opinion, but has anyone come across this? Any thoughts or opinions on whether it is permissible to stop the COLA at plan termination?

[Sellarsian]

FWIW (not that much, I'm afraid), I share your skepticism. If it were permissible to have post-retirement COLAs disappear upon plan termination, why not other features: say, upon plan termination, the pension becomes payable only for the following 3 years ....

While FDLs may help avoid plan disqualification, i wouldn't think that they would force the PBGC to treat annuity contracts without COLAs as satisfying the plan's obligation. You're right to defer to their attorney on this!

[AndyH]

Never heard of such a thing.   Time for ERISA counsel.

[MrAnnuity]

I third the consultation of the ERISA counsel. That being said, I have seen this once before. The annuity contract did not contain the COLA and everything passed just fine. Another consideration is valuing this feature for lump sum calculations.

[AndyH]

On 2/27/2024 at 1:06 PM, MrAnnuity said:

I third the consultation of the ERISA counsel. That being said, I have seen this once before. The annuity contract did not contain the COLA and everything passed just fine. Another consideration is valuing this feature for lump sum calculations.

Well the situation that you describe is clearly an error on the part of whoever set up and/or approved the contract.   Nothing was "just fine" IMO.  In the original post, the error is clearly on the part of whoever wrote the document.

[BruceM]

Related question to this.

I'm retired now but like to read and keep up with changes. During my working years as a financial planner, I don't think I ever saw or even read of a COLA adjusted private defined benefit plan where the COLA wasn't paid for thru a reduced benefit. I've only ever seen government plans providing annual COLA adjustments. Judging by this discussion it would seem they are allowed, but I'd image the reason many/most such plans do not offer it is due to the greater annual funding requirement. If so, are there many such private DBPs out there that provide fixed or variable COLAs.

Thanks so much for any responses.

[John314]

@BruceM It is pretty clearly allowable to have a COLA in a private DB plan, however, in my experience they tend to be quite rare. I imagine this is for a few reasons. The first is likely competitive. If ones competitors aren't offering the COLA, why would you? It isn't needed or expected by your prospective employees so why offer the COLA? The second is cost. COLAs are incredibly expensive. The third reason gets at the root of my initial question. My understanding is the COLA is accrued at the time service is earned under the plan. With the benefit protections in place for pension benefits this means that the COLA can't be removed or limited. Fourth, COLAs can be complicated to administer. If you are looking to provide additional benefits to attract employees, there is generally a simpler way to do it- just do a one time increase in the benefit multiplier. 

 

I am sure there are many other reasons, but these are the first that quickly came to mind for me. 

[AndyH]

On 3/4/2024 at 11:18 PM, John314 said:

@BruceM It is pretty clearly allowable to have a COLA in a private DB plan, however, in my experience they tend to be quite rare. I imagine this is for a few reasons. The first is likely competitive. If ones competitors aren't offering the COLA, why would you? It isn't needed or expected by your prospective employees so why offer the COLA? The second is cost. COLAs are incredibly expensive. The third reason gets at the root of my initial question. My understanding is the COLA is accrued at the time service is earned under the plan. With the benefit protections in place for pension benefits this means that the COLA can't be removed or limited. Fourth, COLAs can be complicated to administer. If you are looking to provide additional benefits to attract employees, there is generally a simpler way to do it- just do a one time increase in the benefit multiplier. 

 

I am sure there are many other reasons, but these are the first that quickly came to mind for me. 

Agree on all points.  But cost is probably #1.   

BTW, COLA provisions used to be very common for very small, tax driven DB plans specifically because they were a technique to increase deductions.  This was before changes to IRC 415 rules (I want to say mid 80's) were changed to limit the maximum benefit payable as a lump sum to the actuarial equivalent of a life annuity, calculated without any COLA provision.