Employers that thought closing their defined benefit plans to new employees would simplify their pension decisions could be in for a rude surprise as they increasingly risk flunking non-discrimination tests.
“When sponsors do a soft freeze, it's not a question of "if', it's a question of "when' you will run into a compliance problem,” said Scott Jarboe, partner with Mercer's Washington office.
The problems arise most often when defined benefit plans are closed to new hires. As the earnings of participants in the closed plans grow, so does the disparity between the richness of their benefits and those of other employees for whom a defined contribution plan is their only choice.
So, more participants in the closed plan are moving into the highly compensated employee category, while newer employees and turnover keep overall benefit values lower in other plans.
When that gap gets wide enough, sponsors can fail the Internal Revenue Service's non-discrimination rules test.
Employers are now hoping the federal government will allow plans that passed the test when first closed to new hires to be considered to have passed permanently, unless plan enhancements are made. They are pushing for either a legislative or regulatory change as soon as possible.
“More and more companies are going to (Capitol Hill) to talk about this issue with members of Congress,” said Kent Mason, an attorney with Davis & Harman LLP. Mr. Mason is outside counsel to the American Benefits Council in Washington, which is leading the charge.
“They're telling them that if this issue does not get addressed, many of the grandfathered employees will have to be removed from the plan. The potential tragedy is that they would lose the best years.”
Rep. Richard Neal, D-Mass., hopes to re-introduce legislation that idled in the last Congress. That bill would allow grandfathering of closed plans at some point, but the timing for getting anything through a distracted Congress is unknown.
A more likely approach is through regulatory channels at the Treasury Department. Although officials there declined to comment, “they are very aware of this issue, and we have had very constructive discussions,” said Mr. Mason. “I think we have an opportunity to fix it.”
Rules to prevent benefit abuses favoring highly paid plan participants seemed like a good idea when passed decades ago. But now, “we're starting to see the results of not letting anyone else in” to the closed DB plan,said David Driscoll, a principal with Buck Consultants, Boston.