Skip to main content
MENU
Subscribe
  • Sign Up Free
  • LOGIN
  • Subscribe
  • Topics
    • Alternatives
    • Consultants
    • Courts
    • Defined Contribution
    • ESG
    • ETFs
    • Face to Face
    • Hedge Funds
    • Industry Voices
    • Investing
    • Money Management
    • Partner Content
    • Pension Funds
    • Private Equity
    • Real Estate
    • Regulation
    • SECURE 2.0
    • Special Reports
    • Washington
    • White Papers
  • Rankings & Awards
    • 1,000 Largest Retirement Plans
    • Top-Performing Managers
    • Largest Money Managers
    • DC Money Managers
    • DC Record Keepers
    • Largest Hedge Fund Managers
    • World's Largest Retirement Funds
    • Best Places to Work in Money Management
    • Excellence & Innovation Awards
    • WPS Innovation Awards
    • Eddy Awards
  • ETFs
    • Latest ETF News
    • Fund Screener
    • Education Center
    • Equities
    • Fixed Income
    • Commodities
    • Actively Managed
    • Alternatives
    • ESG Rated
  • ESG
    • Latest ESG News
    • The Institutional Investor’s Guide to ESG Investing
    • ESG Sustainability - Gaining Momentum
    • ESG Investing | Industry Brief
    • Innovation in ESG Investing
    • 2023 ESG Investing Conference
    • ESG Rated ETFs
  • Defined Contribution
    • Latest DC News
    • The Plan Sponsor's Guide to Retirement Income
    • DC Money Manager Rankings
    • DC Record Keeper Rankings
    • Innovations in DC
    • Trends in DC: Focus on Retirement Income
    • 2023 Defined Contribution East Conference
  • Searches & Hires
    • Latest Searches & Hires News
    • Searches & Hires Database
    • RFPs
  • Research Center
    • The P&I Research Center
    • Earnings Tracker
    • Endowment Returns Tracker
    • Corporate Pension Contribution Tracker
    • Pension Fund Returns Tracker
    • Pension Risk Transfer Database
  • Careers
  • Events
    • View All Conferences
    • View All Webinars
    • 2023 Canadian Pension Risk Strategies
    • 2023 Retirement Income
Breadcrumb
  1. Home
  2. INDUSTRY VOICES
June 20, 2018 01:00 AM

Commentary: Why many companies should terminate defined benefit plans

Joe Rankin
  • Tweet
  • Share
  • Share
  • Email
  • More
    Reprints Print

    Thanks to a convergence of events — strong stock market gains coupled with rising interest rates — this might be the best time in years for companies to terminate defined benefit plans.

    The use of defined benefit pensions has been in long-term decline as employers have moved away from plans that guarantee incomes for retirees, who are living longer, and instead have offered employees 401(k) or similar retirement savings plans.

    All told, private companies have frozen 37% of defined benefit plans, either closing them to new employees or freezing accruals entirely, according to U.S. Bureau of Labor Statistics data. Now, many companies should consider going further: terminating defined benefit plans and giving participants the choice of either taking a lump-sum payment or a set annuity.

    For years, with interest rates at generational lows, U.S. pension asset growth underperformed liability growth, causing a headache for plan sponsors that must ensure plans are adequately funded. That trend has now reversed.

    The S&P 500 gained almost 10% in 2016 and almost 20% in 2017, boosting assets dramatically. At the same time, interest rates are rising, so liabilities are falling. It's a set of circumstances that makes this the best time to terminate a defined benefit plan since the mid-1980s — the last time such a convergence of circumstances took place.

    While there are an enormous number of frozen pension plans, where participants are no longer accruing benefits, employers still assume the liability associated with market volatility. That can be a considerable risk: When assets dip precipitously, as happened in 2001 and 2008, plan sponsors must make up the resulting shortfall over a five- to seven-year period in order to comply with IRS regulations.

    If sponsors choose not to terminate plans now, they will almost certainly pay out more in the long run than they would today. That's because, for many plans, the present value of their future expenses and fees is greater than the cost of terminating the plan now (by making up any shortfall via a company contribution or by borrowing to meet the shortfall.) And, with interest rates rising, buying annuities now is cheaper than it has been in years.

    As a result, sponsors of even modestly well-funded defined benefit plans can save expenses while forever removing from their balance sheets all the risks associated with pension plans. While consultants that cater to the largest plans are helping clients assess the best path of action, countless small to midsize plans might be unaware of this opportunity. Executives at as many as 16,000 frozen plans, generally those with $100 million or less in liabilities, might be unaware of these circumstances.

    Discerning whether it makes sense to terminate a plan starts with a high-level assessment of the potential savings compared to the contributions that would be needed to terminate the plan now. Liabilities comprise both payouts to participants and the present value of anticipated expenses — such things as actuarial and accounting fees, trustee fees, investment fees, Pension Benefit Guarantee Corp. premiums and other costs.

    Having undertaken that high-level analysis, companies have three basic choices about how to proceed:



    • Let the plan remain as it is.

    • Offer a window during which employees and terminated vested participants can accept a lump-sum payment to reduce plan liabilities.

    • Terminate the plan by offering a choice between a lump sum and an annuity to non-retirees and purchasing annuities for retirees.


    When terminating plans, the cost of a lump sum payout is less expensive than an annuity. While most employees typically take the lump sum, those closer to retirement or who are risk-averse, will opt for the annuity. Even firms that decide to offer a lump-sum window, should gather quotes from insurance companies for annuities to have the flexibility to terminate should circumstances change.

    For most companies with a modest shortfall between assets and liabilities, it makes sense to terminate a defined benefit plan. Doing so removes economic and market volatility risks, as noted above, as well as the statutory risk that comes from rising administrative fees. (For example, PBCG premiums have risen sharply in recent years.) Terminating a plan also removes the actuarial risk that liabilities will increase in tandem with rising life expectancy.

    For some companies that are growing rapidly, it might make sense to retain a defined benefit plan. For example, if liabilities are projected to grow at 5% but the firm enjoys a significantly higher internal rate of return on its capital, the business leadership might decide it makes financial sense to keep its defined benefit plan.

    For most firms, however, there may never be a better time to terminate than now.

    Joe Rankin is based in Detroit and leads Plante Moran's employee benefits consulting practice. This content represents the views of the authors. It was submitted and edited under P&I guidelines, but is not a product of P&I's editorial team.

    Related Articles
    UPS to freeze 2 pension plans in 2023
    Avaya seeking to transfer 1 plan to PBGC
    McKesson to terminate U.S. pension plan
    65% of cash balance plans are actively accruing benefits, consultant October Th…
    Avery Dennison to terminate U.S. pension plan
    Recommended for You
    Kathryn Kaminski
    With inverted yield curve, shorting bonds can be useful, strategic tool
    Liang Yin
    Private equity can help fill the gap in financing climate-change fixes
    Tamara Close
    Commentary: Is data the problem or the answer for ESG investors?
    Quest for Quality Amid Market Turmoil
    Sponsored Content: Quest for Quality Amid Market Turmoil

    Reader Poll

    May 1, 2023
     
    SEE MORE POLLS >
    Sponsored
    White Papers
    Middle market credit: We’re gonna need a bigger boat
    Alternative Credit: Differences and Opportunities in CLOs and Credit Risk Shari…
    Fixed Income is Attractive, but Beware of "Fake" Yield
    Counting on a Crisis: A Catalyst for Investment Innovation?
    A Strategic Allocator's Guide to Productivity and Profits
    Research for Institutional Money Management
    View More
    Sponsored Content
    Partner Content
    The Industrialization of ESG Investment
    For institutional investors, ETFs can make meeting liquidity needs easier
    Gold: the most effective commodity investment
    2021 Investment Outlook | Investing Beyond the Pandemic: A Reset for Portfolios
    Ten ways retirement plan professionals add value to plan sponsors
    Gold: an efficient hedge
    View More
    E-MAIL NEWSLETTERS

    Sign up and get the best of News delivered straight to your email inbox, free of charge. Choose your news – we will deliver.

    Subscribe Today
    December 12, 2022 page one

    Get access to the news, research and analysis of events affecting the retirement and institutional money management businesses from a worldwide network of reporters and editors.

    Subscribe
    Connect With Us
    • RSS
    • Twitter
    • Facebook
    • LinkedIn

    Our Mission

    To consistently deliver news, research and analysis to the executives who manage the flow of funds in the institutional investment market.

    About Us

    Main Office
    685 Third Avenue
    Tenth Floor
    New York, NY 10017-4036

    Chicago Office
    130 E. Randolph St.
    Suite 3200
    Chicago, IL 60601

    Contact Us

    Careers at Crain

    About Pensions & Investments

     

    Advertising
    • Media Kit
    • P&I Custom Content
    • P&I Careers | Post a Job
    • Reprints & Permissions
    Resources
    • Subscribe
    • Newsletters
    • FAQ
    • P&I Research Center
    • Site map
    • Staff Directory
    Legal
    • Privacy Policy
    • Terms and Conditions
    • Privacy Request
    Pensions & Investments
    Copyright © 1996-2023. Crain Communications, Inc. All Rights Reserved.
    • Topics
      • Alternatives
      • Consultants
      • Courts
      • Defined Contribution
      • ESG
      • ETFs
      • Face to Face
      • Hedge Funds
      • Industry Voices
      • Investing
      • Money Management
      • Partner Content
      • Pension Funds
      • Private Equity
      • Real Estate
      • Regulation
      • SECURE 2.0
      • Special Reports
      • Washington
      • White Papers
    • Rankings & Awards
      • 1,000 Largest Retirement Plans
      • Top-Performing Managers
      • Largest Money Managers
      • DC Money Managers
      • DC Record Keepers
      • Largest Hedge Fund Managers
      • World's Largest Retirement Funds
      • Best Places to Work in Money Management
      • Excellence & Innovation Awards
      • WPS Innovation Awards
      • Eddy Awards
    • ETFs
      • Latest ETF News
      • Fund Screener
      • Education Center
      • Equities
      • Fixed Income
      • Commodities
      • Actively Managed
      • Alternatives
      • ESG Rated
    • ESG
      • Latest ESG News
      • The Institutional Investor’s Guide to ESG Investing
      • ESG Sustainability - Gaining Momentum
      • ESG Investing | Industry Brief
      • Innovation in ESG Investing
      • 2023 ESG Investing Conference
      • ESG Rated ETFs
    • Defined Contribution
      • Latest DC News
      • The Plan Sponsor's Guide to Retirement Income
      • DC Money Manager Rankings
      • DC Record Keeper Rankings
      • Innovations in DC
      • Trends in DC: Focus on Retirement Income
      • 2023 Defined Contribution East Conference
    • Searches & Hires
      • Latest Searches & Hires News
      • Searches & Hires Database
      • RFPs
    • Research Center
      • The P&I Research Center
      • Earnings Tracker
      • Endowment Returns Tracker
      • Corporate Pension Contribution Tracker
      • Pension Fund Returns Tracker
      • Pension Risk Transfer Database
    • Careers
    • Events
      • View All Conferences
      • View All Webinars
      • 2023 Canadian Pension Risk Strategies
      • 2023 Retirement Income