Cost Considerations When Freezing Your DB Plan

Just because a plan is frozen, doesn’t mean fees will go away altogether.

If you purchased a large home when raising a family, would you continue to pay for it once the kids have grown and moved away? For many, it may be worth downsizing to fit a new set of needs and goals. 

That’s the analogy Monica Gallagher, a partner at October Three Consulting, utilizes to describe the work of administering a frozen defined benefit (DB) plan. Just because a plan is frozen doesn’t mean fees will go away altogether, so a reassessment of needs and services is always in order once a DB plan is frozen. 

According to Gallagher, along with Stu Lawrence, national retirement practice leader from Segal, expenses concerning administration of the plan; actuary and accountant tasks; and Pension Benefit Guaranty Corporation (PBGC) premiums are all still responsibilities sponsors must face when freezing their plans. While most employers outsource plan administration, says Gallagher, others team with providers to tame plan data and answer phone calls concerning benefit accruals. Additional services involve employing actuaries and accountants to evaluate liabilities of pension plans, calculate contributions and audit the plan.

Lawrence notes that while auditing a plan may grow slightly easier as a frozen plan decreases in number of participants, costs—for the most part—will remain the same. “The costs haven’t changed. It might be easier to do an audit of those plans, and the fees from the actuarial calculation might go down, but the accountant and actuary will still charge their basic fee,” he says.

Those that entirely terminate their plan—which can only occur if an employer pays out the value to the worker in a single sum, or finds an insurance company to stand in the shoes of the plan via a pension buyout—face no concerns over PBGC fees, as once a plan is terminated, the fees are dropped.

“Once you terminate a plan, and you in effect settle the liabilities, you no longer have to pay PBGC,” says Gallagher. 

According to Lawrence, DB plans can be in one of four stages—ongoing, closed, frozen and terminated. A terminated plan requires that an employer settles the plan obligation with the worker; ongoing plans have participants who are still accumulating benefits as service continues; closed plans, also known as soft-frozen plans, block new participants from entering, yet allow existing employees to resume benefit accrual; and frozen plans strictly disallow all participants from accruing benefits.

“For most, you start with an ongoing plan, you may become a closed plan, a frozen plan, and at some point, you’re going to be a terminated plan,” says Lawrence.

NEXT: A path for DB plan stages

The experts warn that it is generally not suitable for a closed plan to remain in that state indefinitely. 

As Lawrence describes, when existing plan participants age in a closed plan, pay raises and higher salaries are given; therefore in ten years’ time, when the only workers in the plan are those with a decade of service or more, the plan “transitions from a closed one to a discriminatory one,” because it only favors the higher paid. This, in turn, forces the plan to freeze, unless the plan sponsor finds another way to address discrimination testing challenges. 

“Closed plans can be a temporary state, but at some point, just by the passage of time, it’ll become a discriminatory plan, and then it has to become a frozen plan,” Lawrence explains. However, lawmakers are working to amend nondiscrimination rules for closed or frozen plans.

Rather than allow a closed plan to eventually shift to frozen, Lawrence advises employers to lay out a journey for the plan, and then stick to following it. “A lot of employers overlook the journey to get to the destination,” he says.

As a first step, Lawrence recommends increasing risk mitigation, through gauging the plan’s risk profile, and then conferring with a consultant on how to decrease uncompensated risk.

“If you don’t have the big picture of not only the destination, but of the steps and the journey, if you don’t have that and you live each day at a time, it might actually work against the employer in the future,” he says.

Automated technology—combined with self-service support—can help reduce expensive costs previously accepted for active pension plans. Once a plan is frozen, Gallagher suggests employers calculate and certify all plan benefits immediately.  

As a final move, employers may consider switching vendors—an action considered traditionally expensive with active plans. But, for a plan that is frozen, there are minimal expenses to consider, Gallagher says.