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Managing Defined Benefit Plan Risks Toolkit
Practical Law Toolkit 6-618-2425 (Approx. 9 pages)
Managing Defined Benefit Plan Risks Toolkit
by Practical Law Employee Benefits & Executive Compensation
| Maintained • USA (National/Federal) |
Resources to assist employers and other fiduciaries of defined benefit plans governed by the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code (Code) in managing the risks and liabilities associated with defined benefit plans.
Defined benefit plans are pension plans in which benefits are determined according to a formula set out in the plan document that is generally based on several factors, such as the participant's age, years of service, and salary. Defined benefit plans are funded by the employer (not the participant) on a plan-wide basis (rather than individual accounts) based on actuarial calculations. Employee contributions are sometimes required or voluntary contributions may be permitted.
Defined benefit plans carry significant risks and potential liabilities for a sponsoring employer, especially in transactions, particularly because:
- Minimum funding standards. Pension Benefit Guaranty Corporation (PBGC) premiums and termination liabilities are joint and several liabilities of the plan sponsor and each member of its controlled group. While Employee Retirement Income Security Act of 1974 (ERISA)'s minimum funding requirements were originally designed to ensure the full funding of promised benefits, employers could grant retroactive benefits without proving the ability to fund those benefits and retained discretion about cost and actuarial assumptions. This permitted employers to alter minimum funding levels and resulted in significant underfunding of these plans.
- Low interest rates and the declining stock market. Declining interest rates combined with the loss in value of pension assets invested in the stock market in 2008 and 2009 increased the costs of plan liabilities, thereby increasing funding costs and making defined benefit plans more volatile.
- Mandated forms of benefits. Mandated forms of benefits such as qualified joint and survivor annuity (QJSA) benefits and qualified pre-retirement joint and survivor annuity (QPSA) benefits add to the cost of providing a defined benefit plan.
- Difficult to measure transaction liabilities. In a transaction, how plan assets and liabilities are divided between the parties has a significant impact on the future plan funding requirements and the current financial accounting costs that may apply to the buyer and seller after the transaction. Because these liabilities are valued in different ways for different purposes (for example, funding assumptions differ from current financial account assumptions and PBGC assumptions), they can be a major source of hidden liabilities in transactions.
This Toolkit is a collection of resources to assist employers and other fiduciaries of defined benefit plans in managing the risks and liabilities associated with these plans.