She points out that the liability profile will shift as
participants maintain their balance but increase in age. It is important to
invest assets to match liability as much as possible, she says. The plan will
still need equities and real assets for growth, but ultimately sponsors of
frozen defined benefit plans should manage liability with long-term duration
If there are any alternatives in the portfolio—particularly
if the plan is frozen—as the plan pays benefits, the sponsor will need to wind
down alternatives. “It will no longer be able to support the illiquidity of
these assets [because it has retired participants to support. Thus,] it should
invest in long duration bonds, corporate bonds, equities, etc.,” Bailey says.
Mitigating Participants’ Loss
In many cases, defined benefit plan sponsors will think
about how to view their defined contribution plan from an overall retirement
outcome perspective, according to Bailey. “They want to keep participants’
retirement savings outcomes as similar as possible to when the DB plan was not
frozen,” she says. Things they might do are increase the company match and add
plan design features such as automatic enrollment and automatic deferral
escalation to enhance the advantage of the company match. “They cannot only
implement plan-sponsor-funded design changes, but features that overcome
behavioral hurdles and inertia,” she says.
Bailey adds that Northern Trust’s Path Forward study found
70% of participants appreciate auto-enrollment, and the vast majority said they
would have saved 10% or more into their defined contribution plan if they could
go back and do it differently.
Noting again that freezing a defined benefit plan often
hurts older, longer-tenured employees the most, Lawrence says sometimes plan
sponsors add a special contribution to their DC plan. For example, everyone in
the plan gets 3% of pay, but, depending on a participant’s age plus years of
service, he may get an additional benefit. A new hire gets only 3%, those with
a low age plus years of service will get a bit more, but someone with a high
age plus years of service may get 6% or 9%. “It’s a common way to transition or
to mitigate the hurt to employees,” he says.
Bailey concludes that decisions to freeze a defined benefit
plan have centered around how to enhance the value of benefits to employees and
how to allocate costs for better benefits. She observes that when moving from a
DB to a DC plan, as the latter’s assets grow, plan sponsors have the ability to
lower fees through institutional-type products, and that can improve outcomes
- Cost, portfolio volatility and PBGC premiums are often the
catalysts for sponsors’ decisions to freeze their defined benefit plan.
- Advisers can help plan sponsors decide on the type of
freeze that makes the most sense for their company and determine what changes
to the defined contribution plan might make sense post-DB-plan changes.
- After freezing their DB plan, plan sponsors are still
obligated to fund and pay existing accruals.