A Road Map for Congress to Increase DB Plan Use

The National Institute on Retirement Security has published a report providing recommendations to Congress about how to increase defined benefit plan creation in the private sector. The report was commissioned by the Senate Committee on Health, Education, Labor and Pensions.

The report makes six core policy recommendations: reduce Pension Benefit Guaranty Corporation insurance premium rates; formally recognize risk-sharing plans; provide more flexibility for overfunded plans; allow pre-tax employee contributions; and permit transfers between defined contribution and DB plans.

Lower Insurance Premiums

The PBGC charges DB plan sponsors insurance premiums to cover the risk of plan failure and the PBGC having to take over the plan. The PBGC has two kinds of fees. For 2024, it charges single-employer plans $101 per participant and any plan with an unfunded liability must also pay additional 5.2% of the plan’s funding shortfall. The second element is known as the variable-rate fee and is capped at a maximum of $686 per participant to prevent severely underfunded plans from failing due to high insurance premiums.

NIRS embraces the recommendation made by many in light of the PBGC’s funding levels, that these premiums should be cut. In 2023, the PBGC single-employer fund reported a surplus of $44.6 billion, using risk-averse model that assumes the PBGC would take over any underfunded plan the sponsor of which has a credit rating below investment grade. However, this figure can be volatile, and in 2016, the PBGC reported a deficit of about $20 billion.

Michael Kreps, a principal at Groom Law Group and one of the report’s co-authors, says “it’s time to consider premiums and bringing them down,” and Congress should “make them more reasonable in light of the financial position of PBGC and the pension system.”

John Lowell, a partner at pension consulting firm October Three and also a report co-author, says that “very high historically, PBGC premiums have been a disincentive to stay in the pension world or get into it.” In some cases, especially when certain participants are only entitled to a smaller benefit, the sponsor might end up “giving the PBGC more money than I am giving that person,” Lowell says.

The report states that “the strategies used in third party transfers such as annuity purchases and lump sum window transactions are almost always specifically designed to lower the cost of the plan by reducing PBGC premiums: when the cost of future premiums exceeds the cost of insurance, plan sponsors choose to purchase annuities.”

Risk-Sharing Plans

A risk-sharing plan is a DB plan in which the benefits paid out are partially tied to the performance of the pension’s portfolio. This structure can help insulate the plan’s sponsor from risk if the financial markets decline, because the sponsor could implement benefit cuts to partially offset those losses. Lowell explains that in risk-sharing plans “interest credits are not a guarantee.”

The NIRS report calls for the formal recognition of such plans, which normally have to rely on IRS determination letters for approval and as a result undertake more regulatory risk. The report notes that the retirement systems for Wisconsin and South Dakota, which as public pension funds are largely not regulated by the federal laws that apply to private pension funds, both use risk-sharing schemes.

Lowell says that these kinds of plans would present less risk to the PBGC and therefore should have lower premiums assessed to them.

Flexibility for Overfunded Plans

Kreps explains that one disincentive to DB plan creation is concern about funds being restricted to the pension fund in overfunded plans. He says that “we just need to provide them with solutions for that, while putting some guardrails around it.”

The report reads, “Experience clearly shows that employers are hesitant to overfund plans because the permitted uses of surpluses are narrow. Plans currently have the ability to use some of their surplus to fund health benefits (see IRC 420), but they are hesitant to do so because of the restrictions on the use of transferred funds. Congress should consider broadening the permitted uses for super-surpluses. For example, the excess funding could be used to pay for medical or long-term care benefits.”

Greater flexibility in this area would also have the added effect of sponsors being able to provide additional benefits to those who already have a DB plan.

Permit Pre-tax Contributions

The report argues that “allowing employees to contribute pre-tax to the pension plan is another way to share risk and maintain more level funding.”

It adds that a sponsor with a DC plan considering adopting a DB plan might be deterred by the fact that they cannot permit pre-tax employee contributions into a DB plan. Permitting such contributions could make adding a pension fund easier for those who already have a DC retirement plan or those thinking of replacing their DC offering with a DB.

Allow DC-to-DB Transfers

Lastly, the report calls for a statutory recognition of transfers from DC to DB plans, which currently is permitted by IRS Revenue Ruling 2012-4.

Lowell says that 2012-4 says “it is ok to transfer employee money from a 401(k) plan to a defined benefit plan,” for the purpose of acquiring more lifetime income. Since this policy is an IRS ruling “it did not get a lot of press,” Lowell laments, and “not a lot of plan sponsors know about it.”

The PBGC finalized a rule in 2014 that says such transfers are not subject to maximum coverage rules. In other words, the extra benefits purchased by the DC transfer would be added to the benefit payout provided by the PBGC in the event of plan failure and PBGC takeover.

Lowell would like there to be additional regulatory clarification on when such transfers are permitted and how it affects premium rates. He adds that DB plan participants that have a lump sum withdrawal option should be able to transfer those funds to a DC plan too.

Ruling 2012-4 only applies to 401(k) plans, Lowell says, but it would be “easy to extend the revenue ruling to 403(b)s,” but due to state laws, it would not be “as easy to extend it to 457s.”

Such a reform could make small DB plans an easier sell to sponsors who already have a DC plan, Lowell says.