Closed and Frozen DB Plans Still Require Advisers

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 the job of managing it 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. Additional services involve supervising the actuaries and accountants who evaluate liabilities, calculate contributions and otherwise oversee the plan.

Lawrence notes that while the audit process may grow slightly easier as a frozen plan decreases in the 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. Plan sponsors can use a lot of help in maximizing cost efficiency in this environment.

According to Lawrence, DB plans can be in one of four stages—ongoing, closed, frozen and terminated. Advisers can have a role to play at each stage. A terminated plan requires that an employer build a process for settling the plan obligations; 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, then the client may become a closed plan, a frozen plan, and at some point, you’re going to be a terminated plan,” Lawrence explains.

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. Relevant to this conversation, lawmakers are right now 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.