CBA Published in ASPPA Plan Consultant Publication

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April 1, 2021

Cash Balance Actuaries owner Charlie Steingas was asked to write an article for the Spring 2021 ASPPA issue of Plan Consultant Publication to discuss how defined benefit plans have reacted to COVID-19. The publication titled it the 2020 DB Roller Coaster

Twenty-twenty was a wild and crazy year for a multitude of reasons. And if you sponsored a traditional defined benefit plan, cash balance plan or 412(e)(3) plan, you had many decisions to make to ensure that the plan continued to run smoothly.

Most DB plans require a certain number of hours to be worked during a plan year before a benefit is accrued. Usually it’s 1,000 hours (the maximum allowed by law), so the timing of the COVID-19 pandemic in early spring required some quick thinking if the plan sponsor wanted to lower benefits, and in turn the contributions required to provide those benefits. If the plan year is the calendar year, most 40-hour-per-week employees will hit 1,000 hours in early June. A 204(h) notice to tell employees of the decrease in future benefits is required 15 days in advance of the decrease for small plans with under 100 participants. Plans with 100 or more participants must notify employees at least 45 days in advance of the decrease, so the timing was even tighter for those plan sponsors.
The most common decrease in benefits is to fully freeze the plan so no new benefits accrue during the plan year. Under normal circumstances, freezing a plan is only done to underfunded plans to give the plan sponsor a chance to catch up on funding before the plan is unfrozen or immediately prior to terminating the plan. The IRS does not usually allow plan sponsors to freeze and unfreeze plans each year, as the plan could be found to be in violation of the definitely determinable requirements for DB plans.

However, since the COVID crisis was hopefully a once-in-a-lifetime event, most experts agreed that freezing the plan early in 2020 was a prudent thing to do because the future was so uncertain. And the ability to unfreeze it at the end of the year would be there if things calmed down and the plan sponsor was willing to fund the plan and provide benefits to employees.

There were other concerns like 401(a)(26) minimum meaningful benefit rules for frozen plans to consider as well, but due to the passage of the SECURE Act, most plans that have been around for 5 years or more got an automatic pass on 401(a)(26). And plans that chose to unfreeze were able to meet the 401(a)(26) requirements either way. More than half of our clients who froze their plans early in 2020 unfroze them by the end of the year.

Some plan sponsors decided to take the plan freeze a step further and terminate their DB plan. To do so, the plan sponsor must have a valid reason to terminate the plan. Usually plan terminations occur because the plan has run its course and no longer meets the required objectives, but plan terminations also occur when the ownership of the plan sponsor changes or the plan becomes prohibitively expensive such that it endangers the ability of the plan sponsor to stay in business. So if the plan sponsor’s business was shut down due to COVID-related factors, most experts agreed that terminating the plan would not be frowned upon by the IRS no matter when it was originally set up. The requirement in Treas. Reg. 1.401-1(b)(2) is that the plan sponsor must intend to sponsor the plan permanently when it is set up.

Unlike 401(k) plans, DB plans do not have a requirement that when a plan is terminated, a new one cannot be set up for 12 months. So a few plan sponsors took advantage of the COVID crisis to reduce liability, terminate their current DB plans, and then set up a new one. The IRS position on such an arrangement is beyond the scope of this article, but doing so is a little risky unless the plan sponsor can prove they had a legitimate reason to terminate the prior plan.
Plan sponsors also had to deal with a flurry of new laws that were passed in 2020 to help businesses and employees cope with COVID-related issues. So DB plan sponsors needed to decide whether:
  • they were going to allow increased loan limits (or even to allow loans in the first place):
  • they were going to amend their plan to allow for in-service distributions as early as age 5914; and
  • these new options were only going to be for COVID-related distributions or if they were going to allow them for everyone going forward beyond 2020.
In most small plans, the decision-maker for the plan sponsor is also the plan administrator and the trustee. But for large plans, that isn’t always the case. Regardless, plan administrators had decisions to make in 2020 as well. If money was tight or service was not up to par, should they be negotiating or shopping for new providers like a different actuary, different TPA, different auditor, etc.?
Trustees needed to consider whether a new investment policy statement was required. Should the plan consider a change in investment advisor or custodian? Do dips in the stock market translate to buying opportunities? As interest rates drop, does it make sense to continue asset-liability matching?

In my experience, most plans stayed the course when the markets went crazy and were able to reap the rewards. However, the decisions about how to deal with things going forward are even harder since the stock market is at an all-time high and interest rates for corporate bonds are at all-time lows. Many trustees have been taking advantage of those low interest rates to increase equity exposure and hope for higher returns, but most of them have chosen to simply stay the course and not add any additional investment risk.

The COVID-19 crisis came upon us so quickly, and there were more serious issues for companies than their DB plans. However, with each crisis comes learning and preparation for the next one. As actuaries, TPAs, accountants, advisors, attorneys and plan sponsors, we should be ready to help our clients make fast and appropriate decisions.

This time the crisis happened at a time when many changes could be made during the plan year that affected the current year as well as future years. Back in 2008, when the financial crisis occurred right at the end of the year, we didn’t have as many options with the current year. People who acted quickly came out of things well in the following years. The next time a big event occurs, the markets and businesses may not recover as quickly, so it will be even more important to be ready.

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