Employers who maintain defined benefit pension plans, cash balance or traditional, should be aware of a strategy to help potentially reduce the required contribution for 2020.
The “pot” of money needed to fund benefits in a defined benefit plan is funded through employer contributions and earnings on the plan’s investments. While the required contributions for 2019 were generally reduced by the robust earnings on investments during the year, barring some sort of miraculous turn around in the markets for 2020, the exact opposite will occur for 2020. Increased employer contributions will be required in order to make up for the shortfall in the “pot” of money because of the losses in the market. These increased contributions will come at a time when many employers may not be in a position to make the contributions given the impact of COVID-19 on their businesses.
Employers can gain some relief by “freezing benefit accruals” in 2020 and beyond. This is an actuarial concept that basically means preventing employees from earning additional benefits under the terms of the plan. The “pot” referenced above is essentially determined based on what the participants earned through the end of 2019. Employers will still be required to make contributions based on what has been earned through 2019 but nothing for 2020. THIS STRATEGY DOES NOT NECESSARILY ELIMINATE CONTRIBUTIONS FOR 2020.
There are very specific timing rules for utilizing this strategy. Employees will earn their benefit for 2020 when they work more than 1,000 hours and once their benefit is earned, it cannot be taken away. Generally, full-time employees reach the 1,000 hour mark in mid-June. However, there are certain circumstances where employees can reach the 1,000 hour threshold as early as May 15th. The amendment to freeze benefit accruals must be done before anyone earns their benefit for the year. We recommend freezing benefit accruals no later than May 1, 2020.
The plan will continue to exist. 5500 filings and the annual actuarial valuation are still required.
Employers interested in pursuing this strategy will need to contact their third party administration firm and engage in discussions regarding the specific process for freezing benefit accruals. This contact will need to be made as soon as possible in order to meet the deadlines detailed above.
If you have questions about this strategy, please contact Mark Flanagan of Aronson’s Compensation and Benefits Practice at 301.231.6257.