PLANSPONSOR - February/March 2021 - 29

PLAN DESIGN | DEFINED BENEFITS
The main challenge, of course, for
DB plan sponsors is risk, and the unknown
costs and the required funding of the plan.
" If DB plan sponsors knew consistently
what their costs would be, they'd be more
inclined to stick with it, " Hudson says.
Syed Nishat, a Behavioral Financial
Advisor (BFA) and partner in Wall Street
Alliance Group in New York City, agrees
about risk and notes that plan sponsor
costs are affected by interest rates. " If
interest rates go up, it helps funded status,
and the plan sponsor doesn't have to put
in more money than required or move to
riskier investments in an effort to achieve
higher investment returns, " he explains.
" If rates go down, liabilities and the funded
status deficit decrease, and the sponsor
may have to come up with more money. "
This is one reason many DB plan
sponsors have terminated their plan.
Another is the daunting expense of
Pension Benefit Guaranty Corporation
(PBGC) premiums. This year, the variable-rate
premium (VRP) for singleemployer
plans is $46 per $1,000 of
unfunded vested benefits, and the cap is
$582 times the number of participants.
The 2021 flat premium rate for PBGC's
single-employer plan termination insurance
program is $86 per participant.
Variable Benefit Plans
One type of DB plan piquing sponsor
interest is the variable benefit plan.
Nishat says the variable benefit plan
is a resurrection of the variable annuity
plan introduced in the 1950s. " One issue
brought up with [those] plans [was] the
risk of not knowing what the future will
bring and the potential for a sudden drop
in benefits when the retiree [couldn't]
handle [it]. This fear led to the development
of a new plan design which adjusts
future accrual rates, " he says.
A white paper from Findley, a retirement
plan consultancy now a division of
USI, underscores some benefits of the
new design: " A variable benefit plan is
similar to a traditional DB plan, except
that the investment risk and positive
return is owned by the employees and
not the plan sponsor. The plan sponsor
defines an accrual rate (i.e., how much
benefit is earned each year), usually a
percentage of current year pay payable
as an annuity at normal retirement. The
plan sponsor also defines a 'hurdle rate'-
that is, the benchmark for asset returns,
usually between 5% and 7%. The actual
asset return for the year is compared
[with] the hurdle rate. "
If the plan's investments generate
a return equal to the hurdle rate, the
paper continues, there is no adjustment
to participants' accrual rate. But accrual
rates are adjusted up or down annually
depending on whether the investments
return more or less than that rate.
This design enables plan sponsors to
manage their costs, Hudson says, because
with it, the employer initially decides
what it can afford to put into the plan and
the actuary calculates the level of benefits
that can provide.
Costs for actuarial calculations are
about the same as with a traditional DB
plan, but new computer models allow the
calculations to be done much faster than
before, Hudson says. Still, moving from
a traditional to a variable benefit plan
can cut plan sponsors' PBGC premium
expenses. " Variable plans usually target
being slightly overfunded, 110% or so. The
ones I've worked on have never paid a variable
rate premium, " he says.
The Findley paper addresses the
legality of reducing an accrued benefit.
The firm says the plan design is already
being used with approved determination
letters from the IRS. It also notes that, as
long as the hurdle rate is at least 5%, " the
plan is not considered a 'statutory hybrid
plan' per final IRS regulations and thus
would be exempt for those special rules. "
Cash Balance Plans
The other DB plan that has gained popularity,
frequently with small businesses
such as professional practices, is the cash
balance plan; these began taking hold after
passage of the Pension Protection Act of
When plan
participants
retire or leave
their job, they
can take their
cash balance
plan assets as
a lump sum
or choose to
annuitize it.
2006 (PPA). " Now, about 30% to 40% of
DB plans overall are cash balance plans, "
Nishat notes. " They're easier for employees
to understand and appreciate-they look
like a DC [defined contribution] plan to
them, as participants receive a statement
of their account balance each year. "
With a cash balance plan, the balance
participants see on statements is a guaranteed
benefit. The account balance is
the accumulated value of employer contribution
credits-defined in the plan as a
percentage of pay or a flat amount-and a
guaranteed investment return, or interest
crediting rate. When they retire or leave
their job, participants can take their
balance as a lump sum or annuitize it.
Nishat says he has seen more interest
in cash balance plans since President
Joe Biden issued his proposal to have
a tax credit replace the tax deduction
that employees get when they make a
contribution to their workplace defined
contribution plan. For example, " If
an employee who is older than 50 can
contribute $26,000 to a 401(k) plan,
and if his income is around $300,000,
putting him in the 33% tax bracket, with
the upfront tax deduction, he would save
around $8,580 in taxes. But under the
Biden proposal, he would receive a 26%
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