A defined benefit pension plan question or problem frequently arises. This guide addresses defined benefit plan questions and problems for smaller businesses, although many of the issues are similar for other employers. An overfunded defined benefit pension plan, although rare, can cause serious consequences.
Generally, these plans should be considered when large contributions for older principals are desired. However, they are more costly, difficult to understand and administer than other types of retirement plans and require greater stability in annual employer profitability. Although they provide a retirement benefit more related to employees' needs than defined contribution retirement plans, tax considerations frequently play a more significant role in their adoption.
A qualified pension actuary is needed to help establish and administer a defined benefit program. He/she should be an Enrolled Actuary. Membership in the Society of Actuaries is recommended. The actuary should be experienced with establishing and administering such plans and be available when needed. Although many actuarial concepts are difficult to comprehend, employers should acquire a basic understanding of how their plan works and choose an actuary with whom they can communicate effectively. Flexibility in a benefit formula that provides for possible fluctuations in business income, changes in the composition and compensation of participants and a number of other factors must be considered when designing the plan.
An annual actuarial valuation and the filing of Series 5500 governmental forms are two of the main administrative requirements. Any major changes that may affect the plan, such as those in employee compensation, business income or plan assets should be communicated to the actuary as soon as possible.
Since a mistake can easily occur, it is important to provide your actuary with accurate employee and asset data and information regarding the employer's involvement with any other businesses. An independent actuarial and administrative review is recommended at least once every 5 to 10 years.
Excluding eligible employees, paying a terminated participant the wrong benefit amount and errors in plan documents are some of the numerous mistakes that may occur. They must be fixed. Some errors may be self-corrected, while others require the involvement of the IRS or DoL through their correction programs.
Investments must not involve any self-dealing. The use of an investment manager should be considered. The firm providing administrative services should be consulted regarding any investment compliance issues. An independent advisor should evaluate the suitability of life insurance or other investment products.
The plan's funding status should be constantly monitored. Although overfunded defined benefit pension plan problems can frequently be resolved, significant excess assets can present serious difficulties, since only a maximum amount, by law, can be accumulated for any participant. However, options and alternatives exist to resolve extreme overfunding.
An underfunded defined benefit pension plan may also present problems for a small business. However, solutions are frequently available, including an increase in contributions or a reduction or freezing of benefits. Termination of a defined benefit plan is always a possibility. If the principals are willing to waive some of their benefit to reduce or eliminate the underfunding, difficulties may be avoided.
Termination of a defined benefit pension plan should be considered a last resort. Increasing contributions, reducing or freezing benefits should be thoroughly explored before the plan is terminated.