This is the third post in my series on pension plan restructuring (for prior posts see April 12, 2012 and June 8, 2012). In this post, I will examine the basics of converting your defined benefit (DB) plan to a defined contribution (DC) plan.
To avoid the uncertainty inherent in the funding of a DB plan, where interest rates and volatile investment returns can drastically alter a company's funding obligations, and to achieve certainty going forward, employers may decide to convert their DB plan to a DC plan.
A total DB to DC conversion would involve not only the introduction of DC benefits on a prospective basis, but also the commutation of all members' accrued DB entitlements into account balances under the DC plan. However, because member consent is required by regulatory policy for any accrued benefit conversion, many conversions occur only on a prospective basis. This can be achieved either by setting up a new DC plan, but is more often implemented by adding a DC component to the existing DB plan for future service only — thereby allowing members to preserve their entitlements already earned under the DB plan.
Often members are given the option of converting their existing DB entitlement to a DC account. In designing the conversion an employer may decide to close the DB component to new entrants and "grandfather" existing employees by allowing them to continue accruing DB benefits. In this case the DC component would be mandatory only for new hires. Alternatively, an employer may choose to close and freeze the DB component such that all employees are required to join the DC component in respect of future service (see soft/hard freeze discussion below).
Employee Communications are Key
If members are given the option of joining the DC component or converting their accrued DB entitlements to DC account balances, employers should be very careful when communicating this option. Members must be properly advised of all changes, including the impact of replacing a DB entitlement with future DC accruals, so they can make informed choices relating to:
any past service conversion option; any option allowing certain members to retain grandfathered DB benefit accruals; and their DC account investment choices. Deficient or confusing communications may result in invalid elections and lead to member complaints down the road which, in turn, could result in regulatory action or litigation.
Administrator or Sponsor?
It's worth noting that while plan...