3 steps to help reach your pension plan’s targeted funded status
When your defined benefit (DB) plan is underfunded, you may need to increase your plan contributions—often unexpectedly and by a lot—to avoid costly penalties or restrictions. With the current historic low interest rates, some plan sponsors are finding themselves in that position.
As a business owner or CFO, you don't want to feel unprepared when it comes to funding. So here are three steps to help you reach your plan’s funded status goal.
1. Base your goal on whether your plan is active or frozen.
Evaluating if you’re on track depends mostly on whether your DB plan is active or frozen.
- For active plans, consider the funding ratio on a Pension Protection Act (PPA) funding basis. That might be the level needed to avoid benefit restrictions or to eliminate Pension Benefit Guaranty Corporation (PBGC) variable rate premiums.
- If your plan is hard frozen, consider the funding ratio on a plan termination basis, keeping in mind it should be 100% funded when it’s terminated. To learn more, read “Ready to terminate your DB plan?” (PDF)
2. Plan for interest rate changes.
For many plans, a 1% change in interest rates—up or down—can change plan liabilities (benefits promised to participants) by 10 to 15%.
Keep your eye on interest rates to help you anticipate potential liability shifts. And remember, interest rates impact liabilities differently depending on the ages and benefits of participants in your DB plan.
How interest rate changes can impact a pension’s funded status
3. Match your risk management strategy to your funded status goal.
Wondering how to manage your plan’s risk? Here’s two options.
- You can manage risk through liability-driven investing or dynamic asset allocation.
- Or you can transfer risk, either to participants by offering lump-sum payments or to an insurance company by purchasing annuities. To learn more, read “Considering offering a lump-sum option or purchasing an annuity for your pension plan?”
To better understand these options, read “Pension risk management strategies” (PDF).
Aligning pension plan assets with liabilities as your funded status improves
Special challenges for hard-frozen plans
If you have a hard-frozen plan, how do you make sure your targeted funding is on track so you can terminate your plan? (And keep in mind the funds required to terminate are higher than what’s required to maintain funded status on an active plan.)
Your actuary can help you with an asset liability modeling study, which compares the impact of various asset allocation strategies, taking into account three elements of your plan:
- Risk exposure
- Market volatility
- Projected timeline to termination
When you evaluate the results of the study, look for what gets your plan fully funded to terminate in the shortest amount of time. Consider what reduces volatility the most and at the lowest cost in a variety of market conditions and interest rate environments.
Also think about the potential impact of different funding strategies. Whether you contribute the minimum required or spread the cost over time, choose the funding strategy that works best for your organization.
How we can help
Maintaining your pension plan’s targeted funded status can be complicated. With decades of DB plan experience across industries, we can provide clarity against the challenges you face. Give us a call at 800-952-3343, ext. 22681.
Chart above is for illustrative purposes only.
The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment advice, or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, investment, or accounting obligations and requirements.
Investing involves risk, including possible loss of principal.
Equity investment options involve greater risk, including heightened volatility, than fixed-income investment options.
Fixed-income investments are subject to interest rate risk; as interest rates rise their value will decline.
Insurance products and plan administrative services provided through Principal Life Insurance Co. Securities offered through Principal Securities, Inc., 800-547-7754, member SIPC and/or independent broker-dealers. Principal Life, and Principal Securities are members of the Principal Financial Group®, Des Moines, Iowa 50392.