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The Pension Benefit Guaranty Corporation (PBGC) is a Federal agency that insures certain pension benefits, up to a certain level, in case a sponsor of a defined benefit plan goes bankrupt and cannot pay the pension benefits as promised.
Sponsors of a defined benefit plan pay mandatory “Flat-Rate Premiums” based on the plan’s participant count. If the plan is a single-employer plan, an additional premium, known as the “Variable-Rate Premium,” is charged if the plan is underfunded.
Plan sponsors may not opt in or out of PBGC coverage. However, a defined benefit plan, including a cash balance plan, is exempt from both paying PBGC premiums and the coverage they offer if, for example:
There are fewer than 26 active participants, and the business is considered a “professional service,” or
The plan covers only “substantial owners” of the plan sponsor
PBGC premiums can create a major headwind for ongoing pension finance, but there are ways to manage and reduce these costs.
How it works: For single-employer plan sponsors paying a variable-rate premium, increasing the amount contributed to the plan before the minimum required contribution deadline (8-½ months after the end of the plan year, with extensions) can reduce the cost of Variable-Rate Premiums by a significant amount. Moreover, accelerating certain contributions that are otherwise due in the coming months can also reduce the Variable-Rate Premium.
This is because Variable-Rate Premiums (VRPs) are calculated by multiplying the VRP rate by the plan's unfunded vested benefits as of the plan’s valuation date. Therefore, increasing or modestly accelerating contributions can lower unfunded vested benefits, reducing total variable-rate premiums.
Considerations: Naturally, this route requires earlier spending, but it can be more beneficial to the overall plan by reducing total premiums.
How it Works: Reducing the number of participants in a defined benefit plan can impact PBGC Flat-Rate and Variable-Rate Premiums because both premium types consider the number of total plan participants in their calculations.
Flat-Rate Premiums are relatively simple. Sponsors pay a flat rate per participant, which increases yearly. Reducing the total number of participants reduces total premiums.
Variable-Rate Premiums are somewhat more complex. As mentioned above, Variable-Rate Premiums are determined by the plan’s unfunded vested benefits. However, there is a cap on how much sponsors must pay per participant. This cap also increases yearly with inflation, but for plans that have reached that cap (generally, those that are severely underfunded), reducing total participants can reduce premiums.
Considerations: Reducing the total number of plan participants can be accomplished in a number of ways, including pension plan terminations, the purchase of annuity contracts from insurance contracts, lump-sum windows, and more.
Splitting a single plan into two separate plans may help reduce premiums if the plan is underfunded. For example, a plan might be split by active participants and retired participants.
This can give sponsors a few options to reduce premiums, including optimizing funding to target one plan over the other, and de-risking to reduce total participants.
Considerations: Two plans can be more to manage, and the analysis around splitting plans requires involvement of the plan’s actuary and legal counsel.
As noted throughout this article, every strategy to reduce PBGC premiums requires several considerations. For this reason, we recommend working with experts like the team at October Three to help navigate the complexities of defined benefit plans.
Looking for solutions to reduce your PBGC premiums? Get an actuarial review that doesn’t require additional data and has your best interest in mind. Reach out to our team today to learn how we can support your business.
Include a note about how an actuary helps reduce PBGC premiums.