General Motors (GM), Bank of America and American Airlines announced recently that they will freeze their pension plans.
GM announced on Feb. 16, 2012, that effective Sept. 30, 2012, it will freeze its defined benefit pension plan for U.S. salaried employees, who instead will receive contributions to a defined contribution plan.
“This initiative will affect GM’s U.S. salaried employees hired prior to Jan. 1, 2001. Salaried employees hired after that date are already covered by a defined contribution plan,” the company stated.
In its annual report for 2011, Bank of America announced that it will freeze all benefit accruals for employees participating in the pension plan.
American Airlines, which filed for bankruptcy on Nov. 29, 2011, originally sought on Feb. 1, 2012, to terminate the company’s defined benefit pension plans. But in a March 7, 2012, letter, Jeff Brundage, senior vice president, human resources, stated that “in working with the Unsecured Creditors Committee (UCC) and the Pension Benefit Guaranty Corp. (PBGC), we’ve developed a solution that would allow us to pursue a freeze of our defined benefit pension plans for non-pilot employees instead of seeking termination.”
“Freezing instead of terminating these plans of course would mean we will have significantly larger pension costs than contemplated in our business plan,” he stated. “While we still must achieve the $1.25 billion in employee cost savings outlined in our business plan, we do not plan to increase that employee cost savings target. Instead, as part of our plan of reorganization, we intend to seek new capital at the appropriate time to cover the incremental annual costs of funding the frozen pension plans and to help fund the pension liabilities we will continue to have on our balance sheet. Our ability to attract new capital on terms that will give us the future flexibility we need requires that we achieve the $1.25 billion of employee cost savings as quickly as possible. We must clearly demonstrate to other stakeholders—and now potential investors—that we have addressed our cost challenges and can emerge from Chapter 11 as a viable, well-capitalized airline.”
Freezing Pension Plans
GM, Bank of America and American Airlines are implementing a “full freeze,” where all benefits accruals cease for all employees currently participating in the plan, and no new employees are allowed to begin to participate, remarked Antoinette Pilzner, an attorney with McDonald Hopkins in Bloomfield Hills, Mich.
The other way to freeze a pension plan is a participation freeze, which GM did in 2001 for its salaried employees, she added. With a participation freeze, no new employees are allowed to begin participating in the pension plan, but employees who are already participating in the plan continue to participate and continue to accrue benefits.
With a participation freeze, a plan amendment is all that is required, and the amendment must be adopted before the effective date of the participation freeze.
In addition, a full freeze requires a plan amendment and advance written notice to all active participants advising them that their benefit accruals will cease, she noted. The notice must be provided at least 45 days before the effective date that benefits accruals will cease. “Failing to provide the notice at least 45 days in advance exposes the plan sponsor to an excise tax under Section 4980F of the Internal Revenue Code and possible delay in the effective date of the freeze under Section 204(h) of the Employee Retirement Income Security Act,” Pilzner added.
“There’s a continuing trend to freeze pension plans rather than terminate them for a combination of reasons. Employers cannot afford to continue funding additional benefits accruals under their pension plans, because both interest rates and investment returns are generally down, and both of those factors increase the amounts employers must contribute to their pension plans under IRS rules,” she observed. “However, a pension plan generally cannot be terminated unless it has sufficient assets to pay for all accrued benefits (other than when the sponsoring employer enters bankruptcy).”
Pilzner noted that “in many cases of employers that still have pension plans, the plans are underfunded and cannot be terminated because the employer cannot afford to contribute enough to the plan to cause the funded level to match the accrued benefit level.”
“A freeze is often more attractive than a plan termination because it minimizes the future funding obligations while not forcing an employer to cash out all benefits,” Steven Friedman, an attorney with Littler Mendelson in New York, told SHRM Online. “A current cash out is often not optimal because, in today’s low interest rate environment, lump sum values for defined benefit plan accruals are very high.”
Value of Pension Plans
“Defined benefits plans are still great at providing golden handcuffs to employees who can appreciate the value of a significant pension after working at a company for many years,” Friedman remarked.
And defined benefits plans are simpler as a practical matter than defined contribution plans, contrary to popular belief that defined contribution plans are simpler, said Frank Palmieri, an attorney with Palmieri & Eisenberg in Princeton, N.J., and Alexandria, Va. Defined contribution plans involve “taking out payroll deductions, getting them to recordkeepers, investing them and trying not to screw things up,” he said. “There actually are less errors with defined benefits plans,” where an actuary projects a benefit in the future and tells how much it will cost to fund the plan for the year, giving a low-end and high-end estimate. “As long as you put in money there based on your budget, you’re okay.”
“Some companies see a pension plan as a valuable recruiting and retention tool and may want to maintain the plan for that reason,” Pilzner commented. “Other employers want to provide traditional pension benefits for the owners of the company and need to maintain a pension plan that also covers a sufficient number of nonhighly compensated employees or nonowners so that the pension plan satisfies the applicable nondiscrimination rules.”
She noted that alternatives short of freezing a plan fully include adopting a participation freeze and reducing the amount of pension benefits provided for future years.
Allen Smith, J.D., is manager, workplace law content, for SHRM.
Reprinted with permission of SHRM.