When Plans Freeze, HR Duties Don't

After freezing a defined benefit pension plan, HR still must meet plan participant obligations.

Out of sight, out of mind. That phrase may apply to long-lost friends and overdue library books, but it definitely does not describe frozen defined benefit pension plans. For human resources, the work goes on even after a plan is frozen.

Knowing what continuing work HR must do to manage a defined benefit plan after a freeze is essential if employers are to meet their employees’ needs and the organization’s ongoing obligations. Experts say any defined benefit plan freeze gives rise to legal, practical, communication and employee relations issues.

“The plan still exists, so all the requirements around the plan continue to operate,” says Brian Donohue, a managing director of CCA Strategies LLC, a Chicago-based benefits and compensation consulting firm.

As before the freeze, benefits managers must perform or oversee compliance with the legal and administrative aspects of running the plan. “Communication with employees about their benefits is a fiduciary duty,” too, says attorney Frederick Reish of Reish Luftman Reicher & Cohen in Los Angeles.

A Shift in Plans

As recent plan freezes show, some pension plan sponsors are growing weary of doing the heavy lifting required of pension plans, such as funding the plan and bearing all its investment responsibility and risk. Employers usually don’t want to terminate their defined benefit plans outright—a drastic move typically reserved for bankrupt companies—but they do want to limit their future liabilities and, eventually, end all payments. It’s a trend that’s expected to continue. (See Freeze To Get Deeper.)

A defined benefit plan can be frozen in different ways. An employer may close it to new hires while existing participants continue to accrue benefits, known as a “close” or a “soft” freeze. Or, an employer can stop accruals for all participants, a “hard” freeze that limits benefits to those accrued as of the freeze date. (Unionized employees’ defined retirement benefits are negotiated in collective bargaining agreements, so employers cannot act on them unilaterally.)

In between, there are variations designed to protect older employees who are closer to retirement. For example, an employer may elect to freeze the plan for employees under age 40 but not those 40 and older. Another approach is to freeze credits for years of service, but not pay, for plans in which benefits are based on the average annual pay during the last few years of service.

Legally Speaking

Once the company decides to freeze a plan, HR’s duties, for the most part, don’t disappear. In fact, some new tasks crop up regarding compliance with the Employee Retirement Income Security Act (ERISA) and the federal tax code.

ERISA requires plan sponsors to send participants a “204(h) notice” at least 45 days before the freeze date. This written notice informs them that benefits will stop accruing and describes the impact of the change in general terms, says Bill Evans of Groom Law Group in Washington, D.C. Employers can, but don’t have to, provide employee-specific impact statements or tools that let workers estimate the impact.

Employers that adopt any type of freeze must update the plan document and amend the summary plan description given annually to participants. Employers have until 210 days after the end of the plan year to distribute this “statement of material modification.” But, “as a practical matter, you want to get it out as soon as possible” to keep employees up-to-date, says Lisa Van Fleet, a benefits lawyer with Bryan Cave LLP in St. Louis.

Employers must also continue to file government-required forms, including a Form 5500 annual report with the U.S. Department of Labor, and submit yearly reports and premiums to the Pension Benefit Guaranty Corp., which was created by ERISA to insure pensions and take over terminated plans.

Finally, employers must continue to conduct nondiscrimination testing to ensure that the plan does not benefit higher-paid employees at the expense of lower-paid ones. Passing nondiscrimination tests may become more difficult for employers that freeze plans as the workers covered by a plan gradually become higher-paid and are not offset by new, lower-paid employees, experts say.

Overseeing Plan Changes

HR’s primary duties in a defined benefit plan involve day-to-day administration—keeping records, answering participants’ questions, calculating benefits for new retirees and so on. Depending on the type of freeze, a few tasks may fall by the wayside and a few more may appear, but mostly it’s business as usual.

“All of the existing administrative functions are at least at the same level, and some of them are higher [in a frozen plan],” says Alan R. Glickstein, a senior consultant for Watson Wyatt Worldwide in Dallas. And they will continue for decades—until the last participant dies.

Some tasks do end, however. In any freeze, it’s no longer necessary to inform job candidates of the defined benefit plan or to explain it at new-hire orientations.

In a hard freeze, there’s no need to track future pay, and annual statements can be eliminated because there are no more accruals. But consultants say it’s a good idea to audit pension data for accuracy, estimate each affected participant’s benefit as of the freeze date and store the information securely, so that it will be accessible years later when it’s needed to figure out the final benefit. Normally, this calculation doesn’t occur until employees retire.

“Consider trying to calculate as soon as possible what the frozen benefit is,” says Ari Jacobs, who directs the U.S. retirement practice at Hewitt Associates, an HR consulting firm based in Lincolnshire, Ill. The actual final benefit will be adjusted for early retirement and other factors.

In a soft freeze, employers must continue to track each participant’s age, years of service, salary, vesting status and other data used to calculate a final benefit. Any service providers—recordkeepers and actuaries, for example—must be retained.

“There isn’t much of a change at all. I just don’t add any new people to the plan,” says Jacobs. Although HR has a limited role in the financial aspects of a defined benefit plan freeze, it should be aware of the general requirements: continued annual contributions, especially if the plan is underfunded; yearly actuarial valuations; and, eventually, a new investment strategy to adjust the allocation of assets as the covered population becomes smaller and nears retirement age.

Glickstein says, “HR definitely has a significant role in understanding changes in plan demographics” and their impact on plan finances.

Spreading the News

Perhaps HR’s biggest new role in a defined benefit plan freeze is employee communications. The time between the announcement of the freeze and the freeze date—as little as a few months or as long as two years—determines the schedule. The first and most important message is the nature of and reason for the freeze.

“People want to know what’s happening and why,” says Nenette Kress, senior VP and national communications practice leader at the Segal Co., a New York-based actuarial and HR consulting firm. Corporate leaders, including the CEO, should explain the upcoming freeze in as much detail as possible to participants, spouses and the business community to prevent rumors and misinformation, she says.

Lockheed Martin Corp.’s soft freeze affects only salaried employees hired after Jan. 1, 2006, but the defense and aerospace company communicated its intent last October to all employees to allay concerns over the much-publicized issue, says Dave Waller, director of HR communications for the Bethesda, Md.-based firm.

“Our current workforce was interested in this whole topic. We took a comprehensive approach and laid it all out there,” he says. The closed defined benefit plan covers about 85,000 salaried employees; another 25,000 are in separate union plans. New hires are offered the old 401(k) plan as well as a new, more generous 401(k).

In an industry where the typical employee is in his mid-40s, Lockheed was sensitive to the needs of long-serving employees, according to Waller. “You really owe it to those people to tell them what you’re planning to do,” he says. “We put a lot of people’s minds at rest.”

Kress adds, “When something happens of this magnitude, we recommend a high-touch” approach—meetings to explain the transition, reinforced by newsletter articles and other written communications. HR and first-line supervisors also should be prepared to answer individuals’ questions by telephone or online. Lockheed’s HR department spent weeks educating HR and other managers before the e-mail announcement went out to employees, Waller says. v Despite the best communication efforts, a freeze can lead to concern and anger, as postings on www.VerizonRetirementWatch.com show. The web site, sponsored by the Communications Workers of America (CWA) and the Pension Rights Center, was started in January after Verizon Communications Inc., a telecommunications company based in New York, announced a hard freeze of its defined benefit plan for 50,000 management employees.

“People who’ve been with the company a long time feel like the promise has been broken,” says CWA spokeswoman Candace Johnson. The CWA has called on Verizon to rescind the freeze, which does not affect the retirement benefits of Verizon’s 80,000 unionized employees.

Verizon HR executives declined to comment. “Not until it’s all said and done do they want to talk about this,” says company spokesman Alberto Canal. The freeze took effect June 30.

Softening the Blow

In general, freezes hit older, longer-tenured workers the hardest because they don’t have as much time as younger ones to make up lost pension benefits through a 401(k), shows a study issued in March by the Employee Benefit Research Institute, a nonpartisan think tank in Washington, D.C.

The specific impact varies widely with plan design, age and other variables, the study found. For instance, a median annual 401(k) contribution of 7 percent (from any source) is needed to make up benefits a worker would otherwise have gained in a career average pension plan frozen in 2006, assuming an 8 percent rate of return.

That is why, in most cases, employees affected by a freeze are offered a new or redesigned 401(k) plan with more-generous employer matches than before. Alcoa, a Pittsburgh-based aluminum products producer, for instance, closed its pension plan to new hires earlier this year and, at the same time, began to contribute up to 9 percent of pay to a 401(k) plan, including 3 percent to those who don’t contribute on their own.

IBM Corp. will double its current 401(k) match, to 100 percent up to 6 percent of salary deferrals, when it hard freezes its defined benefit plan in December 2007. In addition, the Armonk, N.Y.-based computer-services company will contribute 1 percent to 4 percent of each participant’s pay into individual 401(k) accounts and fund a “special savings award” of 5 percent of pay for nonexempt participants.

Employers usually announce enhancements to their 401(k) plans at the same time they announce a defined benefit plan freeze. Reish says, “It’s a good idea to describe the two together so employees know what’s being taken away from them and what’s replacing it.”

Indeed, employees who have relied on a defined benefit plan may find it confusing to start or pay more attention to a 401(k) plan, so HR should conduct an extensive educational campaign. “If there’s a shifting of risk, participants need to understand they’re more responsible for investment objectives,” Glickstein says.

Carolyn Hirschman is a business writer in Rockville, Md., who specializes in HR and benefits issues.