EBRI Issue Brief
Defined Benefit Plan Freezes: Who's Affected, How Much, and Replacing Lost Accruals
• Pension freezes not a new trend: Despite recent news reports about the supposedly “new” trend among private defined benefit plan sponsors of “freezing” their pension plans, these decisions have been quite prevalent in recent years, and are part of the well-documented and long-term decline of “traditional” pension plans.
• Current data: According to PBGC analysis of 2003 Form 5500 filings (the most recent year available), more than 2,700 of the 29,000 private-sector defined benefit pension plans for which data are available were already hard-frozen in 2003. Between 1975 and 2004, more than 3,400 terminations of underfunded single-employer plans had taken place, as well as of least 165,000 adequately funded plans. Many of these plans may well have been frozen at some point prior to termination.
• EBRI analysis of impact on workers: This Issue Brief provides a detailed analysis of how such activity s likely to impact existing employees as a function of plan type and employee demographics. The accumulation portion of the EBRI-ERF Retirement Security Projection Model was used to estimate the financial consequences of a potential pension freeze for the general population of participants in private defined benefit plans in 2006.
• Wide range of results due to different factors: This analysis provides a construct for employers to estimate the relative impact of certain demographics on those covered by defined benefit pension plans in general. This report presents its findings in terms of additional compensation (in a defined contribution plan, whether provided by the employer and/or the worker) needed to cover the accruals lost to a pension freeze. Results range widely for a variety of factors, since each plan contains design features that make it unique; workers vary widely by age, wage, and tenure; and future interest rates will vary. There is fundamentally no simple answer to the question of how all workers will be affected by a pension freeze: Individual analysis of costs and benefits needs to be done for each employer contemplating such a move.
• General findings:
o For workers in career-average pension plans: The median annual contribution rate needed to financially indemnify a participant in a career-average defined benefit pension plan whose plan was frozen in 2006 would be about 7 percent, assuming an 8 percent rate of return. A contribution rate of about 15 percent would cover three-quarters of the employees in this type of plan.
o For workers in final-average pension plans: The median contribution rate for a final-average plan is slightly larger: 8 percent (assuming an 8 percent return); a contribution rate of 16 percent would cover three-quarters of the workers in this type of plan.
o Cash balance plans: For workers in hybrid pension (cash balance) plans, the median contribution rate would be about 3 percent; a contribution rate of 4.5 percent would cover three-quarters of the workers, based on current interest credits.
o Interest rate impact: In all of these scenarios, the rate of return on investments has a major impact on the contribution rate; lower rates would require higher contributions to offset the benefit loss from a pension freeze.