Content area
Full Text
Options for utilizing surpluses in an ongoing plan
MANY employers are finding their defined benefit pension plans in a surplus position on an ongoing basis.
But with a broad range of surplus utilization options available, how do companies know which alternative is best for their particular situation?
There are various options employers can select from when looking for the best alternative to align with their specific business strategies and circumstances. Basically, employers have the following choices:
1) leave the surplus untouched, as a safety cushion against unfavourable economic conditions;
2) use the surplus to take a contribution holiday...a holiday for the employer alone or a shared holiday with the employees;
3) use the surplus to fund benefit improvements, either conventional or non-conventional; or
4 ) withdraw the surplus from the plan, either by the employer alone or on a shared basis with the plan members.
Option 1: Safety cushion
One surplus option is "save it for a rainy day"; that is to leave the surplus untouched in the plan as a reserve against unfavourable investment and/or demographics. For example, a decline in interest rates can significantly increase plan liabilities. A decline in stock market performance can also significantly decrease plan assets. Experience in 1998 shows just how volatile the financial status of a pension plan can be. However, there are limitations on this option. If, for example, the surplus reserve becomes too large, the income tax legislation does not allow it to remain untouched but requires the employer to adopt another option.
Instead of leaving the surplus untouched as a safety cushion, a variation of this option is to use the surplus to "strengthen" the actuarial funding basis - make it more cautious -- which has the effect of increasing the liabilities and reducing the surplus accordingly.
Option 2: Contribution holidays
Another option is to use the surplus to cover the ongoing costs of the plan. One preliminary caution is make sure the surplus is "real." Though it is not typical, it is possible for a pension plan to have a surplus on an ongoing basis, but a deficit on a wind-up basis. In these situations, the surplus, measured on an ongoing basis, often cannot be used for contribution holidays.
Assuming the surplus is...