Defined Benefit LOSAP Plan or Defined Contribution LOSAP Plan – That is the Question
By Bruce Linger, Lincoln Financial Group
A Length of Service Award Program (LOSAP) is a plan that provides tax-deferred income benefits to active volunteer members of an emergency service organization, such as a fire, EMS, or rescue department. Essentially, this is a way a department can provide a retirement benefit to its members, which both rewards longtime volunteers as well as can serve as a recruitment and retention incentive. The longer a volunteer serves, the bigger their LOSAP benefit will be.
The tax-deferred income benefits for emergency services volunteers come from contributions made solely by the governing body of the municipality or fire district – also known as a plan sponsor – on behalf of those volunteers who meet the criteria of a plan created by that governing body.
Now for the hard question: Should the LOSAP plan sponsor choose a Defined Benefit Plan or Defined Contribution Plan? The real issue is sustainability.
A Defined Benefit LOSAP Plan is what it sounds like – it defines the benefit that will be received at the end of a working period. The risk of the benefit is the responsibility of the plan sponsor. The annual contribution to the LOSAP is typically based on multiple factors, including the promised benefit amount, how long the benefit will last, when the benefit will begin, years of bona-fide service, interest rates and investment performance, annual funding requirements, and sometimes more. All of this needs to be annually reviewed and determined by an actuary. This type of plan has been favored by participants in the past due to the “specified monthly benefit” concept. However, over recent years it has become increasingly difficult for the plan sponsors to maintain these plans because of rising costs and longevity of the participants.
Alternatively, with a Defined Contribution LOSAP Plan the plan sponsor makes an annual LOSAP contribution to the participant’s account. The participant is responsible for the investment choice and eventual outcome – this is where this risk has been shifted.
The challenge facing fire departments and other emergency service organizations is to obtain a balance between offering a retirement benefit and the ability to keep the funding available to sustain the retirement program in the long run. Each year the commissioners or LOSAP trustees receive a report on their LOSAP Defined Benefit Plans. The report entails a percentage-funding requirement and a projected shortfall and funding obligation to make the plan financially sound. The commissioners have a fiduciary and moral obligation to address any issues for all members of the plan. The main question is how to meet the obligation without taking too much investment risk (i.e., how the funds are invested) while maintaining the promised benefit. That said, there are emergency service organizations that are adequately funded and have the assets to meet the obligations.
The trend has been to move existing plans to the Defined Contribution model – which by all means is not a complete solution and has its own set risks. What the Defined Contribution Plan does do is control the annual funding requirement issue as there is an annual limit that is allowed for annual per participant funding ($6,000), but now the potential investment return has been placed on the shoulders of the participants. This can be mitigated in most cases with simplified investment models based on the participant’s appetite for risk. But the risk is clearly on the participant.
In the end, decisions need to be made for the good of the whole and sustainability of the organization. Using dollar cost averaging does not ensure a profit and does not protect against loss in a declining market. Also, using this investment method involves continuous investment in securities regardless of fluctuating price levels of securities. Therefore, an investor should consider his/her financial ability to continue purchasing through periods of low-price levels.
Bruce Linger is a registered representative of Lincoln Financial Advisors Corp.
Securities and advisory services offered through Lincoln Financial Advisors Corp., a broker/dealer (Member SIPC) and registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. Lincoln Financial Group is the marketing name for Lincoln National Corporation and its affiliates. CRN-4749499-051822