After months of negotiations, Congress has passed, and President Obama has signed, the Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act of 2010 (Pension Relief Act). It will help many employers manage increasing pension contribution obligations. Those employers will be able to use funds that would have been contributions to make capital investments, create jobs, and promote growth. However, the relief is temporary, and Congress will likely have to return to the defined benefit plan funding rules to provide more permanent relief.
Background
Five years ago, Congress turned its attention to the perceived underfunded status of many defined benefit pension plans, both single employer and multiemployer plans. The result was the Pension Protection Act of 2006 (PPA) – a law intended to accelerate funding for these plans. PPA mandated larger employer contributions for many plans and benefit restrictions for materially underfunded plans, all in an effort to improve retirement benefit security and to relieve potential liabilities for the Pension Benefit Guaranty Corporation (PBGC).
Unfortunately, these changes were introduced at a dreadful time. The combination of severe economic conditions, a corresponding downturn in stock prices, and historically low interest rates – especially when coupled with the introduction of changes in the financial accounting rules related to these plans – produced many underfunded plans with large contribution obligations from employers that had little cash. Thus, a need for pension plan funding relief from the new rules was created. The result was the Pension Relief Act.
The following focuses on the defined benefit plan funding relief portion of the Pension Relief Act.
Pension Funding Relief for Single Employer Plans
In essence, under the PPA’s funding requirements for single employer plans that are not fully funded, the employer must contribute the normal cost for the plan year plus the shortfall amortization charge. The current year’s funding shortfall is any excess of accruals over assets, less amounts required to satisfy funding shortfalls from prior years. The result, referred to as the shortfall amortization base, is to be paid in equal installments over a seven-year period. The shortfall amortization charge for a year is the installment for the current year plus current amounts for the prior seven years of shortfall amortization.
Marrying these new rules with the adverse financial changes listed above resulted in exponentially greater contribution obligations for many employers.
The Pension Relief Act provides employers with two alternatives for stretching the 7-year amortization period under the PPA. The employer may use an alternative for any one or two of the 2009, 2010 and 2011 plan years (and for certain plan years beginning late in 2008).
- The 2 + 7-year schedule. This alternative permits the employer to pay only interest on the shortfall amortization base for the first two plan years, and to pay interest and principal for the following five plan years. This will effectively shift costs from years one and two to years six and seven.
- The 15-year schedule. This alternative replaces the original 7-year amortization schedule with a 15-year amortization schedule. This choice will effectively shift cost from each of the first seven years to each of the last eight years.
The Secretary of the Treasury has been instructed to provide additional guidance on how employers may: (1) make an election of one of the alternatives; (2) seek IRS approval to revoke an election; and (3) make elections for more than one plan. The Secretary of the Treasury must also provide rules on the impact of a merger or acquisition on an employer that has made an election of one of the alternatives.
An electing plan sponsor must provide notice of the election to both plan participants and the PBGC.
Electing one of the alternatives does not eliminate any funding obligation, but rather it shifts a portion of the current year’s funding obligation to future years. It is also important to note that this portion of the Pension Relief Act is actually a revenue raiser for the government, as many electing employers will be deferring the payment of tax-deductible contributions to future years, thereby increasing their current income tax liability.
The Quid Pro Quo for Electing Single Employer Plan Funding Relief
An employer that elects one of these funding alternatives must also agree to contribute an installment acceleration amount, if applicable, during a restriction period. The restriction period is three years for a 2 + 7 election or five years for a 15-year schedule. The period begins in the later of the election year or the plan year beginning in 2010.
The installment acceleration amount is the sum of “excess employee compensation” plus extraordinary dividends and redemptions. Excess employee compensation is generally compensation paid to any employee over $1 million in a year. Dividends and redemptions are extraordinary when they exceed the greater of (1) the sponsor’s net income for the prior tax year or (2) the dividends payable in the current year determined in the same manner as for the past five years, if dividends were paid in each of those years. Dividends and redemptions on most preferred stock issued before March 1, 2010, are exempted, as are intra-group dividends in a controlled group.
If the installment acceleration amount exceeds the funding limit for the year, any excess is carried forward. The carry forward ends one year after the restriction period for a 2 + 7 election and two years after the restriction period for a 15-year schedule.
Pension Funding Relief for Multiemployer Plans
Certain multiemployer plans also have an opportunity to elect to amortize investment losses and to smooth asset values over a longer period through Pension Relief Act elections.
Under the PPA, multiemployer plans must amortize net experience gains and losses over a 15-year period. Under the Pension Relief Act, they may extend the amortization period of “net investment losses” to 30 years (actually, 29 years as the current plan year must be included in the period). The Secretary of the Treasury is instructed to provide a definition of “net investment losses.”
Also, multiemployer plans may reduce plan funding volatility by smoothing asset values over a period of five years, as long as the smoothed value remains within an 80% / 120% corridor of actual asset values. The Pension Relief Act permits eligible multiemployer plans to elect to smooth asset values over a period of up to 10 years and to expand the corridor to 80% / 130% of actual asset values.
These multiemployer plan elections apply only to the first two plan years beginning after August 31, 2008. The plan sponsor may elect to apply the extension or the asset smoothing to either or both of such years. Special rules apply where the plan requests an extension from the IRS under existing PPA rules.
To qualify for both of the above elections, the plan must pass a solvency test by having its actuary certify that the plan is projected to have sufficient assets to pay expected benefits and expenditures over the amortization period, including any extension elected under the Pension Relief Act.
An electing plan sponsor must provide notice of the election to both plan participants and the PBGC.
Again, electing one or both of the multiemployer plan alternatives does not eliminate any funding obligation, but rather it shifts a portion of the current year’s obligation to future years. It is also a revenue raiser for the government, as many employers that must contribute to electing plans will be deferring the payment of tax-deductible contributions to future years, thereby increasing their current income tax liability.
The Quid Pro Quo for Electing Multiemployer Plan Funding Relief
If either election is made by a multiemployer plan, a prohibition on amendments to increase benefits applies during the following two plan years. Benefits may be increased only if: (1) the actuary certifies that benefit increases are paid from additional contributions and the plan’s funded percentage is as high as it would have been without the amendment had not be adopted, or (2) the amendment is needed to maintain tax qualification of the plan.
For more information on the Pension Relief Act and its implications, please contact the authors or any member of the McGuireWoods Employee Benefits or Labor & Employment teams.