In October, the government published final regulations under IRS Code Sections 430 and 436 in the Federal Register relating to single employer defined benefit funding rules and benefit restrictions on underfunded plans. These regulations revise the rules proposed (i) in August 2007 regarding funding balances and benefit restrictions for underfunded plans, and (ii) in December 2007 regarding the measurement of assets and liabilities for pension funding purposes.
Both Code Sections 430 and 436 were added to the Code by the Pension Protection Act of 2006. Section 430 specifies the minimum funding requirements that apply to single employer defined benefit pension plans. Code Section 436 imposes a variety of limits on the benefits payable, and the manner in which those benefits may be paid, under a single employer defined benefit plan if a plan’s funding status drops below certain prescribed levels. The final regulations expand and clarify these requirements and make clear that plan documents must contain provisions relating to the restrictions that are imposed under Code Section 436.
Key benefit restriction provisions of the final regulations that require defined benefit plan amendments are described below. Note that each provision includes a reference to the plan’s adjusted funding target attainment percentage (AFTAP). This is essentially the plan’s assets-to-liabilities funding ratio, adjusted by certain annuity purchases.
Plan Amendments That Increase Benefits
A defined benefit plan amendment that increases benefits (and therefore increases plan liabilities) may not take effect if the plan’s AFTAP for the plan year is less than 80%, taking into account the increased liabilities created by amendment. A plan sponsor may avoid the restriction by making a sufficient special contribution in addition to any minimum required contribution for that plan year. The final regulations clarify how these rules apply to certain pre-existing plan provisions and contain provisions for determining when a plan amendment is considered to take effect.
Restrictions Where Plan Is Under 60% Funded
If a defined benefit plan’s AFTAP for a plan year is less than 60%, several restrictions are activated:
- Participants and beneficiaries may not be permitted to elect, and the plan may not pay, an optional form of benefit that includes a “prohibited payment” with an annuity starting date on or after the applicable measurement date.
- To determine whether a payment is a “prohibited payment”, the payment is measured against the monthly amount paid under a single life annuity (with some adjustments). If the payment exceeds the amount payable in the form of a single life annuity, it is a prohibited payment. Certain annuities purchased from insurers to pay benefits are also prohibited payments.
- The final regulations clarify certain elections that must be provided to participants and beneficiaries with respect to any prohibited payment.
- Benefit accruals under the plan will cease as of the applicable measurement date. They may resume when the plan sponsor makes certain contributions described in the final regulations (in addition to any minimum required contribution for that plan year).
- If a plan provides for any “unpredictable contingent event benefit” (such as special benefits paid on a plant shutdown), the benefit may not be paid if the plan’s AFTAP for the plan year is less than 60%, taking into account the benefits attributable to the unpredictable contingent event. However, a plan sponsor may circumvent this restriction by making a sufficient special contribution to the plan that is in addition to any minimum required contribution for that plan year. The final regulations clarify that these limitations apply on a participant-by-participant basis.
Restrictions Where Plan Is 60% - 80% Funded
As a general rule, if a defined benefit plan’s AFTAP for a plan year is 60% - 80%, participants and beneficiaries may not elect, and the plan will not pay, an optional form of benefit that includes a prohibited payment with an annuity starting date on or after the applicable measurement date. However, an exception under the final regulations exists where the present value of the portion of the benefit that is being paid in a prohibited payment does not exceed certain specified amounts. The final regulations describe how to determine the portion of the benefit that is being paid in a prohibited payment. The final regulations also specify certain elections that must be provided to participants and beneficiaries with respect to any prohibited payment.
Restrictions When Plan Sponsor is in Chapter 11
Participants and beneficiaries may not elect an optional form of benefit that includes a prohibited payment, and a defined benefit plan may not pay any prohibited payment, with an annuity starting date that is during a plan year in which the plan sponsor is a Chapter 11 bankrupt debtor. This restriction is lifted when the plan’s actuary certifies that the plan’s AFTAP is at least 100%.
Rules to Avoid Benefit Limits
The final regulations also specify additional rules on contributions made to avoid benefit limitations and certain underfunding presumptions.
The final regulations are effective Oct. 15, 2009, and generally apply to plan years beginning on or after Jan. 1, 2010. For plan years beginning before Jan.1, 2010, plans may rely on the final regulations, or they may rely on the proposed regulations.
All single employer defined benefit plans should be reviewed and amended, as necessary, for compliance with the final regulations. Plan amendments must be adopted by the last day of the first plan year beginning on or after Jan. 1, 2009 (Dec. 31, 2009 for calendar plan years).
McGuireWoods has extensive experience advising plan sponsors as to the funding requirements for and benefit restrictions imposed on defined benefit plans. In addition, in September 2009, we circulated a separate article related to pension funding.
For additional information or questions regarding the defined benefit plan limits discussed in this article, or for assistance in reviewing and updating your plans, please contact the authors or any other member of the McGuireWoods Employee Benefits or Labor & Employment teams.