Respite Not Relief for Defined Benefit Plans
Beleaguered defined benefit plan sponsors have struggled to comply with the funding requirements and potential benefit restrictions of the Pension Protection Act of 2006. Funding ratios withered during the severe market downturn in 2008 and generally lower discount rates for their 2010 plan years will increase liabilities and contribution requirements.
The Congress and the Internal Revenue Service have doled out small doses of relief during the last two years, but the fundamental requirement of the PPA remains at full funding of benefits in 7 years. Consequently, "relief" was more of a respite: "a usually short interval of rest or relief."
The latest short interval of rest is contained in H.R. 3962, the "Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act of 2010" (the Relief Act). The Relief Act was signed into law on June 29, after an extended period of consideration. The Relief Act offers two main kinds of relief for single employer DB plan sponsors:
• A reduction in amortization amounts for two years or spreading of the amortization for 15 years instead of the normal 7 years
• A suspension of two types of benefit restrictions
Reduction in amortization amounts
Under PPA, a new amortization base is established if the unfunded (shortfall of assets compared to liabilities) is greater than the present value of previous years' amortization bases. The new amortization base is amortized over 7 years. The Relief Act allows plan sponsors to do one of two things:
1. Pay interest only for two years and then amortize the balance over 7 years
2. Amortize the new base over 15 years instead of 7 years
The modifications are allowed for any two years beginning in 2008, 2009 and 2010. The relief must be elected prior to the due date for the last contribution for the plan year; effectively, this can only be used for plan years in 2009 and 2010 (only 2008 plans with a December 1st plan year have not yet reached the final date for contributions). For calendar year plans, the 2009 relief would have to be elected by September 15, 2010, which is the last date on which a contribution may be made and taken into account.
What does this mean for a plan sponsor? Assume that the new amortization base established for 2009 is $1,000,000. Under the regular rules, you would pay roughly $167,000 at the beginning of each year for 7 years to pay it off. Under the first alternative, you would pay roughly $64,000 for each of the first two years and then $167,000 for the next 7 years.
This schedule delays the start of the usual amortization for two years, while paying interest so that the initial balance would not grow. This would enable you to save slightly more than $100,000 for the first two years, for the price of two additional payments during the eighth and ninth years.
Under the second alternative, you would pay roughly $99,000 for 15 years, and this would save you $68,000 during the first 7 years, at the cost of eight extra years' payments during years 8-15.
The savings may be reduced if you pay compensation in excess of $1,000,000 to any employee (excluding commissions and already granted stock options) or extraordinary dividends or stock redemptions.
Furthermore, you are required to inform participants and beneficiaries if you take advantage of the relief, and you are also required to inform the PBGC that you have elected to use the amortization relief.
Respite from benefit restrictions
PPA restricts the ability to make amendments, pay certain optional forms, and even the ability to continue benefit accruals if your plan's funding ratio falls below 80% or 60%. The Relief Act provides that you can look back to the funding ratio for the plan year beginning on or after October 1, 2007 and before October 1, 2008, if either of the following two restrictions would otherwise apply for any plan years beginning on or after October 1, 2008 and before October 1, 2010:
1. The plan's ratio was below 80% and the plan pays a Social Security leveling option (a type of benefit option that pays a higher amount prior to receipt of SS benefits and less thereafter, so that the sum of SS and plan benefits is level or nearly so)
2. The plan's ratio was below 60% and the plan was required to stop the accrual of benefits
Is Relief for you?
Clearly, if your plan would be restricted in the payment of normal benefits or continuation of accruals, relief from benefit restrictions would be appealing even if temporary. A temporary reduction in contribution requirements is less clearly beneficial, unless the need to conserve cash trumps other considerations.
Any reductions in contributions have to be made up later, and lower contributions now may mean much higher contributions later, if the plan hits certain thresholds that trigger accelerated funding. The excess compensation and dividend rules may wipe out any relief, and may have to be evaluated very carefully before implementing the relief provisions. The necessity of informing plan participants and the PBGC that you are contributing less to the plan also may create employee relations problems and invite additional governmental interest.
While it is said that you should never look a gift horse in the mouth, with pension relief, a closer examination before accepting this gift is imperative.