July 2010

Temporary Pension Funding Relief Becomes Law

On June 25, 2010, President Obama signed into law the Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act of 2010,1 which the House of Representatives passed the previous evening and the Senate passed on June 18, 2010.

This long-awaited funding relief is welcome news for employers that sponsor defined benefit plans, but it is important to note that the law places some limits on the relief. Furthermore, the significance of this funding relief may vary substantially from plan to plan. This Bulletin summarizes the major elements of the funding relief that applies to single-employer defined benefit pension plans.

BRIEF BACKGROUND

Congress has been debating pension funding relief since soon after the dramatic market downturn of late 2008. Recently, the Senate was considering the American Jobs and Closing Tax Loopholes Act of 2010 (popularly referred to as the tax-extenders bill), which included pension funding relief provisions that the House of Representatives had passed on May 28, 2010. However, the Senate leadership was unable to muster the 60 votes needed to defeat a Republican filibuster of that bill.

As a fallback strategy, similar pension funding relief was incorporated into the recently enacted law to restore the level of Medicare payments to doctors. The pension funding provisions were used as a source of revenue for the federal government to offset the cost of those Medicare payments.

FUNDING RELIEF

Longer Amortization of Funding Shortfalls

The new law allows all single-employer plans, including "frozen" plans, to elect to defer the amortization of their funding shortfalls beyond the seven years required under the regular rules by using one of two options:

  • Two-Plus-Seven Relief  This is, in effect, extending the amortization over a nine-year period, with lower payments for the first two years. During the initial two-year period, an employer would only pay interest on the shortfall. Then the original funding shortfall is amortized over the next seven years.
  • 15-Year Relief  Employers can opt to amortize the funding shortfall over 15 years.

Employers can elect this funding relief for one or two eligible plan years, defined as those beginning in the late-2008 to 2011 period. If elected for two years, both years must utilize the same option. The Treasury Department is directed to prescribe the form and manner that elections are made.

The pension funding relief only applies to the amount of employers' contribution requirements. It does not change the funding levels that plans need to reach in order to avoid the various ramifications under the law, except for a temporary lookback to ease certain benefit restrictions. (This lookback is discussed in more detail below.)

Less Funding Relief for "Excessive" Compensation, Shareholder Distributions

The available pension funding relief is reduced if a "cash-flow rule" applies. Essentially, this rule states that, to the extent an employer is paying what the law labels as "excessive compensation" to employees and/or "excessive distributions to shareholders," it will not be allowed to postpone its pension funding obligation. Specifically, for an employer that makes those types of payments, the required contributions will not be reduced as much as the relief would otherwise allow.

There are two ways in which the relief could be rolled back:

  • Excess Employee Compensation  If the annual taxable compensation for any employee2 exceeds $1 million, the relief is offset by the total excess compensation for the controlled group.
  • Extraordinary Dividends and Redemptions  To the extent the sum of a company's dividends and stock redemptions exceeds the company's average of adjusted net income over the past five years, the relief is offset by the amount of the excess.

Numerous special rules and exclusions refine the relevant concepts.

This cash-flow rule will apply for three years, if an employer elects the two-plus-seven relief. It will apply for five years, if the employer elects the 15-year relief. In no event would the cash-flow rule raise plan contributions above what would have been required without the relief.

Notification Requirement

The law requires employers that elect funding relief to notify participants, beneficiaries and the Pension Benefit Guaranty Corporation.

LIMITED, TEMPORARY "LOOKBACK" PERMITTED

The funding relief does not generally relax the standards for restrictions on lump-sum payments or other restrictions. Indeed, plan funding is more likely to dip below the 80 percent or 60 percent threshold, if contributions are cut back. However, as noted, the law includes temporary relief through 2010 that allows a "lookback" to the 2008 funded status for these limited purposes:

  • To prevent a plan from being forced to freeze accruals, if the funded percentage is below 60 percent,3 and
  • To avoid the restriction on a Social Security leveling option, if the funded percentage is below 80 percent.

This extended lookback appears to be both required, and retroactive to 2009. Thus, if the plan has been operated in accordance with the restriction that applied before relief, it may be required to retroactively remove the restriction.

Special rules apply to noncalendar year plans.

Note about Special Relief for Charities: The law also includes some targeted funding relief for Section 501(c)(3) tax-exempt organizations. Under the regular funding rules, credit balances (accumulated prior contributions in excess of the minimum requirements) cannot be used to pay the current required contribution if the prior year funding ratio is less than 80 percent. If credit balance use would otherwise be restricted, this relief provides a lookback to 2008 for the 2010 and 2011 years (instead of the 2009 and 2010 years, respectively). In addition, another targeted rule provides substantial extra funding relief for charitable organizations if two or more of them, including branches and affiliates, participate in the same pension plan, as long as all of the sponsoring organizations are exempt from tax under Section 501(c)(3).

IMPLICATIONS

As noted, the implications of the new funding relief will vary greatly from plan to plan. In addition to the employer's financial condition, the following are among the variables to consider when deciding whether to take advantage of the funding relief now available:

  • The magnitude of the funding shortfalls for the available election years,
  • Whether and by how much the relief would be reduced for excessive employee compensation and/or shareholder distributions, and
  • Whether contributions are required or advisable to reach certain thresholds regardless of the relief.

•   •   •

As with all issues involving the interpretation or application of laws and regulations, employers that sponsor defined benefit plans should rely on their attorneys for authoritative advice on the interpretation and application of Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act of 2010. Sibson can help employers to determine the implications of the new law and decide whether and how to opt for funding relief.

1
When the law (Public Law 111-192), which amends the Employee Retirement Income Security Act and the Internal Revenue Code, is available online, it will be accessible from the following page of the Government Printing Office's Web site: http://www.gpoaccess.gov/plaws/index.html
2
This rule is not limited to the top executives or to public companies.
3
This is an extension of the relief provided in the Worker, Retiree, and Employer Recovery Act of 2008, which allowed for a lookback for 2009 to 2008.

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