Single Employer Defined Benefit Plan CARES Act Guidance Issued by IRS

IRS Notice 2020-61 was issued on August 6, 2020, and provides clarification on the relief the CARES Act provided to single employer defined benefit plans. The CARES Act extended the due date of all 2020 calendar year required pension plan contributions to January 1, 2021, and allows the use of the prior year AFTAP certification to avoid benefit restrictions.

Extended Contribution Deadline

Many plan sponsors are considering taking advantage of the extended due date for the 2020 calendar year required contributions. As this option is considered, plan sponsors should be aware of the potential impact on the administration of the plan. IRS Notice 2020-61 has provided additional details regarding the impact to the plan’s administration.

Single Employer Defined Benefit Plan CARES Act Guidance Issued by IRS

Contribution amounts will be increased as a result of the later payment date. The due dates are extended but as required by §430, interest is added at the plan’s effective interest rate until the date the contribution is paid. The CARES Act has waived the additional 5 percentage point penalty for late contributions until the new due date of January 1, 2021. Any contribution made after January 1, 2021 will start to accrue the additional 5 percentage point interest penalty on January 2, 2021 in addition to the effective interest rate.

An amended Form 5500 filing will be required. The only contributions that are allowed to be included in the 5500 filing are those that have already been contributed to the plan as of the filing date, which is October 15th for calendar-year plans. Consequently, if a plan sponsor opts to delay any 2019 contributions, the 5500 contribution will need to be filed omitting those contributions. Once the contributions are made, the 5500 filing will need to be amended in order to avoid any additional penalties that would be triggered on unpaid contribution requirements.

The audit report may need to be updated once the contributions are made in order to match the amended 5500 filing. This should be discussed with the auditor prior to delaying contributions. Some auditors may choose to footnote the audit report either this year or next year in order while other auditors may choose to update the audit report.

The contribution deadline applies to excess contributions in addition to required contributions. For calendar year plans, any contribution made before January 1, 2021 can be applied to the 2019 plan year even if it is made after September 15, 2020. Plan sponsors therefore have additional time to improve the 2020 funded level of the plan. Note, however, as detailed in our earlier article, contributions made after the filing of the PBGC premium payment for 2020 cannot be included to reduce PBGC premiums.

AFTAP certification for 2020 may be lower because any calendar year plan will need an AFTAP certification by September 30, 2020 but such certification can only include contributions made as of the date of certification. Once the contributions are made, the plan can update their certification if it materially changes the funded percentage of the plan. Alternatively, the CARES Act also allows plan sponsors to use their 2019 AFTAP certification for 2020 which is discussed later.

Prefunding Balance elections are also delayed to January 1, 2021. Plan sponsors have until January 1, 2021 to elect to use the Prefunding Balance towards any contribution requirements or to increase the Prefunding Balance with any excess contributions.

Use of Prior AFTAP Certification

A Plan Sponsor may use the prior year AFTAP certification for any plan year occurring in 2020. This will help keep plans from falling into benefit restrictions as a result of a lower 2020 AFTAP certification.

The election can be used for a 2019 plan year if it ends in 2020. Any plan that has a plan year that ends in 2020, can opt to use the prior year’s AFTAP as long as that prior year ends on or before December 31, 2019.  For example, a July 1, 2019 plan year that ends June 30, 2020 can use the July 1, 2018 AFTAP for 2019. The same AFTAP can also then be used for the plan year beginning July 1, 2020.

Plan Sponsors must make the election by notifying their plan actuary and plan administrator in writing. The process to make such an election is similar to the elections made regarding the plan’s credit balances. The certification is deemed to be made on the day the Plan Sponsor makes the election. An attachment should then be included with the applicable Schedule SB indicating such an election has been made.

Election by the Plan Sponsor is a recertification if the actuary had already certified the AFTAP. Therefore the election would be applicable from the date of the election forward. The actuary cannot certify the AFTAP after an election unless the Plan Sponsor revokes their election in writing.

Presumptive AFTAP for the following year is based on the actual AFTAP instead of the plan sponsor’s election. Therefore for any calendar year plan, the 2021 presumed AFTAP as of April 1, 2021 would be the actual 2020 AFTAP less 10% ignoring the participant’s election to use the 2019 AFTAP for 2020.

There are many administrative hurdles that should be considered before choosing to elect any of the options provided in the CARES Act.  However, for plan sponsors that need the relief, these are several strategies you can employ. For more information regarding this notice and its effects on single employer defined benefit plans, contact Amy Gentile in the form below.

Published August 12, 2020

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Copyright © 2020 by Findley, Inc. All rights reserved.

Developing a Strategy for Moving from Pension to 401(k) Benefits

Budgeting for next year’s cost of employer-provided benefits can seem daunting, especially when an organization sponsors both a defined benefit pension plan and a 401(k) defined contribution plan. Is it time to consider moving away from the defined benefit pension plan to avoid the volatility and risk? If so, plan sponsors should develop a well-thought-out process for analyzing the alternatives and impact to both employer costs and participant benefits. The overall strategy and objectives should be reviewed.

Each year, an actuary provides projections for the defined benefit pension plan and the amount required to fund seems to be ever-increasing. It feels like there’s no end in sight. Becoming fully funded seems to be a dream instead of a reality. Even in years when the assets in the plan had double-digit returns, there was either a new mortality table that needed to be adopted or the required interest rates dropped – all increasing the plan’s liability. This can be very difficult to manage going forward.

Strategy for Moving from Pension to 401(k) Benefits

While it is challenging to deliver an equivalent benefit in a defined contribution plan at the same level of contribution, defined contribution plans provide a predictable level of employer contribution each year. If plan sponsors are considering a transition to a replacement 401(k) plan, an analysis should be conducted to:

  • Determine the level of benefit desired for employees
  • Set a budget that provides the desired level of benefit when considering a defined benefit pension plan freeze

Performing the Analysis

When performing this type of analysis, we encourage companies to start by thinking of both the defined benefit pension and defined contribution plans together as a total retirement benefit. This allows the plan sponsor to contemplate its philosophy and develop a strategy related to short- and long-term goals for the retirement program.

Pension to 401(k) Benefits Flowchart

Establish Guidelines

Plan sponsors should start with a well-defined and proven process, taking the time to establish guidelines and understand the financial strategy. Begin by discussing the organization’s philosophy and define objectives for the retirement program to guide decision-making. These guidelines should include how the plan sponsor feels about management/budgeting of retirement plan costs, willingness to take on risk, providing benefits based on the organization’s ability to fund – discretionary vs. mandatory, the level of employees’ retirement benefits, and the competitiveness of benefits.

Determine Affordability

By evaluating all the current retirement plans and the projected cost and benefits, organizations will better understand the current and projected state of the plans and be able to determine the affordability of current plans over the long-term. The evaluation also allows them to discuss acceptable benefit levels and a cost strategy. A thorough analysis of the current and projected costs should include an outline of the current state of the program, including five-year projections under three scenarios for the defined benefit pension plan:

  • Ongoing plan
  • Closed to new entrants
  • Frozen accruals

In addition, the termination liability estimate under agreed upon assumptions should be calculated.

Determine Competitive Position

The guidelines and budgets are then coordinated with competitive market benchmarking to identify relevant alternatives to evaluate. Benchmarking the retirement plan benefits with competitive norms relative to the market allows the organization to measure the competitive position of benefits and expenses compared to industry/geographic region/employer size based on revenue or number of employees. The benchmarking helps the plan sponsor make informed decisions on the:

  • Form of benefit to be provided
  • Desired level of benefit for new hires/newly eligible participants
  • Impact on total compensation and the benefits package
  • Desired contribution allocation structure – pro-rata on pay, position-based, or based on age and/or length of service

Evaluate Alternate Strategies

Potential plan design alternatives including utilizing the current defined contribution plan should be developed based on previous discussions related to the organization’s philosophy, objectives and strategic direction for the retirement program. Alternative strategies can be assessed to determine the final strategic direction of the retirement program, such as modifying the current level of pension benefits or reduction/elimination of the defined benefit pension plan by freezing pension benefit accruals for all participants and moving toward a defined contribution plan only strategy.

Other strategies such as grandfathering selected participants or providing participants a “choice” between defined benefit and enhanced defined contribution benefits should be considered. If providing enhanced defined contribution benefits, determination of how the benefit will be provided – either with matching contributions and/or non-elective contributions in a fixed amount, performance-based, or based on a tiered age and/or service allocation – should be evaluated as well.

Modeling different plan designs that include variations of both defined benefit pension and defined contribution structures helps the plan sponsor compare costs and benefits. Based on the guidelines set upfront, these plan designs reflect the organization’s philosophical principles for providing these benefits to employees. The results of this analysis and each alternative are compared to the current plan(s) to show the overall impact on the employer-provided cost and level of employee benefit. Be prepared to study supplemental alternatives at this point because the first set may provoke additional thoughts or refinements.

Plan sponsors must be aware of compliance testing restrictions and be sure that any alternative considered will satisfy compliance rules — there is no point in studying an alternative that cannot be adopted due to nondiscrimination or coverage issues.

Making and Implementing the Decision

When all alternatives are reviewed, a final recommendation that ultimately links the retirement strategy with the philosophy and desired objectives is presented. Any potential transition issues or challenges should be outlined and a communication strategy should be developed. Establishing a formal communication plan is very important.

Develop and Document the Retirement Plan Strategy and Implementation Plan

The end result of the review should include a proposed retirement plan strategy to be presented to the board of directors. The proposed strategy should document the findings and conclusions of the review process and identify the steps necessary to carry out the recommendations within the strategy.

Change Management: Communicating to Employees

After the decision is made to change retirement benefits, communication to those impacted is key. This is the perfect time to remind employees of the retirement program and its overall value. In addition to government-required notices, you should also consider proactively sending out an individualized statement outlining the changes and providing the impact on participant’s benefits. It is important to make sure the changes are communicated clearly and that each participant understands the changes. Sometimes plan sponsors will hold group or one-on-one meetings with those impacted.

In Perspective

A change in the retirement program is a significant decision that affects the organization and its employees significantly. A thoughtful approach to a change like this can lead to better alignment of the overall program with organizational philosophy and goals, while still providing employees with competitive benefits.

If you have any questions regarding your options with transitioning from pension to 401(k) benefits, please contact Amy Kennedy at amy.kennedy@findley.com or Kathy Soper at kathy.soper@findley.com.

Published May 14, 2020

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Breaking Down the Secure Act – Required Minimum Distributions

Benefits experts are still poring through the SECURE Act’s various mandated provisions, optional provisions, and effective dates, some of which may be retroactive. This series of articles will break down the implications that the Act has for existing tax-qualified retirement plans. This article will focus on the Act’s impact on required minimum distributions (RMDs) for both defined benefit and defined contribution plans. Related articles will address (1) changes that impact 401(k) and other defined contribution plans only, (2) changes for defined benefit plans only; and (3) other changes to the retirement plan landscape.

Remedial Amendment Period

Plan sponsors generally have until the last day of the 2022 plan year to adopt amendments that reflect the Act’s required revisions.  For calendar year plans the last day is December 31, 2022. Governmental plans have until the 2024 plan year to amend. Remember that operational compliance is still required during the period from the effective date for the Act’s required changes and the date the plan is amended.

Delay of Lifetime RMDs – MANDATORY

Prior law: Distributions from an eligible employer retirement plan must be made by April 1 of the calendar year following: (a) the calendar year in which the participant turns age 70-1/2, or (b) for a participant who is not a 5% owner, the calendar year in which he or she terminates employment after age 70-1/2.

Under the Act: The required age for RMDs is raised from 70-1/2 to 72. Participants who are not 5% owners and who work beyond the required age for RMDS, under the Act still don’t trigger RMDs until the calendar year in which they retire. The Act did not change the way in which 5% owners are determined. In addition, post-death distributions to a participant’s surviving spouse are not required to begin before the calendar year in which the participant would have obtained age 72 (formerly 70-1/2). 

Effective date: The new age applies to employees who turn age 70-1/2 after December 31, 2019; that is, for those born after June 30, 1949. For those born on or before June 30, 1949 (already obtained age 70-1/2 prior to January 1, 2020), the prior law applies.

What to do and when: Plan sponsors should work with their service providers to track two populations: those born on and before June 30, 1949 (for whom age 70-1/2 is the RMD trigger date), and those born after that date (for whom age 72 is the RMD trigger date). Distributions of RMDs for the latter population therefore need not begin until April 1 of the calendar year following the year they attain age 72.

This change to tax-qualified retirement plans will necessitate updates to distribution forms, SPDs, 402(f) notices, and participant communications.

Post-Death RMDs are accelerated – MANDATORY

Prior law: In general, distributions are permitted to be paid annually over the beneficiary’s life expectancy. In general, if the participant died before RMDs began, distributions could be made at various times, provided the entire account was distributed by the end of the fifth year following the participant’s year of death.

Under the Act:  Following the death of the participant, distributions must generally be made by the end of the 10th calendar year following the year of death. The determination of the 10-year period is presumably calculated in the same way that the 5-year period was calculated. Payments can be made over the beneficiary’s life expectancy provided the beneficiary is an “eligible designated beneficiary”, which can be the surviving spouse, a disabled/chronically ill individual, a minor child of the participant or a beneficiary no more than 10 years younger. Prior rules still apply to a beneficiary that is not a “designated beneficiary”.

Effective date: The rule regarding the acceleration of post-death RMDs is effective for deaths that occur after December 31, 2019. Special delayed effective dates apply to collectively bargained and governmental retirement plans. 

What to do and when: Sponsors of tax-qualified retirement plans should be working with their service providers to implement these rules now.

This change will impact beneficiary designation forms, distribution forms, SPDs and other participant/beneficiary communications.

Special Note for Defined Benefit Pension Plans

The Act does not change actuarial increases required by Internal Revenue Code 401(a)(9)(C).  For individuals who continue working and choose to retire late, a defined benefit plan must provide actuarial increases beginning at age 70-1/2.  

General Thoughts

Commentators anticipate IRS guidance to provide self-correction relief for plans that fail to implement the new rules correctly during the remedial amendment period and clarify the Act’s impact on current regulations. Tax-qualified plan sponsors considering an amendment prior to the remedial amendment deadline, for the sake of clarity for itself and its service providers, may want to wait to see how further guidance may affect that amendment.

Questions? Please contact the Findley consultant you regularly work with or Sheila Ninneman at Sheila.Ninneman@findley.com, or 216.875.1927.

To learn more about the passage of the Secure Act and changes to retirement plans, click here

Published March 19, 2020

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Impact of Historic Interest Rate Decline on Defined Benefit Plans

How will defined benefit pension plans be impacted by historic year-to-year interest rate declines? The U.S. has experienced over a 100 basis point decrease on 30-year treasury rates and significant decreases across treasury bonds of all durations from year-to-year. After a slight uptick in rates during the fourth quarter of 2019, interest rates have plummeted in the first quarter of 2020. The low interest rate environment, coupled with recent volatility in the market arising from concerns over the Coronavirus, has pension plan sponsors, CFOs, and actuaries alike, taking an in-depth look at the financial impact.

Historic Interest Rate Decline on Defined Benefit Plans and options to consider.

How Will Your Company be Impacted by Historic Interest Rate Decline?

Under U.S. GAAP and International Accounting Standards, pension liabilities are typically valued using a yield curve of corporate bond rates (which have a high correlation to Treasury bond rates) to discount projected benefit payments. Current analysis shows that the average discount rate has decreased approximately 100 basis points from the prior year using this methodology.

Due to the long-term benefit structure of pension plans, their liabilities produce higher duration values than other debt-like commitments, that are particularly sensitive to movement in long-term interest rates. The general rule of thumb is for each 1% decrease in interest rates, the liability increases by a percentage equal to the duration (and vice versa). The chart below, produced using Findley’s Liability Index, shows the percentage increase in liabilities for plan’s with varying duration values since the beginning of 2019.

Pension Liability Index Results - 2/29/2020

Assuming all other plan assumptions are realized, the larger liability value caused by the decrease in discount rates will drive up the pension expense and cause a significant increase in the company’s other comprehensive income, reflecting negatively on the company’s financial statements.

Considerable Growth in Lump Sum Payment Value and PBGC Liabilities

Additional consequences of low treasury bond rates include growth in the value of lump sum payments and PBGC liabilities. Minimum lump sum amounts must be computed using interest rates prescribed by the IRS in IRC 417(e)(3) which are based on current corporate bond yields. PBGC liabilities are also determined using these rates (standard method) or a 24-month average of those rates (alternative method). For calendar year plans, lump sums paid out during 2020 will likely be 10-20% higher for participants in the 60-65 age group, than those paid out in 2019. For younger participants, the increase will be even more prominent.

In addition, if the plan is using the standard method to determine their PBGC liability, there will be a corresponding increase in the liability used to compute the plan’s PBGC premium. In 2020, there will be a 4.5% fee for each dollar the plan is underfunded on a PBGC basis. Depending on the size and funding level of the plan, the spike in PBGC liability may correspond to a significant increase in the PBGC premium amount.

What If We Want to Terminate our Pension Plan in the Near Future?

For companies that are contemplating defined benefit pension plan termination, there will be a significant increase in the cost of annuity purchases from this time last year. The actual cost difference depends on plan-specific information; however, an increase of 15-25% from this time last year would not be out of line with the current market. This can be particularly problematic for companies who have already started the plan termination process. Due to the current regulatory structure of defined benefit pension plan terminations, companies must begin the process months before the annuity contract is purchased. The decision to terminate is based on estimated annuity prices which could be significantly different than those in effect at the time of purchase.

Actions You Can Take to Mitigate the Financial Impact

Contributions to the plan in excess of the mandatory required amount will help offset rising PBGC premiums since the premium is based on the underfunded amount, not the total liability. Additional contributions would also help offset the increase in pension expense.

The best advice we can offer at this time is to discuss these implications internally and with your service providers. Begin a dialogue with your investment advisors about the potential need to re-evaluate the current strategy due to market conditions. Contact your plan’s actuary to get estimated financial impacts so you can plan and budget accordingly. If your plan has recently begun the plan termination process, you may need to reconvene with decision-makers to make sure this strategy is still economically viable.

Questions? For more information, you can utilize Findley’s Pension Indicator to track the funded status of a variety of plan types each month. To learn more about how this historic interest rate decline may impact your plan specifically contact your Findley consultant, or Adam Russo at adam.russo@findley.com or 724.933.0639.

Published on March 3, 2020

© 2020 Findley. All Rights Reserved.

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Year-End Spending Bill includes the SECURE Act and other Retirement Plan Changes

Featured

With the passage of the 2020 federal government spending bill less than a week before Christmas, Congress has gifted us with the most significant piece of retirement legislation in over a decade. This newly enacted legislation incorporates the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) that was overwhelmingly passed by the House of Representatives earlier this year but never considered by the Senate. The spending bill even has a few additional retirement-related tidbits that were not part of the SECURE Act.

Here are some of the key changes:

Frozen Defined Benefit Plan Nondiscrimination Testing

Currently- Defined benefit plans that were frozen to new hires in the past and operate with a grandfathered group of employees continuing to accrue benefits have ultimately run into problems trying to pass nondiscrimination or minimum participation requirements as the group of benefiting employees became smaller and normally higher paid. This problem for frozen defined benefit plans has been around for a while and the IRS has been providing stop-gap measures to deal with it every year.

Effective as of the date of enactment of this legislation and available going back to 2013 – plans may permit the grandfathered group of employees to continue to accrue benefits without running afoul of nondiscrimination or minimum participation rules so long as the plan is not modified in a discriminatory manner after the plan is closed to new hires. This special nondiscrimination testing relief also extends to:

  • defined benefit plans that close certain plan features to new hires,
  • defined contribution plans that provide make-up contributions to participants who had benefits in a defined benefit plan that were frozen.

Increasing the 10% Limit on Safe Harbor Auto Escalation

Currently – a safe harbor 401(k) Plan with automatic enrollment provisions cannot automatically enroll or escalate a participant’s contribution rate above 10%.

Effective for Plan Years beginning after Dec. 31, 2019 – the 10% cap would remain in place in the year the participant is enrolled but the rate can increase to 15% in a subsequent year.

Simplifying the Rules for Safe Harbor Nonelective 401(k) Plans

Currently – All safe harbor plans must provide an annual notice prior to the beginning of the year that provides plan details and notifies employees of their rights under the plan. Also, any plan sponsors that want to consider implementing a safe harbor plan generally must adopt the safe harbor plan provisions prior to the beginning of the plan year.

Effective for Plan Years beginning after Dec. 31, 2019 – the notice requirement for plans that satisfy the safe harbor through a nonelective contribution has been eliminated. Also, sponsors can amend their plan to become a nonelective safe harbor 401(k) plan any time up until 30 days prior to year-end. The safe harbor election can even be made as late as the end of the next year if the plan sponsor provides for at least a 4% nonelective contribution.

Open Multiple Employer Plans (Open MEPs)

CurrentlyMultiple employer plans (MEPs) are legal and actually quite common, but a couple of limitations have stunted the development of a concept called open MEPs. An open MEP is a situation where the employers within the MEP are not tied together through a trade association or some common business relationship. In 2012 the DOL issued an Advisory Opinion provided that a MEP made up of unrelated employers that did not have “common nexus” must operate as a separate plan for each of these unrelated employers and not as a single common plan. This advisory opinion took away much of the perceived advantages of operating an open MEP. Additionally, the IRS has followed a policy that provides if one employer within the MEP makes a mistake, that the error can impact the qualified status of the entire plan; this is known as the “one bad apple” rule, this policy is clearly a negative selling point for any plan sponsor that might consider signing up to participate in a MEP.

Effective for Plan Years beginning after Dec. 31, 2020 – the “common nexus” requirement and the “one bad apple” rule are eliminated. The new open MEP rules provide for a designated “pooled plan provider” that would operate as the MEPs named fiduciary and the ERISA 3(16) plan administrator. The open MEP will be required to file a 5500 with aggregate account balances attributable to each employer. These changes are expected to create a market for pooled plans that will offer efficient retirement plan solutions to smaller plan sponsors.

Required Minimum Distribution Age Now 72

Currently Required Minimum Distribution from a qualified plan or IRA must begin in the year the participant turns 70 ½.

Effective for Distributions after 2019, with respect to individuals who attain 70 ½ after 2019. – This is a simple change to age 72 for computation purposes, but note the effective date means that if the participant is already subject to RMD rules in 2019 they remain subject to RMDs for 2020 even though the person may not be 72 yet. Also, plan sponsors should be aware that distributions made in 2020 to someone that will turn 70 ½ in 2020 will not be subject to RMD rules and therefore would be eligible for rollover and subject to the mandatory 20% withholding rules.

Increase Retirement Savings Access to Long-Term Part-Time Workers

Currently– Plans can exclude employees that do not meet the 1,000 hours of service requirement

Effective for Plan Years beginning after Dec. 31, 2020 – Plans will need to be amended to permit long-term part-time employees who work at least 500 hours over a 3 year period to enter the plan for the purpose of making retirement savings contributions. The employer may elect to exclude these employees from employer contributions, nondiscrimination, and top-heavy testing.

Stretch IRAs are Eliminated

Currently– If Retirement plan or IRA proceeds are passed upon death to a non-spouse beneficiary; the beneficiary can set up an inherited IRA and “stretch” out payments based upon the beneficiary’s life expectancy. Depending upon the age of the beneficiary and the size of the IRA this strategy potentially provided significant tax advantages.

Effective for distributions that occur as a result of deaths after 2019 – Distributions from the IRA or plan are generally going to need to be made within 10 years. There are exceptions if the beneficiary is (1) the surviving spouse, (2) disabled, (3) chronically ill, (4) not more than 10 years younger than the IRA owner or plan participant, or (5) for a child that has not reached the age of majority, the ten year rule would be delayed until the child became of age.

Increased Penalties for Failure to File Retirement Plan Returns and Other Notices

Current Penalty Structure:

Failure to file Form 5500$25 per day maximum of $15,000
Failure to report participant on Form 8955-SSA$1 per participant, per day maximum of $5,000
Failure to provide Special Tax Notice$10 per failure up to a maximum of $5,000

New penalty structure:

Failure to file Form 5500$250 per day maximum of $150,000
Failure to report participant on Form 8955-SSA$10 per participant, per day maximum of $50,000
Failure to provide Special Tax Notice$100 per failure up to a maximum of $50,000

Other Retirement Plan Changes Effective for Years Beginning After December 31, 2019

  • Phased retirement changes – defined Benefit Plans can be amended to provide voluntary in-service distributions begin at age 59 ½, down from the current age 62 requirement.
  • Start-up credits – the cap on tax credits that small employers (up to 100 employees) can get for starting up a new retirement plan has gone up from $500 to $5,000.
  • Auto-Enroll credits for small employers – small employers can get an additional $500 tax credit for adopting an automatic enrollment provision.
  • More time to adopt a plan – currently a qualified plan must be adopted by the end of the employer’s tax year to be effective for that year. The new rule will permit a plan to be adopted as late as the due date of the employer’s tax return for the year.
  • Plan annuity provisions – in recognition that defined contribution plans typically do not offer lifetime income streams two changes have been added to encourage in-plan annuity options.
    • A fiduciary safe harbor standard that if followed, would protect plan sponsors from potential liability relating to the selection of an annuity provider.
    • Plans may permit tax-advantaged portability of lifetime income annuity options from one plan to another.
  • 403(b) changes include providing a mechanism for the termination of a 403(b) custodial account and clarification that non-qualified church controlled organizations (e.g. hospitals and schools) can participate in Section 403(b)(9) retirement income accounts.
  • Penalty free distribution for birth or adoption expenses – up to $5,000 could be distributed from a defined contribution or 403(b) plan to cover costs relating to birth or adoption of a child.
  • Special tax penalty relief and income tax treatment for distributions for qualified disaster distributions from qualified plans up to $100,000.  Additionally, plan sponsors can permit the $50,000 participant loan limit to be increased to $100,000 with increased repayment periods for participants that suffered losses in a qualified disaster area.

Other Changes with a Delayed Effective Date

  • Lifetime income disclosure – this provision will require a defined contribution plan to provide all participants with an annual statement that discloses the projected lifetime income stream equivalent of the participant’s account balance.  This requirement will become effective for benefit statements furnished one year after applicable DOL guidance has been issued that will be necessary to provide the prescribed assumptions and explanations that will be used to create this disclosure.
  • Combining 5500 – IRS and DOL have been directed to permit a consolidation of Form 5500 reporting for similar plans. Defined contribution plans with the same trustee, same-named fiduciary and same plan administrator using the same plan year and same plan investments may be combined into one 5500 filing. This is scheduled to begin no later than January 1, 2022, for 2021 calendar plan year filings.

What to Do Now

Obviously the SECURE Act is bringing a lot of changes to retirement plans. Many of the operational aspects to this new retirement legislation will need to be implemented immediately, in particular, tax withholding related items that will change in 2020 will necessitate plan sponsors and their recordkeepers act immediately to review tax withholding and distribution processes. Plans do have until the end of the 2022 plan year to adopt conforming amendments to their documents. The amendment deadline is the 2024 plan year for governmental plans.

If you have any questions about the SECURE Act and this new retirement plan legislation we encourage you to contact the Findley consultant you normally work with, or contact John Lucas at 615.665.5329 or John.Lucas@findley.com.

Published December 23, 2019

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Terminating an Overfunded Pension Plan? Who Gets the Excess?

If a single employer overfunded pension plan is terminating and its participants and beneficiaries are on track to receive full benefits, the plan sponsor will likely ask if the excess is theirs. In other words, will the surplus revert to the plan sponsor? The answer is maybe.

To determine how excess plan funds can be exhausted, which may include a reversion to the plan sponsor, there are 7 possibilities to consider. As always, the place to start with any retirement plan issue is to answer the question: what does the plan say?

Terminating an Overfunded Pension Plan

Possibilities to Consider if the Terminating Plan Document does not Permit a Reversion

A plan document may state that no part of the plan’s assets can be diverted for any purpose other than for the exclusive benefit of participants and beneficiaries. The plan may also indicate that the plan cannot be amended to designate any part of the assets to become the employer’s property. If an overfunded pension plan has these provisions, it is tempting to assume the only choice is to allocate the excess among participants and beneficiaries. However, even in the face of these explicit provisions, there may be other provisions that permit an employer to recover or use a portion of the excess assets.

Possibilities 1 and 2 – Return of Mistaken and Nondeductible Contributions

Plan documents generally indicate that if an employer makes an excessive plan contribution due to a mistake, the employer can demand the surplus is returned. The employer is required to request this from the trustee within one year after the contribution was made to the trust. In addition, plans generally provide that a contribution is made on the condition that the employer receives a corresponding tax deduction. In the unlikely event that the deduction is not permitted by the IRS, the contribution can be returned to the employer within one year following the IRS’ final determination that the tax deduction was not allowed.

An example of a contribution mistake may be an actuarial calculation error. In a 2014 Private Letter Ruling, the IRS considered a surplus reversion when a terminating single employer plan purchased an annuity contract. The excess assets were created when the purchase price selected to fully fund plan benefits actually came in at a lower price than estimated. Using reasonable actuarial assumptions, the plan’s actuary had advised the employer to contribute a higher amount than was ultimately calculated as necessary by the insurance company. In this case, the IRS permitted the return of the mistaken excess contribution. 

Possibility 3 – Have all Reasonable Plan Expenses Been Paid from the Trust?

Many plan documents provide that plan expenses can be paid from the trust. In some instances, appropriate and reasonable plan termination expenses will go a long way to exhaust excess assets. Reasonable plan termination expenses include determination letter costs and fees, service provider termination charges and termination implementation charges such as those for the plan audit, preparing and filing annual reports, calculating benefits, and preparing benefit statements.

Possibilities to Consider if the Terminating Plan Document Permits a Reversion

The overfunded pension plan may explicitly state that excess assets, once all of the plan’s obligations to participants and beneficiaries have been satisfied, may revert to the plan sponsor. On the other hand, the plan may not explicitly permit a reversion. In that case, the plan sponsor may want to consider amending the plan to allow a reversion well ahead of the anticipated termination.

Possibilities 4 – Take a Reversion

If the first three possibilities do not work or are inadequate to exhaust the surplus, and the overfunded pension plan allows a reversion, there are three more possibilities. In the first, the employer takes all. The employer can take all of the excess funds back subject to a 50% excise tax, as well as applicable federal tax.  Notably, a not-for-profit organization may not be subject to the excise tax on the reversion at all if it has always been tax-exempt.

Possibility 5  – Transfer the Excess to a Qualified Replacement Plan

The opportunity to pay only a 20% excise tax (and any applicable federal tax) on part of the surplus is available where the remaining excess assets are transferred from the terminating pension plan to a newly implemented or preexisting qualified replacement plan (QRP). A QRP can be any type of qualified retirement plan including a profit sharing plan, 401(k) plan, or money purchase plan. For example, an employer’s or a parent company’s 401(k) plan, whether newly implemented or preexisting, may qualify as a qualified replacement plan.

Once an appropriate plan is chosen, the amount transferred into the QRP must be allocated directly into participant accounts within the year of the transfer or deposited into a suspense account and allocated over seven years, beginning with the year of the transfer.

There are additional requirements for a qualified replacement plan. At least 95% of the active participants from the terminated plan who remain as employees must participate in the QRP. In addition, the employer is required to transfer a minimum of 25% of the surplus into a qualified replacement plan prior to the reversion. If all of the QRP requirements are satisfied, then only the amounts reverted to the employer are subject to a 20% excise tax and federal tax, if applicable. 

Possibility 6 – Provide Pro Rata Benefit Increases

If the employer chooses not to use a QRP, it can still limit the excise tax if it takes back 80% or less of the surplus and provides pro rata or proportionate benefit increases in the accrued benefits of all qualified participants. The amendment to provide the benefit increases must take effect on the plan’s termination date and must benefit all qualified participants. A qualified participant is an active participant, a participant or beneficiary in pay status, or a terminated vested participant whose credited service under the plan ended during the period beginning 3 years before termination date and ending with the date of the final distribution of plan assets. In addition, certain other conditions apply including how much of the increases are allowed to go to participants who are not active.

A Possibility That’s Always Available

Possibility 7 – Allocate all of the Excess Among Participants and Beneficiaries

It is always possible to allocate all of the excess assets among participants in a nondiscriminatory way that meets all applicable law. A plan amendment is necessary to provide for these higher benefits.

You may know at the outset of terminating your plan that there will be excess assets. On the other hand, a surplus may come as a surprise. Even if a pension plan is underfunded at the time the termination process officially begins, it is possible that the plan becomes overfunded during the approximate 12 month time period to terminate the plan. In this scenario, the plan sponsor will have to address what to do with the excess assets.

Dealing with the excess assets in a terminating defined benefit plan can be a challenge. There are traps for the unwary, and considerations beyond the scope of this article. Plan sponsors need to determine first how the excess was created, because the answer to that question may determine what happens to it. If there is no obvious answer in how to deal with the surplus, then the plan sponsor needs to look at all of the possibilities. It may be that a combination of uses for the excess plan assets is best. If you think you will find yourself in this situation with your defined benefit plan, consult your trusted advisors at your earliest opportunity so that you know the possibilities available to you.

Questions? Contact the Findley consultant you normally work with, or contact Sheila Ninnenam at sheila.ninneman@findley.com, 216.875.1927.

Published July 10, 2019

© 2019 Findley. All Rights Reserved.

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December 2018 Wreaks Havoc on Pension Plan Termination Funding – Could It Have Been Avoided?

The last few months once again have shown how volatile pension plan funded status can be. In 2018, leading up to December, many thought that their pension plans were getting closer and closer to being financially ready for a plan termination. Equity markets were seeing high returns and interest rates were on the rise. As a result, most pension plans saw an improvement in funded status.

Then December happened. The markets went south and interest rates took a dive. Plan sponsors that measured the plan’s funded status on December 31 saw a poor financial outcome for 2018. Based on Findley’s December 2018 Pension Indicator, the funded status for a frozen pension plan with a typical equity/fixed income asset portfolio saw a reduction in its funded status of around 6% to 8% from November to December.

However, plan sponsors that started planning for a plan termination in early 2018, and monitored the improving funded status of the plan may have taken some steps to help mitigate the impact of a market downturn. In this case, a plan sponsor which hedged the assets to better match the liabilities prior to December experienced only about a 2% reduction in the plan’s funded status in December.

The lesson is most plan sponsors probably didn’t really know how close (or far) the plan was to being financially ready for a plan termination. And, as the adage goes, “failure to plan is a plan to fail.”

Planning is Fundamental to Success

To help plan sponsors understand this volatility and know how to manage it, Findley has developed a process to help plan sponsors prepare for plan termination. (See Findley’s article “Mapping Your Route to Pension Plan Termination Readiness”). The plan termination process itself requires many steps, but there are also steps that a plan sponsor can take prior to beginning a plan termination to be better prepared. Whether plan termination is only a couple, 5, or 10 years away, planning is critical.

Taking a closer look at plan’s financial readiness, there are a few topics plan sponsors should explore:

  • the plan’s investment strategy,
  • the benefits of de-risking strategies, and
  • a formalized contribution policy.

Reviewing these financial topics early and monitoring them periodically can help plan sponsors achieve plan termination financial goals in a more orderly and predictable way.

Knowing the time horizon, identifying data issues, and reviewing the plan document are other areas to include in your readiness planning. Findley’s Rapid MapTM process helps plan sponsors take a project management approach to all of these aspects of getting ready for a plan termination.

In Perspective

As it turns out, most pension plans rebounded nicely in January and February of this year. So if you are contemplating plan termination, take advantage of this reprieve. Planning early for a plan termination can have a long-term effect on the point in time when your plan is ultimately ready to terminate. Take steps now to put a process in place to regularly monitor your plan’s funded status. Spending time now can reap rewards and potentially mitigate the negative outcomes from future market downturns.

Questions? Contact the Findley consultant you normally work with, or Larry Scherer at Larry.Scherer@findley.com, or 216.875.1920.

Posted on March 12, 2019

© 2019 Findley. All Rights Reserved.

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IRS Announcement May Allow Lump Sum Window for Retirees

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Pension plan sponsors may have a new tool available to use in de-risking their pension plans – paying lump sums to retirees currently in payment status. As with some other de-risking initiatives, a retiree lump sum window could accomplish the reduction in PBGC headcount premiums as well as reduce the size of the plan liability and therefore reduce the risk to the organization.

Through the release of IRS Notice 2019-18 on March 6, 2019, the IRS officially announced that there will be no amendments to the minimum distribution regulations under IRC 401(a)(9) to address the retiree lump sum window concerns raised under Notice 2015-49. In addition, the IRS says that until further guidance is issued, they will not claim that a plan amendment providing for a retiree lump sum window program causes the plan to violate minimum distribution regulations. However, they will continue to evaluate whether such an amendment would cause concerns in regards to other sections of the IRS Code, namely those sections dealing with non-discrimination, vesting, benefit limits, optional forms of payment, and benefit restriction rules.

While IRS Notice 2019-18 does not make the legality of retiree lump sum windows perfectly clear, and the IRS has stated that it will “continue to study the issue of retiree lump sum windows,” plan sponsors interested in possibly utilizing this de-risking technique should discuss the approach with their ERISA counsel and actuary to get a better understanding not only of the legalities, but the advantages and disadvantages associated with the approach. Some of these are listed below.

Advantages and Disadvantages of a
Retiree Lump Sum Window

Advantages

  • PBGC Premium reduction
    • Plan sponsors will save money annually for each retiree that takes a lump sum.
    • Premiums are based on participant counts and depending on the funded status of the plan, plan sponsors could save between $80 and $600 per person each year.
  • May provide positive balance sheet impact
    • In the current interest rate environment, there are many plans where lump sums may be less expensive than current accounting liabilities.
    • End of year funded status may improve as a result of paying out lump sums.
  • PBGC funded status may improve in the current interest rate environment
    • Variable Rate premiums could be reduced.
    • 4010 filing requirements may no longer be required.
  • One step towards full plan termination
    • Lump sums to retirees would reduce the size of the plan and take the plan sponsor one step closer to full plan termination.
  • Reduced administrative expenses
    • Fewer 1099s will need to be distributed.
    • Payment processing fees will decrease.
  • Reduction in headcount may lead to exemption from certain compliance requirements:
    • Control groups below 500 participants are exempt from at-risk provisions of the Internal Revenue Code.
    • PBGC 4010 filing requirements are eliminated if the headcount of the control group falls below 500.
    • A plan audit is no longer required if plan size reduces to less than 100 participants.

Disadvantages

  • Additional pension expense and funding requirements
    • The lump sum window could trigger a one-time additional pension expense in the year lump sums are paid. The amount of expense will depend on the amount of lump sums paid as well as the balance sheet position at the end of the fiscal year.
    • A retiree lump sum window may lower AFTAP funding percentage and lead to increased minimum funding requirements.
  • Increase in volatility
    • Retirees are the most stable group of participants in terms of liability.
    • Removing all or a portion of retirees will make the plan’s liability more unstable and can make it harder for plan sponsors to plan or budget.
  • Plan termination will be more costly
    • Retirees have the least per person cost in an annuity purchase.
    • Annuity providers will charge a higher premium when being offered a plan with a relatively small group of retirees.
    • Many annuity providers will also choose not to bid on plans that have previously offered retirees lump sums.
  • Adverse selection
    • Retirees who opt to take the lump sum are more likely to be in poor health, and more likely to die before their actuarial life expectancy. By taking a lump sum today, they are being paid for future benefits that they might not otherwise survive to receive and therefore the plan could be overpaying this liability.
    • Retirees left in the plan are typically healthier and have a longer payment stream, making the remaining group a more expensive population to fund and later insure.

Another Option

Plan sponsors do not have to offer lump sums to their entire retiree population. This approach allows the plan sponsor to benefit from the advantages described above but also avoids the potential disadvantages. The retiree group can be carefully selected to maximize the results of the window.

Final Thought

Clearly there is a lot to consider and each plan and plan sponsor is different. Therefore it is highly recommended that plan sponsors review their plan with their actuary and ERISA counsel to determine if offering lump sums to retirees is an ideal strategy.

Questions? Contact Wesley Wickenheiser at 502-253-4625, wesley.wickenheiser@findley.com or Amy Gentile at 216-875-1933, amy.gentile@findley.com, or the Findley consultant whom you normally work with.

Posted March 8, 2019

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