The Pension Protection
Act of 2006 (PPA), which fundamentally changed the funding of
defined benefit plans, was signed into law about three years ago.
Guidance needed to interpret this new law has trickled in over these
three years.
This newsletter summarizes the recent guidance that we have
received regarding PPA as well as some potential strategies for
addressing the increased costs for the 2009 year brought about by
the adverse market conditions. Further, PPA has imposed additional
requirements with respect to defined benefit plan documents and
participant notices which will also be reviewed.
2009 Funding Requirements
PPA changed the interest rates used to determine plan costs and
limited flexibility in determining the actuarial value of plan
assets. Under PPA, interest rates used to determine a plan's funding
requirement must be a function of corporate bond interest rates, and
the actuarial value of plan assets may not be less than 90% nor more
than 110% of the market value of plan assets.
Typically, the 2008 actuarial valuation of a defined benefit plan
determined the plan's funding requirement based on three interest
rate segments (based on a 24-month average of corporate bond rates).
The corporate bond rates used to determine the segmented interest
rates steadily climbed during most of 2008. Simultaneously, many
defined benefit plan sponsors suffered in light of current economic
conditions and sought to limit their funding requirement for 2009.
One approach many practitioners consider is a switch in the basis
for determining interest rates for funding purposes to what is known
as the "yield curve." Unlike the above-mentioned segment rates,
corporate bond rates are not averaged in determining the underlying
interest rates of the yield curve. Therefore, switching to the yield
curve would allow plan sponsors to take advantage of the funding
reductions associated with the run up in the 2008 corporate bond
rates.
However, PPA requires IRS approval to switch from the segmented
interest rates used in 2008 to the yield curve in 2009. Recognizing
this problem, the IRS stated in March that final regulations will
indicate that any change in the determination of interest rates used
for 2009 funding purposes will be automatically approved.
The determination of the actuarial value of plan assets for
funding purposes experienced similar issues. A typical defined
benefit plan used the market value of plan assets to determine the
2008 funding requirements. Due to the severe declines in the
financial markets during 2008, the use of the plan's market value of
assets to determine 2009 funding requirements will lead to a
significant cost increase.
For 2009 valuation dates, switching to an average asset value
will often result in an actuarial value of plan assets that is 110%
of the market value of the assets. Once again, PPA required IRS
approval to switch from a market value of plan assets to an average
asset value. However, relief found in IRS Notice 2009-22 stated that
such a change in the determination of the actuarial value of plan
assets will receive automatic approval.
Market declines have led to increased funding requirements in
2009 in an economic environment that requires employers to minimize
expenditures wherever possible. In light of these economic times,
defined benefit sponsors could look to take advantage of the relief
that is available in changing the basis of their funding interest
rates and the determination of the actuarial value of plan assets to
help mitigate the impact of the difficult economic conditions.
PPA Plan Amendment
PPA changes many of the rules associated with the plan funding,
plan operations and potential benefit restrictions due to a plan's
funded status. A sponsor of a defined benefit plan has been required
to operate in compliance with PPA rules but was not required to
amend its plan document until the end of the 2009 plan year. As this
deadline is rapidly approaching, below is a description of many of
the issues that need to be addressed in the PPA plan amendment.
Actuarial Assumptions for Lump Sum
Distributions
Commencing with the 2008 plan year, lump sum distributions from
defined benefit plans must be based on prevailing corporate bond
rates. However, prior to PPA, lump sum benefits were determined
based on 30-year Treasury rates. In order to ease the impact of the
change in the basis for lump sum determination, there is a
transition period from 2008 through 2011 where lump sum
distributions are based on a combination of the prevailing corporate
bond and 30-year Treasury rates.
Qualified Optional Survivor Annuity
Generally, defined benefit plans must offer plan benefits in the
form of an annuity. If a participant is married, a joint and
survivor annuity must be offered as a benefit option. Prior to PPA,
a plan was only required to offer a single form of joint and
survivor annuity (typically a joint and 50% survivor benefit). PPA
requires an optional survivor annuity form in addition to the
pre-PPA requirements.
Non-Spouse Beneficiary Rollovers
Commencing with distribution after December 31, 2006, PPA allows
non-spouse beneficiaries of tax-qualified retirement plans to roll
over distributions to an IRA. This was originally a voluntary
feature that will become mandatory for distributions occurring after
December 31, 2009.
Notice and Election Period Extended
Upon becoming eligible to receive plan benefits, a defined
benefit plan was permitted to notify plan participants of their
benefit options and elect their form of benefit up to 90 days prior
to the benefit commencement date. Commencing with plan years after
December 31, 2006, PPA allows a defined benefit plan to voluntarily
extend the election period to 180 days.
Age 62 In-Service Distributions
Commencing for plan years after December 31, 2006, PPA allows a
defined benefit plan to make distributions to participants that have
reached age 62 even if they are still employed by the plan sponsor.
Such a feature may be voluntarily elected by a defined benefit plan
sponsor.
Benefit Restrictions
If a defined benefit plan's funded status falls below 80%, the
plan may be subject to a funding-based benefit restriction. This
restriction, which became effective for plan years beginning in
2008, must be detailed in the terms of the plan document.
Normal Retirement Age
In 2007, the IRS issued regulations and subsequent guidance
regarding the definition of a reasonable normal retirement age.
These rules have particular importance because a defined benefit
plan is permitted to make a distribution to a participant who has
reached the plan's normal retirement age even though such a
participant remains actively employed.
In order to take advantage of this rule, plans were established
using a very low normal retirement age so that participants could
take out a lump sum benefit (determined based on plan defined
actuarial assumptions). Upon receipt of the lump sum, the benefit
was then rolled over to an IRA or 401(k) plan that allowed the
participant to direct how the lump sum benefit was invested.
In order to prevent such arrangements, the final regulations and
subsequent guidance basically state that, if a plan uses a normal
retirement age prior to age 65, it must be reasonably representative
of the typical retirement age for the industry in which the covered
workforce is employed.
A normal retirement age between the age of 62 and 65 is deemed to
be reasonable. According to the guidance, deference is given to a
plan using a retirement age between 55 and 62 assuming it is
reasonable under the facts and circumstances. In practice, the IRS
has not necessarily been showing deference to plans using a normal
retirement age between ages 55 and 62. In these cases, they have
been asking for data substantiating the plan's defined normal
retirement age. Such data is very difficult to provide for a small
retirement plan that has limited data regarding the age of the
employer's typical retiree.
Generally, a defined benefit plan can be amended to comply with
the 2007 normal retirement age regulations. Such an amendment must
be adopted by the later of the end of the first plan year beginning
after June 30, 2008 or the due date for filing the employer’s tax
return for the employer’s taxable year that includes the first day
of the plan year beginning after June 30, 2008.
The IRS is closely scrutinizing plans that use a normal
retirement age between the ages of 55 and 62. Without obtaining a
determination letter that approves the use of such retirement age, a
plan’s qualified status could be jeopardized.
Reporting Requirements
Missed Quarterly Contributions
Generally, the Pension Benefit Guaranty Corporation (PBGC) must
be informed whenever a minimum funding obligation is not met. A
failure to make a plan's required quarterly contribution on a timely
basis is considered to be such a failure. Historically, the PBGC
waived this requirement for a plan with less than 100 participants.
However, the PBGC eliminated this waiver for plan years commencing
in 2009.
After an outcry from practitioners and plan sponsors, the PBGC
issued limited relief from the requirement that they must be
notified each time a plan sponsor fails to make a required quarterly
contribution. This relief is only provided if the plan sponsor paid
the PBGC flat rate premium in 2008 and the financial inability of
the plan sponsor to make the contribution is not the reason for the
missed quarterly contribution.
The relief also applies to plans with 25 to 99 participants. Such
plans only have to inform the PBGC of their first failure to make
the required quarterly contribution on a timely basis.
Annual Funding Notice
Defined benefit plans that are covered by the PBGC's insurance
program have a new notice requirement commencing with the 2008 year.
The new notice brought about by PPA is known as the Annual Funding
Notice and replaces the Summary Annual Report. The purpose of this
new notice is to provide plan participants with additional
information regarding a defined benefit plan's funded status. The
new notice must provide information regarding:
- The plan's funding policy;
- The plan's asset allocation;
- A general description of benefits eligible to be guaranteed by
PBGC;
- Statement of right to obtain copy of Form 5500 on request;
- Impact of plan amendments;
- Specific information regarding the plan's funded status; and
- Summary of rules regarding a plan termination.
The notice must be provided no later than 120 days after the end
of a plan year if the plan has at least 100 participants. For plans
with less than 100 participants, the notice must be provided no
later than the date the plan sponsor files its Form 5500.
Conclusion
PPA has changed life significantly for sponsors of defined
benefit plans. There have been dramatic changes to the funding
requirements which can create burdens on plan sponsors during
difficult economic conditions. Plan sponsors need to work closely
with their advisors to ensure that appropriate funding techniques
are being utilized, the plan is timely amended and new notice
requirements are being satisfied.
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