On October 15, 2009, the Internal Revenue Service published final regulations construing the new funding and benefit restriction requirements applicable to single employer defined benefit plans for plan years beginning after December 31, 2009, under Internal Revenue Code (“Code”) sections 430 and 436. Code sections 430 and 436 were added by the Pension Protection Act of 2006 (“PPA”) as amended by the Worker, Retiree, and Employer Recovery Act of 2008 (“WRERA”). This article highlights some of the key provisions of the final regulations governing the benefit restriction provisions of Code section 436. This article does not describe the impact of the final regulations on the minimum funding requirements of Code section 430.
The Pension Protection Act of 2006 added Code sections 430 and 436. Code section 430 provides employers with minimum funding requirements applicable to their single employer defined benefit pension plans. Code section 436 limits the benefits (e.g. benefit accruals and certain benefit forms) if a single employer defined benefit plan is underfunded by more than certain specified percentages. The restrictions that apply are determined by the plan’s Adjusted Funding Target Attainment Percentage (“AFTAP”) and are generally summarized as follows:
- An amendment to increase benefits cannot take effect if a plan’s AFTAP is less than 80%, or would be less than 80% taking into account the amendment.
- If a plan’s AFTAP is less than 80% but at least 60%, the maximum amount the plan may pay as an accelerated benefit (such as a lump sum) or use to purchase an annuity as an irrevocable commitment to provide benefits is the lesser of:
- 50% of a lump sum benefit: or
- the lump sum value of the PBGC guaranteed benefit.
Payments to a participant, an alternate payee and a beneficiary receiving benefits on the participant’s behalf are aggregated for this purpose.
- A plan cannot pay benefits in an accelerated form (such as lump sum) or purchase an annuity as an irrevocable commitment to provide benefits if the plan’s AFTAP is either less than 60%, or less than 100% if the employer is in bankruptcy.
- A plan cannot pay shutdown or other unpredictable contingent event benefits if the plan’s AFTAP is less than 60%, or would be less than 60% taking into account the occurrence of the event.
- If a plan’s AFTAP is less than 60%, benefit accruals cease unless the employer contributes an amount sufficient to increase funding to 60%, in addition to the minimum required contribution for the year.
For purposes of these rules, the AFTAP of the plan is generally based on the ratio of plan assets (reduced by credit balances) to the funding target for the year, as determined under the general rules for funding, not the at-risk rules.
The IRS issued proposed regulations on August 28, 2007, providing guidance on these restrictions. The final regulations are similar to the proposed regulations, but make some important changes.
Key Provisions of the Final Regulations
The guidance provided by the final regulations includes the following:
- Code section 436(g) provides that the limitations of Code section 436 (with the exception of the limitation on accelerated benefit payments) do not apply to a plan during its first five years. In determining whether a plan is in its first five years, plan years include plan years when the plan was maintained by a predecessor employer, as well as plan years of another defined benefit plan maintained by the current or a predecessor employer within the preceding five years (if any participants in the plan participated in the other defined benefit plan).
- The limitation under Code section 436(d) (limitation on accelerated benefit payments) will not be applied to prohibited payments made to carry out the termination of a plan in accordance with applicable law. For example, a plan sponsor’s purchase of an irrevocable commitment from an insurer to pay benefit liabilities in connection with a standard plan termination is not prohibited by Code section 436(d).
- In the case of a multiple employer plan to which Code section 413(c)(4)(A) applies, the rules under the final regulations apply separately with respect to each employer under the plan, as if each employer maintained a separate plan. As a result, the benefit limitations under Code section 436 can apply differently to employees of the separate employers under the multiple employer plan. If Code section 413(c)(4)(A) does not apply, the final regulations apply as if all participants in the plan are employed by a single employer.
- If a plan provides for a restoration of benefit accruals for the period of the limitation, the plan is generally treated as having adopted an amendment that has the effect of increasing liabilities under the plan, requiring a determination of whether such restoration of benefits is permitted under the Code section 436 limitation. The proposed regulations provided an exception to this rule if the period of the limitation is less than 12 months. This exception is maintained in the final regulations, but is clarified to be available only if the plan’s AFTAP would be at least 60% taking into account the restored accruals.
- If a plan amendment does not go into effect as of the effective date of an amendment because of the limitations of Code section 436(c) (limitation on plan amendments increasing liability for benefits), but is permitted to go into effect later in the plan year as a result of either additional contributions that satisfy the requirements of Code section 436(c)(2) or a certification of the AFTAP for the plan year, then the plan amendment must automatically take effect as of the first day of the plan year, or the enactment date of the amendment, whichever is later.
- For purposes of the deemed election to reduce the prefunding balance or funding carryover balance applicable to collectively bargained plans, the definition of collectively bargained plan is expanded to include plans where at least 50% of the employees benefiting under the plan are members of collective bargaining units for which the benefit levels under the plan are specified under a collective bargaining agreement.
- The rules regarding the limitations on unpredictable contingent event benefits are clarified to provide that they apply on a participant-by-participant basis (i.e. whether the participant satisfies the plan’s eligibility requirements for such a benefit) and to provide that if the benefit depends on the occurrence of more than one unpredictable contingent event, the event for purposes of the limitation occurs on the last of those events.
- For purposes of Code section 436(c) (limitation on plan amendments increasing liability for benefits), in the case of an amendment that increases benefits, the amendment takes effect on the first day that any participant or beneficiary has a legal right to the increased benefit. Therefore, if an amendment is adopted in a prior plan year but a participant does not have a legal right to the increased benefit until a subsequent plan year, whether the limitation applies is determined with respect to the subsequent year.
- For a participant whose benefit form is restricted due to the limitation of Code section 436(d), the plan is not required to provide such participant with the right to defer commencement of his or her benefit until the limitation period ends unless such deferral right is permitted by the plan and the applicable qualification requirements of the Code (such as Code section 401(a)(9)). However, a plan can offer special optional forms of benefit during the limitation period. For example, a plan may permit a participant who commences benefits during this period to elect, within a specified period after the date on which the limitation period ends, to receive the remaining benefits in the form of lump sum payment equal to the present value of the remaining benefit.
- The definition of “prohibited payment” includes any transfer of assets and liabilities to another plan maintained by the same employer (or member of its controlled group) that is made in order to avoid the application of the Code section 436 benefit limitations.
- Rules relating to techniques a plan sponsor may use to avoid the benefit limitations are described and include making additional contributions (either increasing the annual funding contribution or making a special contribution in accordance with the rules under Code section 436), reducing the funding standard carryover balance and prefunding balance, and providing security to the plan as described in Code section 436(f)(1).
- As an alternative to certifying a specific number for the plan’s AFTAP, an enrolled actuary is permitted to certify during the first 9 months of a plan year that the plan’s AFTAP for that year is within a percentage range that is either:
- 60% or higher, but less than 80%;
- 80% or higher; or
- 100% or higher.
If a timely range certification is filed, a specific AFTAP is permitted to be certified at any time prior to the end of a plan year. However, if not certified by the end of the plan year, the AFTAP is retroactively deemed to be less than 60% as of the first day of the tenth month of the plan year. The permissible range certifications also were expanded to include a range below 60%.
The final regulations under Code section 436 apply to plan years beginning on or after January 1, 2010. For plan years beginning before January 1, 2010, plans are permitted to rely on the provisions set forth either in the final regulations or in the proposed regulations.
The final regulations provide important clarification and guidance on the benefit restriction provisions of Code section 436. Plan amendments reflecting Code section 436 are due by the end of 2009 plan year (December 31, 2009 for calendar year plans). We also note that subsequent to the issuance of the final regulations, the IRS stated that it will soon be issuing additional regulations (in proposed form) that will address items not addressed in the existing final regulations. We will keep you apprised of the issuance of any additional regulations under Code section 436. Please contact us if you have any questions on the final regulations, or on what plan amendments may be required before the end of the 2009 plan year.