The Pension Protection Act of 2006 (the “PPA”) imposes many requirements in order to strengthen the funding levels of defined benefit plans. As a result, sponsors of significantly underfunded pension plans (starting at 80 percent funding) may be precluded from amending a plan to increase benefits; may not make lump sum or other payments of more than the single life annuity amount; and are prohibited from “funding” non-qualified deferred compensation plans for the top five officers and certain other key employees.

Because of recent economic events, many defined benefit plans are now severely underfunded and subject to these restrictions. While there have been increasing calls for Congress to grant relief, such plans must now consider how the PPA’s benefit restrictions may impact their defined benefit plans, as well as their ability to “fund” their non-qualified deferred compensation plans.

While the severe benefit restrictions apply to plans with an “AFTAP” (adjusted funding target attainment percentage) of less than 60 percent, substantial benefit restrictions also apply to plans with an AFTAP of between 60 and 80 percent, as well as “at risk” defined benefit plans.

Additionally, sponsors must send timely notices to participants explaining the relevant funding status and restrictions, when they apply.

The determination of current AFTAP and “at risk” status is complex, and sponsors must work with the plan actuary to determine when the restrictions apply.

Here is a brief summary of the restrictions that apply to various underfunded percentages.

Plan sponsors should immediately:

  • Review their plan’s AFTAP and “at risk” limitations, as applicable, with their actuary 
  • Discuss the consequences of their plan’s funding level with their legal counsel and the plan’s actuary, including possible benefit restrictions that may apply to the defined benefit plan and funding restrictions that may apply to non-qualified deferred compensation plans, as well as any necessary participant notices 
  • Consider whether they may implement strategies to avoid the benefit and funding restrictions, and how potential benefit restrictions may affect collectively bargained benefit plans

Although these benefit and funding restrictions have generally been in effect since 2007 and/or 2008 (with certain delayed effective dates for collectively bargained plans), the restrictions become more relevant as the funding methodology/phase-in period of PPA matures, and as pension plans are experiencing record levels of underfunding as a result of recent market declines.