Beginning January 1, 2008, new funding requirements enacted as part of the Pension Protection Act of 2006 (PPA) will apply to defined benefit pension plans.

The Big Picture

These new rules will require all plan sponsors, including those who have frozen plans or who have closed their plans to new hires, to:

  • fund their plans at a higher level over a shorter period of time; and
  • deal with greater volatility of plan asset values and interest rates.

Certain underfunded plans will be subject to additional requirements and restrictions, including:

  • higher funding requirements;
  • restrictions on providing additional benefits;
  • inability to reduce required minimum contributions by credit balances from past overfunding;
  • restrictions on lump sum payouts; and
  • tax sanctions for top executives if assets are set aside to fund non-qualified deferred compensation.

In late August 2007, the Internal Revenue Service (IRS) issued the second in a planned set of proposed regulations interpreting these new funding requirements. Further guidance is anticipated.

How These Changes May Affect You

The impact of these new rules could be sufficient to change your plan from one that is considered well-funded to one that is considered underfunded. If your plan is underfunded, you will have the option of making additional contributions to avoid benefit restrictions that otherwise would be applicable.

In addition, presumptions contained in the regulations could require your plan to be treated as if it were subject to the benefit restrictions if your actuary misses certain deadlines for certifying the plan’s funding percentage, even if the plan is not actually underfunded. On the other hand, an optional decision, such as choosing to reduce available credit balances, might improve your plan’s funded status.

Action Plan

To avoid unpleasant surprises and unanticipated cash flow requirements, we recommend that sponsors of defined benefit plans review with their actuaries the impact of the new funding requirements, the deadlines for certifications and any available elections if they have not already done so. Consider whether to make additional contributions or amendments that would impact future plan funding requirements, whether short- or long-term, such as reducing future benefits, freezing accruals, cutting off new entrants, or merging plans with better funded plans.

Plan sponsors and their actuaries should prepare to meet impending deadlines for certifying a plan’s funding percentage to keep funding presumptions from taking effect. Presumptions will apply if the actuary has not certified the 2007 funding percentage before the beginning of the 2008 plan year, and also if certain plans have not obtained a 2008 certification by April 1, 2008.

If Your Plan is Frozen

If your plan is frozen, participants do not earn new benefits, but your plan remains subject to the funding and qualification requirements until it is terminated and participants are paid out. You may also want to explore with your advisers both the cost of terminating the plan completely, including by purchasing annuities from an insurance company, and the way any lump sum payouts must be calculated.

Will There Be More Time To Comply?

We cannot know at this time whether compliance deadlines will be extended. The IRS has been asked to extend compliance deadlines for plan sponsors, but has not indicated an intention to do so. Plan sponsors should exercise prudence and plan for compliance without assuming that any extended time for compliance will be available.