Proposed legislation, Retirement Protection Act of 1993. (Employee Benefit Plans)by Ellner, Steven H.
It is expected that this legislative proposal will not be addressed until later in 1994, as health care reform now appears to be Congress' primary focus. Nevertheless, employers need to carefully analyze the effect of this proposed legislation upon their qualified plans, particularly defined benefit plans that are not fully funded and defined contribution plans using cross-testing (i.e., age-weighted allocations) under the non-discrimination rules.
Elimination of Age-Weighted Profit Sharing Plans
The IRC provides that the contributions or benefits provided under a plan may not discriminate in favor of highly compensated employees. Department of Treasury regulations specify how this qualification requirement may be met by defined benefit and defined contribution plans, by permitting that a plan may b "cross-tested" to determine whether it is discriminatory. Thus, a defined benefit plan may be tested on the basis of equivalent contributions, and a defined contribution plan may be tested on the basis of equivalent benefits. In a traditional profit sharing plan, contributions are allocated to each participant's accounts on the basis of a uniform percentage of compensation. In an age-weighted profit sharing plan, contributions generally are made on the basis of compensation and age. Thus, contributions increase as a participant's age and compensation rise. Some age-weighted plans also take into account years of service in the allocation of employer contributions.
Accordingly, these profit sharing plans often permit significantly greater contributions to be made annually (as a percentage of compensation) on behalf o older highly compensated individuals then on behalf of younger, lower-paid individuals, without the traditional employee protection provided by defined benefit plans. The Act eliminates the ability of defined contribution plans (other than certain target benefit plans) to satisfy the non-discrimination requirements by cross-testing on a benefits basis. Target benefit plans may continue to cross-test provided these plans satisfy the safe harbor provided in the Treasury regulations.
New Minimum Funding Rules
The Act would increase the minimum contribution requirement for many underfunde plans and would minimize the ability for employers to select interest and mortality assumptions for purposes of calculating the minimum contribution. To insure that underfunded plans are able to meet their benefit obligations, the Act would also require underfunded plans to maintain cash and marketable securities equal to approximately three years' worth of benefit payments and other expenses, based upon disbursements made by the plan during the prior 12-month period. If the plan does not have sufficient liquid assets, the employer would be required to make quarterly "solvency payments" to bring plan assets up to the required liquidity level.
If an employer fails to make a quarterly solvency payment, the Act would impose a 10% excise tax for each quarter the solvency payment is outstanding. If the required solvency payment is not made for four quarters, the employer would be subject to a 100% excise tax. In addition, the Act would require that benefit payments under the plan be reduced until the solvency payment is made. Under this provision, the plan would be prohibited from making benefit payments in excess of the amount payable under a straight life annuity (plus any Social Security supplements) until the solvency payments are made. These new minimum funding rules would generally go into effect beginning with the 1995 plan year. However, a transitional rule would phase in the new minimum contribution to protect employers from disproportionately large increases in required contributions.
New Disclosure Requirement to Participants for Underfunded Plans
The Act would impose a new annual reporting requirement on sponsors with certai underfunded plans to provide the PBGC with information on the financial condition of their plans. The notice requirement would apply if a) the total unfunded vested benefits under all underfunded plans of the controlled group exceed $50,000,000, b) missed funding contributions exceed $1,000,000, or c) minimum funding waivers in excess of $1,000,000 had been granted and any portio is outstanding.
The Act would also create four new reportable events designed to provide PBGC with notice of events that could threaten a plan's funding or viability. These disclosure requirements are generally effective as of the date of enactment. However, the new reportable event requirements would be effective for events occurring 60 days after the date of enactment.
Increased Premiums for Underfunded Plans
The variable rate premium, which applies to underfunded defined benefit plans, is currently $9 per $1,000 of underfunding and is capped at $53 per participant The Act would phase out the cap on the variable premium over a three-year period, beginning with plan years commencing on or after July 1, 1994. Accordingly, the elimination of the cap on the variable PBGC premium, along wit the accelerated requirements and quarterly solvency payment, could make it very expensive for companies maintaining underfunded plans.
Modification of Quarterly Contribution Requirement
The IRC requires a defined benefit plan to pay quarterly installments of its estimated funding obligation for a plan year, often before the actual amount of this obligation for the year is determined. For certain well funded plans, thes quarterly payments may later be found to exceed the plan's full funding limit. Contributions exceeding this limit are non-deductible and subject to the 10% excise tax under the code. The Act would repeal the quarterly contribution requirement for a plan year for plans that are fully funded for current liability for the preceding year. This change would be effective for plan years beginning after the date of enactment. This relief would be felt by those employers who often contribute too much on a quarterly basis and are then force to request a ruling from the IRS to obtain a refund of the non-deductible contributions made to the plan to avoid the imposition of an excise tax.
Interest Rate and Mortality Assumptions
Under current law, lump-sum payments under a defined benefit plan must be calculated using an interest rate no greater than the applicable PBGC rate (or 120% of the applicable PBGC rate if the lump sum exceeds $25,000). Any reasonable mortality table may be used. The Act would amend the interest rate restrictions and would require the use of a particular mortality table in determining lump sums under a defined benefit plan. The use of the new interest assumptions rather than the PBGC rates would generally result in smaller lump sum payments to participants.
Exceptions to 10% Excise Tax on Non-Deductible Contributions
To encourage small employers to fully fund their benefit liabilities upon plan termination, the Act would eliminate, in certain cases, the 10% excise tax for terminating plans (with less than 100 participants) where non-deductible contributions are required to fully fund termination liabilities. This provisio would be effected for taxable years ending on or after the date of enactment.
The Act would also eliminate the 10% excise tax on certain contributions that are non-deductible solely because of the combined deduction limit applicable to defined contribution and defined benefit plans. Under the combined deduction limits, aggregate contributions to both a defined contribution and defined benefit plan generally may only be deducted up to 25% of compensation. Because of the combined deduction limits, employers are often hesitant to maximize thei contributions to a defined benefit plan because of the possibility that 401(k) elective deferrals or employer matching contributions may not be deductible and be subject to the 10% excise tax. To encourage better funding of defined benefi plans, the Act eliminates the 10% non-deductible contribution excise tax for said deferrals and matching contributions, up to 6% of total compensation, that are non-deductible as a result of the combined deduction limits. This provision would be effective for taxable years ending on or after December 31, 1992.
Cost of Living Adjustments
The Act would also modify the annual cost of living adjustments to the limits o contributions and benefits and to the 401(k) elective deferral limits. Under this provision, the $90,000 defined benefit and $30,000 defined contribution dollar limits under the IRC would be indexed in $5,000 increments, and the $7,000 limit on 401(k) elective deferrals would be indexed in $500 increments. For example, if this provision were to become effective in 1994, the limit on 401(k) elective deferrals, which is expected to exceed $9,000, would be held at $9,000 until the indexed amount would otherwise exceed $9,500.
When a plan is terminated, it is often difficult to protect the rights of missing participants. Under the Act, a new procedure would be established for dealing with missing participants in a defined benefit plan undergoing a standard termination. Under this new procedure, the "designated benefit" of eac missing participant upon plan termination, for whom an annuity has not been purchased, would be transferred to the PBGC. Employers would be required to mak a diligent search for participants prior to transferring benefits to the PBGC. If the missing participant is subsequently located, the PBGC would pay the participant his or her benefit in the form required under the plan. This procedure would become effective upon the issuance of regulations by the PBGC implementing this program.
The Act would amend the IRC to provide an exception from the spousal consent an anti-cutback requirements for benefits of missing participants that are transferred to the PBGC upon plan termination. It is nevertheless unclear what happens to the amounts transferred to the PBGC if the missing participants does not come forward to claim his or her benefit. In addition, the provision only applies to defined benefit plans undergoing a standard termination, and therefore the missing participant problem continues to exist for terminating defined contribution plans.
Amendments to Increase Benefits
The Act would require employers to recognize immediately, for funding purposes, any benefit increases that have been negotiated under a collective bargaining agreement that have not yet become effective. Under current law, employers are permitted but not required to recognize these benefit increases immediately. Th provision would be effective for plan years beginning in 1995. The new rules would apply to increases that become effective in 1995 even if they are negotiating prior to the effective date. Furthermore, the Act would prohibit a company in bankruptcy from adopting a plan amendment to increase benefits if that amendment would cause the plan to be underfunded, unless the benefit increase does not become effective until after the company emerges from bankruptcy. This restriction will not apply to amendments needed to meet qualification requirements or to amendments adopted prior to bankruptcy. Thus, the Act does not prohibit the amendment of underfunded plans to provide improve benefits for participants (unless the sponsoring employer is in bankruptcy). This provision would be effective for plan amendments adopted on or after the date of enactment.
Strengthening PBGC Compliance Authority
The Act would strengthen the PBGC's enforcement position against underfunded plans. Under the Act, the PBGC would have the authority to bring a civil action to enforce the minimum funding standards when missed contributions exceed $1,000,000. Further, the Act would impose joint and several liability upon contributing employers (and controlled group members) that are being liquidated for their share of the plan's underfunded liabilities, as if the plan were terminated on the date the liquidation was initiated. The claim can be asserted by the plan, but any amounts collected by the PBGC would have to be paid to the plan.
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