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Guest Article

Deloitte logo

(From the April 28, 2008 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

Use of Credit Balance to Satisfy Quarterly Contribution Requirements May Have Unintended Consequences


The Pension Protection Act (PPA) has caused a seismic shift in the way employers plan when and how to fund their defined benefit plans. Prior to PPA, many employers used their defined benefit plan's credit balance as part of that strategy. Employers with credit balances must now adjust their thinking to the new requirements of PPA. In particular, the IRS's proposed regulations on determining minimum required contributions under the PPA rules preclude plan sponsors from temporarily using credit balances to pay their quarterly contributions and later restore those credit balances with contributions for the year -- a common practice prior to the PPA.

Pre-PPA Example

Prior to the Pension Protection Act (PPA), a plan sponsor could make use (temporarily) of a credit balance to satisfy the quarterly contribution requirements, and recoup the credit balance later when contributions are made for the year.

For example, assume that for 2006 the minimum required contribution (not taking into account any credit balance) is $150,000. The plan has a credit balance of $100,000, and quarterly contribution requirements of $25,000 per quarter. (In all examples, for simplification purposes, interest will be ignored.) The plan sponsor could use the credit balance to satisfy all four of the quarterly contribution requirements, and then would be required to contribute at least $50,000 by September 1 5, 2007 to meet the minimum funding requirements. Any contribution made for the year in excess of $50,000 would generate a credit balance. Many plan sponsors desire to maintain the credit balance, and would ultimately make a contribution of $150,000 for the year. In that case they would end the year with a credit balance of $100,000. This result is the same whether they made quarterly contributions of $25,000 per quarter and then contributed $50,000 by September 15, 2007, or if they utilized their credit balance to satisfy the quarterly contributions and made a contribution of $150,000 by September 15, 2007.

PPA Issues

Under PPA the results are different.

The prefunding balance accumulates contributions made in excess of the minimum required amount. Specifically, the plan sponsor can elect to increase the prefunding balance by an amount not more than the excess of the contributions for the year (discounted back to the valuation date using the effective interest rate) over the minimum required contribution for the year (determined without regard to any election to offset the minimum required contribution by any available credit balance). (IRC §430((f)(6)(B)(i) and Prop. Treas. Reg. § 1.430(f)-1(b)(1)(ii)(B).)

Using the numbers in the example, $150,000 was contributed for the year and the minimum contribution for the year is $150,000. There will be no addition to the prefunding balance for the year. This is the case even if a credit balance is used to satisfy part of the minimum required contribution. Cash contributions made for the year in excess of $150,000 can be used to increase the prefunding balance.

Whereas prior to PPA the ultimate credit balance was not dependent on whether or not the plan sponsor temporarily used the existing credit balance to satisfy quarterly contribution requirements, under PPA it is vitally important.

For example, assume that for 2008 the minimum required contribution (not taking into account any credit balance) is $150,000. The plan has a funding standard carryover balance of $100,000, no prefunding balance, and quarterly contribution requirements of $25,000 per quarter. In case 1 the plan sponsor makes quarterly contributions of $25,000 each quarter and a final contribution of $50,000 by September 15, 2009. The funding standard carryover balance of $100,000 is maintained (and adjusted with interest for the year), and no addition to the prefunding balance is permitted.

In case 2 the plan sponsor elects to use the funding standard carryover balance to satisfy the quarterly contribution requirements, and makes a contribution of $150,000 by September 15, 2009. In this case, there is still no addition to the prefunding balance. In addition, the plan sponsor used the entirety of the funding standard carryover balance to satisfy quarterly contribution requirements, so that the funding standard carryover balance is reduced to zero. This result is different than the pre-PPA scenario, andmay be troubling to many plan sponsors.

The IRS's proposed regulations require the plan sponsor to elect to use the credit balance to satisfy a quarterly contribution requirement. The preamble to the proposed regulations asks for comments on whether rules should be provided under which a plan sponsor is deemed to make an election to use a credit balance to the extent available to avoid a failure to make a required quarterly contribution.

Many companies did not make a cash contribution to their plan on April 15, 2008, and instead relied on their credit balance to satisfy the quarterly requirement. Many have done so without the benefit of a written election. (The lack of a written election may not be an issue in 2008 based on good faith compliance and the fact that the proposed regulations are not effective until 2009.) These sponsors may have unwittingly used part of their funding standard carryover balance when they did not intend to.

Conclusion

In this year of transition into the new world of PPA, plan sponsors need to be wary of following the status-quo and consult with their advisors.


Deloitte logoThe information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.

If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595, Deborah Walker 202.879.4955.

Copyright 2008, Deloitte.


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