Guest Article

(From the January 12, 2009 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

PPA Technical Corrections Affecting Defined Benefit Plans

On December 23rd, President Bush signed the Worker, Retiree and Employer Recovery Act (WRERA). WRERA contained many provisions designed to provide relief in light of the recent market declines, and also included a number of technical corrections to the Pension Protection Act of 2006 ("PPA").

A comprehensive article discussing the "bailout"-related provisions of WRERA and PPA technical corrections related to individuals and defined contribution plans was published in the December 22, 2008 edition of Washington Bulletin. This article is focused on technical corrections that relate to defined benefit plans. These technical corrections are discussed in more detail below.

Funding Rules

PPA completely overhauled the way in which minimum funding requirements for defined benefit plans are calculated. The old "funding standard account", with its varying amortization periods for plan amendments, experience gains and losses, etc., was replaced by a system that focuses on plan solvency: Contributions each year must at least equal the cost of benefits accruing during that year (the "target normal cost") plus the amount necessary to amortize any beginning-of-year funding shortfall over a period of roughly seven years. Poorly funded plans that meet "at-risk" criteria are subject to accelerated funding requirements. WRERA corrects a few problems with the PPA provisions and adds some refinements:

Deduction Rules

WRERA reverses the position taken by the IRS in Notice 2007-28, which held that the deduction limitations of IRC §404(a)(7), as revised by PPA, apply whenever an employer contributes to both a defined benefit and a defined contribution plan (unless the latter includes only elective deferrals). The effect of the IRS' position in Notice 2007-28 was to make PPA's expanded deduction limitation for 2007 worthless to most employers, as IRC §404(a)(7) overrode it. /2/ Under pressure from key Members of Congress and in anticipation of corrective legislation, the IRS ultimately announced it would not enforce the position it took in Notice 2007-28.

Restrictions on Distributions from Underfunded Plans

PPA imposed restrictions on lump sum distributions, benefit increases and continued benefit accrual under poorly funded defined benefit plans. If a plan's funding level is below 80 percent, it may not be amended to increase benefits or to add new benefits, and its ability to make lump sum distributions or any other accelerated form of payment is limited. If its funding level is below 60 percent, it is also prohibited from paying shut down or other unpredictable contingent event benefits and from making any accelerated form of benefit distribution, and all benefit accruals must cease. Employers may avoid these restrictions by making contributions (or providing security to the plan) sufficient to bring funding above the pertinent threshold or to offset a benefit increase. WRERA makes a few corrections to these rules:

Calculation of Limitations on Lump Sum Distributions

Section 415(b) limits the benefits that a defined benefit plan may pay to any participant. The limitations are defined in terms of a life annuity beginning at any age between 62 and 65. When benefits are paid in a different form, the limitation must be converted to that form using prescribed actuarial assumptions. PPA provided that the mortality assumptions used in IRC §415(b) calculations would be based on the Commissioners' standard table for determining reserves under group annuity contracts (IRC §807(d)(5)(A)). WRERA substitutes the table used for converting benefit accruals to lump sums under IRC §417(e). This change is mandatory beginning in 2009 and may be adopted voluntarily before then.

Cash Balance Plans

PPA included a number of provisions to clarify the status of so-called "hybrid" pension plans. These include "cash balance plans" - plans that are technically defined benefit plans, but resemble defined contribution plans because each participant's accrued benefit is expressed as a balance of a hypothetical account which is credited with a set amount per year (typically expressed as a percentage of the individual's compensation for the year), plus an interest credit.

PPA addressed a number of issues related to cash balance plans, including age discrimination, conversions of traditional defined benefit plans to cash balance plans, and the so-called "whipsaw" effect, under which, in certain circumstances, a plan could be required to distribute more than the hypothetical balance in the participant's account.

WRERA makes a few revisions to the rules related to cash balance and other hybrid plans:

/1/ Reasonable administrative expenses may be paid from plan assets, if the plan permits it. The determination of whether an expense is a "plan administrative expense" and whether the amount is reasonable is subject to the fiduciary rules under Title I of ERISA.

/2/ Starting in 2008, plans insured by the Pension Benefit Guaranty Corporation (almost all plans except those maintained by governments, churches and small professional firms) are exempt from IRC §404(a)(7), which, therefore, will cease to be much of an issue.

The 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, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595, Deborah Walker 202.879.4955. Copyright 2009, Deloitte.