questions regarding defined benefits for a company

[Guest MaryMary]

If a co has a defined benefit plan what can be done should they not generate a profit for the year? Are there any outs in this situation? were a little leary to start a plan in case we hit a downswing sometime. also, if employees leave the company and later return, is there a way to hold the plan and re-enter? there's a frequent turnover in employment and many return later.

[Lorraine Dorsa]

Defined benefit plans are subject to the minimum funding standards of IRC 412 and as such, contributions are required. Only profit sharing plans (which include 401k plans) can allow the employer to determine the amount of contributions, if any, to be made in any given year.

Therefore, the company needs to think carefully before it adopts the plan. Be sure that the plan is designed to produce a cost that the company can expect to afford each year.

If, even after careful planning and reasonable budgeting, the company cannot afford to make a contribution in any year, there are some outs.

First of all, contributions may be made as late as 8 1/2 months after the close of the plan year, so maybe by that time the company can come up with the $.

If the company is just short one year, the contribution can be missed and made up the next year. However, a 10% excise tax on the amount not contributed will apply. (Expensive, but that's the way it goes.)

If the company realizes that it's initial estimate re how much it can afford for the plan was overstated, the plan can be designed to provide lower benefits and therefore lower future contributions.

In the worst case, the plan can be terminated. Note that termination of the plan does not relieve the employer of the responsibility for making contributions for any missed prior years and that to terminate assets must be sufficient to pay all benefits earned to date.

All in all, defined benefit plans involve an obligation which the company must be prepared to meet and the plan must be designed within the employer's budget. The employer must also work closely with the plan's actuary and let him know about the company's expectations so he can recommend adjustments to address issues before they have become a problem.

As an actuary, I have found that sponsors who understand DB plans and work closely with their actuary are very happy with them. Those who simply adopted a plan with a big cost since they had a large profit one year and never think about the plan again except when they write the contribution checks run the risk of being very unhappy.

[david rigby]

As usual, Lorraine offers good advice.

Let me add a couple of points:

1. There is a provision is tax law for a waiver of a minimum funding requirement. However, the due date for applying is 2-1/2 months after the close of the plan year, even though the due date of the contribution is 8-1/2 months (example: 3/15/99 deadline for applying for a waiver for 1998 calendar year, while the contribution is due 9/15/99). My limited experience with waivers is to avoid them.

2. As a mid-point between continuing a plan that is (temporarily) expensive and terminating it, the plan sponsor can "freeze" it. The sponsor still must make required contributions for years up to the freeze. A frozen plan can be unfrozen anytime, including awarding service for the frozen period, usually without difficulty.

[Lorraine Dorsa]

To clarify Pax's comment, "freezing" a plan means ceasing the additional accrual of benefits, which may or may not reduce contributions in the freeze and subsequent years to zero.

The plan sponsor is still obligated to fund the plan, but the required annual contribution is usually significantly smaller and in many cases (but not all cases) zero.

[Larry M]

Couple of additional comments

1. defined benefit funding can be established in a way which allows you to contribute more than a minimum amount each year. To the extent the minimum is exceeded, it develops a credit balance which can be used to reduce a future year's contribution (to zero if necessary). For example, if you feel your comapny can afford a plan which averages five percent of compensation over the next few years, the funding method could allow you to put in 7% for a few years and build up the extra (with interest) as a cushion against lean years.

2. whatever qualified plan your comapny chooses, it should anticipate making contributions for a number of years. This is true whether it is a defined benefit plan, a money purchase plan or a profit sharing plan