Use by Defined Benefit Plan Overfunding to extinguish existing corpora

[Guest Gibson]

Can the sponsor of an overfunded defined benefit pension plan use the plan's excess to extinguish an existing corporate liability? Plan sponsor owes severance benefits to employees (who are participants in the DB plan) of a wholly owned subsidiary. Sponsor is selling the sub, and wants to use the excess from the plan to satisfy the severance obligation. Can they do this?

[Lorraine Dorsa]

If the DB plan is overfunded, it can be terminated and the overfunded amount reverted to the employer. The reversion is subject to an excise tax of 50% (can be reduced to 20% if some of the excess is used to increase DB plan benefits or is transferred to a replacement DC plan) and to ordinary income taxes. The remaining amount is available for the employer to use as it sees fit.

So the answer is yes, excess DB assets can be used for corporate purposes, but the cost is very high.

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[david rigby]

Another possibility might be to amend the DB plan to include the severance benefits. This may require some negotiation if a union contract is involved or might include some creative design approach.

The advantage of this approach might be to avoid the plan termination, and hence the excise tax. Don't forget to check for discrimination issues before amending.

[Everett Moreland]

I'm interested in how a DB plan amendment can extinguish an existing corporate liability to pay severance benefits. Is your thought that the amendment would not extinguish but merely fullfil the obligation?

[Guest ljelaw]

I agree with Pax. I have done this, and while it presented some technical pension law challenges, we were able to overcome them. In fact, we did three different "severance" offerings within 3 years, in connection with layoffs.

[david rigby]

I'm not sure about your use of the terms "extinguish" and "fulfill". How about "replace"? The solution here is to analyze the source of the severance "liability".

For example, if it arises in a union contract based on a "plant closing" (or similar action), then the terms of that collective bargaining agreement will apply. Now suppose the plan sponsor realizes that the cost of this can be handled more easily under the qualified DB plan (rather than using corporate cash). In that case, perhaps the plan can be amended to provide this benefit; however, the sponsor may be required (under the terms of the CBA) to negotiate any change to the DB plan. Likely the sponsor will want to do so to make sure that the union accepts the pension plan as the vehicle for providing the benefit as replacement for the provisions in the CBA.