overfunded DB plan

[David]

I believe the overfunding can be used for a retiree medical benefit plan and I have heard that there are people/firms out there who "buy" excess assets although I don't know how this works (but I would like to find out more). I'm sure there are other opportunities available, hopefully this topic will generate some interesting responses.

[Guest beth beaube]

What are the implications/opportunities of an over-funded defined benefit plan that has no plans of being terminated any time in the near future?

[Lorraine Dorsa]

"Overfunded" has several different meanings:

Overfunded on a termination basis means that the plan has more than enough $ to pay benefits if the plan terminated today. If the plan is to be terminated today or in the near future, this is relevant. If is not going to be terminated, this fact is somewhat irrelevant. (Theoretical funded status on a termination basis is used in the determination of current liability which is used in certain calculations with regard to full funding and PBGC premiums so it's not totally irrelevant.)

Plans which are at the full funding limitation (current contributions are limited because the plan assets are high in relation to the plan benefits) are often called overfunded, but this is often a temporary situation and contributions will be required in future years to pay the benefits that will ultimately be payable.

From a participant's point of view, having your plan well or overfunded is like having a security blanket--you know there are plenty of assets to pay benefits.

A plan sponsor may think that if his plan is overfunded he has put too much money in the plan and wishes he could have spent the $ elsewhere. In most cases, overfunding is a result of actual experience not matching actuarial assumptions. If, as has been not uncommon in the last few years, if the actuary assumed the plan asset would grow at 7% and they actually grew at 15%, it is possible the plan could become overfunded. Or if the actuary assumed than x% of the participants would terminate employment in a given year and 3 times x% actually terminated, the plan could become overfunded.

For an ongoing plan, being overfunded on a termination basis is not an issue--future employer contributions will be smaller and the relation of the plan benefits and assets will tend to move back into synch.

If the plan is being terminated, excess assets can either be reallocated to the plan participants, thus increasing their benefits, or reverted to the employer (but are subject to excise taxes and income taxes).

In the prior answer, it was assumed that the plan was overfunded on an ongoing basis and that the employer wanted to use some of these assets to provide other benefits (retireee health benefits may be funded through a DB plan), rather than have future contributions be reduced or reduced as dramatically.

This is probably a much more complex answer than you expected, but there are different answers depending on what you mean by overfunded.

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[jlf]

The overfunded amount is simply factored into the actuarial calculation in computing the sponsor's annual contribution. In many instances the computation results in a very small or zero appropriation.

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[Guest Alex B]

I think the implications/opportunities of an overfunded ongoing DB plan will depend on the facts and circumstances. For most plans, the overfunding provides a "contribution holidy" i.e. the sponsor does not need to come out of pocket to fund the plan. The real value here is the after-tax cost of the annual contributions.

Companies with lots of employees can typically utilize the overfunding to increase retirement benefits or provide for post-retirement medical benefits (420 and 401h). Public companies actually benefit through increased earnings under FAS87.

For closely held companies with few employees and a large overfunding relative to the benefit liability (say > 25%), I recommend looking at the sale option that David mentioned. The reason is that in those situations the overfunding generally continues to grow faster than can be used for benefits. The owners will not realize any significant value for the overfunding and if the plan is eventually terminated, 90% will be lost to taxes. I have worked with Pension and Tax Advisors (888) 801-5269. They buy the stock of the plan sponsor and pay 75% or more for the overfunding in the stock price. They then match the plan with an underfunded plan and merge the two plans. All the current participants receive annuities or lump sums that can be rolled out to IRAs.