Employee Plan Compliance Unit (EPCU) - Projects with Summary Reports - Single Employer DB Plans under PPA
The Single Employer DB Plans under PPA project was conducted in two phases. The first phase began in December 2011 and ended in September 2012. The second phase began in November 2012 and ended in December 2013.
The project goals were to determine whether plan sponsors of single employer defined benefit plans with an adjusted funding target attainment percentage (AFTAP) of less than 80% were aware of the benefit restrictions introduced by the Pension Protection Act of 2006 and were in compliance with these restrictions.
The overall compliance rate was about 73%.
Processing error cases and cases with errors on returns amounted to approximately 20% of the total cases reviewed. On the majority of these cases the plan sponsor failed to indicate the plan was frozen on line 8A of the Form 5500 return. A significant number of cases, due to both processing errors and taxpayer errors had AFTAPs of over 80% and if originally reported correctly, would have been excluded from our sample.
Approximately 7% of the cases reviewed had some issue pertaining to Code section 436. The cases requiring correction violated Code section 436(d). In each of these cases, the plans had AFTAPs between 60% and 80% and were required to limit lump sum distributions to 50% of each participant’s or beneficiary’s total benefit.
The concept of benefit restrictions was introduced by the Pension Protection Act of 2006 which added section 436 to the Code. Under Code section 436, a Single Employer Defined Benefit Plan with an (AFTAP) of less than 80% is considered underfunded and subject to benefit restrictions. More restrictions apply to plans that have AFTAPs of less than 60%.
A plan’s AFTAP is defined as follows:
[Plan Assets – Credit balances + Annuity purchases]
[Funding Target + Annuity Purchases]
The restrictions imposed by Internal Revenue Code (IRC) Section 436 affect the following types of benefits:
- Unpredictable Contingent Event Benefits - IRC Section 436 (b)
- Amendments Increasing Benefits – IRC Section 436 (c)
- Accelerated Benefit Payments – IRC Section 436 (d)
- Benefit Accruals – IRC Section 436 (e)
Accelerated benefit forms, are any payments made in excess of the monthly benefit amount paid under a straight life annuity (plus social security supplements). Under IRC Section 436 (d), an accelerated payment is referred to as prohibited payment. A prohibited payment also includes any payment for the purchase of an irrevocable commitment from an insurer to pay benefits; and any transfer of assets and liabilities to another plan maintained by the employer that is made to terminate or avoid benefit restrictions.
IRC Section 436 indicates the following:
- If a plan has an AFTAP of 80% or above, there are generally no restrictions unless the plan is in bankruptcy.
- If a plan’s AFTAP is at least 60% but less than 80%, plan amendments increasing plan liabilities for benefits (including cost of living increases for Section 415 benefit limitations) cannot take affect; and the plan must partially restrict accelerated benefit forms (typically lump sum distributions but also payments provided under the social security leveling option). The accelerated payment is limited to the lesser of 50% of the present value of the accrued benefit or the present value of the maximum PBGC guaranteed payment.
- If the plan’s AFTAP is less than 60%, benefit accruals must cease, plan amendments as outlined above, cannot take effect, prohibited payments, as defined above, cannot be paid and shutdown or other unpredictable contingent event benefits (UCEBs) cannot be paid. The limitation on UCEBs does not apply for the first 5 years a plan is in effect.
There are some exceptions to the prohibited payment rules. Under WRERA, the prohibited payment restriction does not apply to automatic cash outs under $5,000. If the plan was frozen before September 1, 2005, and there are no increases in benefits for any participants, the prohibited payment restriction does not apply regardless of the plan’s AFTAP. If the plan is in bankruptcy, no prohibited payments can be made unless the AFTAP is100%.
The plan’s AFTAP for a plan year is to be certified by the plan’s actuary. Until an actuarial certification is provided for the current plan year, a plan is deemed to have the same AFTAP as it had in the prior year. If the plan’s actuary has not certified the plan’s AFTAP by the first day of the 4th month of the plan year, as of that date, the plan will have a presumed AFTAP of the prior year’s AFTAP minus 10 percentage points. If the plan’s actuary has not certified the plan’s AFTAP by the first day of the 10th month of the plan year, as of that date, the plan’s AFTAP is presumed to be less than 60% for the remainder of the year and at the beginning of the following year until the AFTAP is certified.
If partial restrictions on prohibited payments apply, the plan must specify that the following options are available to participants:
- defer the entire benefit to a later date, (when restrictions no longer apply)
- choose a form of benefit that is not subject to restriction or
- receive the amount that is permitted to be paid as a prohibited payment with the remaining amounts only payable in a non-accelerated form.