Troubled Corporate Pensions Look to CARES Act for Relief

Missed employer contributions can lead to penalties or plan terminations

By Michael Kreps and Katie Kohn © Groom Law Group April 16, 2020

The economic slowdown associated with the COVID-19 pandemic will dramatically impact cash flows and the ability of defined benefit plan sponsors to meet their pension obligations. Although the pension funding relief in the recently enacted Coronavirus Aid, Relief, and Economic Security (CARES) Act may ease funding burdens, plan sponsors should still be aware of both the challenges posed by underfunding pensions and some of the potential solutions.

Missed Contributions

It is common for plan sponsors facing financial challenges to miss one or more minimum required contributions. Missed contributions should be monitored carefully as they can result in reporting requirements, excise tax liability and liens.

When an employer misses a contribution that, together with any other missed contributions (including interest), exceeds $1 million, a statutory lien automatically arises on all of the assets of the plan sponsor.

Additionally, employers are responsible for excise taxes on missed contributions.

Partial Termination

A pension plan can experience a partial termination when a group of plan participants loses coverage under the plan due to employer-initiated layoffs. A general rule developed by the courts and the IRS is that a reduction in active participants of 20 percent or more creates a rebuttable presumption that a partial termination has occurred.

If there is a partial termination, all employees who left employment for any reason during the plan year in which the partial termination occurred must be fully vested as of the date of the partial plan termination.

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Shutdown Liability

Plan sponsors may be required to make supplemental contributions to their plans in the context of corporate downsizing through facility closures. Specifically, the Employee Retirement Income Security Act (ERISA) provides that a liability arises when a "substantial cessation of operations at a facility" occurs, meaning that operations at a facility permanently cease, resulting in a workforce reduction of more than 15 percent of eligible employees.

The PBGC requires the plan sponsor to notify the agency when a facility shutdown occurs, as well as if the sponsor elects to satisfy its shutdown liability by making additional contributions.

Options for Underfunded Pensions

Plan sponsors under financial stress may find it impossible to fund their pension plan. Although there are no easy answers, plan sponsors do have options for addressing serious pension funding challenges. Some of these options are discussed below.

Freezing benefits.

Plan sponsors can limit the growth of pension liabilities by "freezing" some or all of the plan's benefit accruals. There are a number of different approaches and each will have a different impact on future pension liabilities. For example, a plan sponsor could:

  • Close the plan to new entrants while allowing current participants to continue to accrue benefits.
  • Eliminate accruals for all participants but allow benefits to increase based on wage growth.
  • Stop benefit accruals for some participants based on age, tenure, job classification, or plant location.
  • Entirely cease accruals for all active participants.

To freeze a plan, the plan sponsor must adopt an amendment stopping some or all future accruals. Both ERISA and the tax code prohibit reductions to participants' accrued benefits, so plan sponsors must ensure that all participants retain their accrued benefits after the plan is frozen. For this reason, although certain plan amendments can be retroactive, an amendment to freeze benefits may only apply prospectively.

Plans with more than 100 participants generally must provide participants with a written notice of the amendment at least 45 days before the effective date of the freeze. Similarly, the plan's annual funding notice may have to reflect the freeze because it may have a material effect on plan liabilities or assets for the year.

In some cases, the benefits payable to executives under a Section 409A deferred compensation plan are offset by the benefits paid by the pension plan. If a plan sponsor freezes pension benefits, it could trigger increased obligations under the executive pension plan because the pension offset stops increasing.

A plan sponsor should also consider whether a benefit freeze would contravene any collective bargaining agreements with unionized workers. If a collective bargaining agreement requires the accrual of benefits, the sponsor will likely need to bargain with the union for an amendment to the agreement.

In-kind contributions.

Another option for employers is to make an in-kind contribution of property to the pension instead of a cash contribution. That allows the employer to conserve cash. However, employers should be aware that the process is subject to a variety of complex rules and restrictions.

In particular, the Department of Labor (DOL) takes the position that in-kind contributions are prohibited transactions, so they are only permissible if an exemption is available. There is a statutory exemption that permits a plan to acquire "qualifying employer securities" (e.g., stock and some employer debt instruments) or "qualifying employer real property" (e.g., real property and related personal property leased by a plan to the plan sponsor or its affiliates). The exemption imposes additional requirements that demand careful scrutiny.

Funding waivers.

Employers facing a temporary business hardship that prevents them from funding their defined benefit plan should consider applying to the IRS for a funding waiver, which reduces the employer's minimum required contributions for a single year. The deferred contributions then must be repaid over the following five years.

The IRS can grant a waiver for up to three of any 15 consecutive plan years, but generally does not grant a waiver for more than one year at a time.

An employer can obtain a funding waiver only if it is able to demonstrate that it is both:

  • Unable to make the minimum required contributions due without "temporary substantial business hardship."
  • Application of the minimum funding requirements "would be adverse to the interests of plan participants in the aggregate."

Funding waivers can be helpful in certain circumstances, but the application process can be costly and challenging.

[SHRM members-only toolkit: Designing and Administering Defined Benefit Retirement Plans]

Funding Relief Legislation

On March 27, 2020, Congress passed the CARES Act, which lets plan sponsors delay making contributions that would otherwise be due during calendar year 2020 (i.e., quarterlies and final) until Jan. 1, 2021.

Although the contributions will not be due until Jan. 1, 2021, they will still accrue interest starting on the prior deadlines. The interest charged would be at the plan's effective rate of interest, which is generally calculated each year by the actuary based on the interest rates used to determine the plan's liabilities.

For plan years that include any portion of 2020, the CARES Act also permits a plan sponsor to elect to treat the plan's adjusted funding target attainment percentage (AFTAP) as being equal to the percentage from the last plan year ending before Jan. 1, 2020. Absent this relief, plans with plan years that start after January might have reported unusually low 2020 AFTAPs because of the recent decline in the financial markets. These low AFTAPs could have triggered funding-related benefit restrictions, such as lump sum prohibitions and benefit accrual restrictions.

With the relief, plan sponsors may be able to avoid these restrictions.

Lawmakers may revisit pension funding policy changes that were considered but not included in the CARES Act. For example, there have been active discussions about extending contribution smoothing for single-employer retirement plans and providing PBGC premium relief.

Michael Kreps and Katie Kohn are attorneys with Groom Law Group in Washington D.C.© 2020 Groom Law Group, Chartered. All rights reserved. Republished with permission. A longer version of this article can be read on the Groom Law Group website.

Related SHRM Articles:

Viewpoint: The COVID-19 Economic Crisis May Worsen the Retirement Crisis, SHRM Online, April 2020

When Employers Must Cut Their 401(k) Contributions to Stay Afloat, SHRM Online, March 2020

Help Panicking 401(k) Participants to 'Stay the Course'SHRM Online, March 2020



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