Freezing and Terminating Plans Presenters: Moderator: Richard Sirus,JD Greenberg Traurig, LLP David Strom, FSA, EA, MAAA - Segal Laura Mitchell, EA, MSPA, Actuarial Consultants, Inc. Freezing Plans 2 1
Types of Plan Freezes Hard Freeze No future service accruals or salary credit for calculation of Final Average Earnings Service must continue for vesting and eligibility purposes Soft Freeze Close plan to new entrants Current participants continue in plan without change, but new hires do not participate in plan Modified Hard or Slushy Freeze No future service accruals Continued crediting of future salary for calculation Final Average Earnings Service must continue for vesting and eligibility purposes 3 Why Freeze? Plan sponsor can not afford the cost of the plan Plan sponsor wants to terminate the plan, but it is significantly under funded Plan sponsor wants to shift costs to another plan 4 2
Process of Freezing a Plan Formal amendment by plan sponsor 204(h) notice required if rate of future benefit accrual may reasonably be expected to be significantly reduced Notice goes to: Affected Participants including alternate payees Notice Timing: Large plans: 45 days Small plans (less than 100): 15 days Multiemployer plans: 15 days Consider whether a partial termination has occurred to determine if full vesting is needed Consider whether to request a favorable determination letter from the IRS 5 Qualification Requirements Applicable to Freezing Plans Minimum participation of 401(a)(26) Minimum Coverage of 410(b) Nondiscrimination of 401(a)(4) Survivor Annuity of 417(e) Minimum funding of 412 Prohibition of employer reversion until plan is terminated and all benefits paid 6 3
Accounting Issues Under Fas88 (Single Employer Plan) Curtailment an event that: Significantly reduces the expected years of future service for present employees Eliminates for a significant number of employees, some or all of future benefit accruals Soft Freeze (closing plan to new entrants) does not trigger a curtailment Modified Hard or Slushy Freeze (no future service accruals) will likely trigger a curtailment Hard Freeze (no future service accrual or salary credit) will definitely trigger a curtailment 7 Accounting Issues Under Fas88 (Single Employer Plan) 1. Unrecognized Prior Service Cost that was being spread over future service (now being eliminated) is a curtailment loss 2. Reduction in PBO from plan freeze is a gain that may be recognized immediately or deferred: If plan has net deferred gains, then the reduction in the PBO is a curtailment gain If the plan has net deferred losses, then the reduction in the PBO is offset against such losses with the excess of such reduction over losses being a curtailment gain 3. If the net effect of 1) and 2) is: A loss, it shall be recognized in earnings when it is probable that the curtailment will occur and the effect can be reasonably estimated; or, A gain, it shall be recognized in earnings when the amendment is adopted 8 4
Multiemployer Plan Freezes In general, a multiemployer plan: Is funded by negotiated contributions per collective bargaining agreements between participating unions and employers Provides benefits as determined by the trustees that are intended to be supported by the level of contributions coming into the plan If contributions become insufficient to provide the plan benefits, the Trustees can reduce or eliminate future accruals under the plan to bring back into balance with available resources Freezing plans can be problematic as members participate in the plan through a diversion of wages; However, there may be no other option. Under the Pension Protection Act of 2006 (PPA 2006), Trustees have various additional tools to address funding shortfalls of troubled plans by changes to adjustable benefits 9 Plan Terminations 10 5
Why do Plans Terminate? The plan sponsor can no longer afford the plan The plan sponsor perceives that it is not getting value for maintaining the plan The plan sponsor is dissolving or being purchased by a third party The plan no longer works well due to changes in the law The PBGC involuntarily terminates the plan 11 How Does a Plan Termination Happen? Must look at plan document to see what is required to terminate the plan Usually a Board action Should you do a plan amendment? Need to clarify administrative issues Need to update to comply with the law through date of termination Need to cease entry of new participants May need reversion provision 12 6
Freeze or Termination? The IRS says in regulations that a freeze occurs when no future benefits will accrue, but benefits are not being distributed Therefore, in order to have a termination, there must be an intent to distribute benefits The status controls the types of documentation that need to be done for a plan Limitations for collectively bargained plans 13 Employee Communications The Code and ERISA require pension plans to give advance notice of a future decrease in benefit accrual Large plans: 45 days Small plans (under 100): 15 days Multiemployer plans: 15 days If the plan was previously frozen, it does not need additional notice The PBGC requires covered defined benefit plans to provide affected parties with a Notice of Intent to Terminate Timing: At least 60, but no more than 90 days, before effective date 14 7
Funding considerations Special Issues Defined Benefit Plans Can terminate a non-pbgc defined benefit plan that has insufficient assets to pay benefits (see IRC 411(d)(3) vested to the extent funded) How will insufficiency be handled? PBGC style allocation? Owner absorbs insufficiency? Waiver vs. Allocation Can the employer fund up the plan on termination? Yes, but may not be currently deductible IRC 404(g) permits special deduction of funding on termination only for PBGC plans and only to the extent of funding PBGC guaranteed benefits 15 Special Issues PBGC-Covered Plans PBGC-covered plans can terminate only in 3 situations: 1. Standard Termination: assets are sufficient to pay ALL benefits or Majority Owner waiver 2. Distress Termination: assets are insufficient, but certain criteria are met 3. Involuntary Termination: PBGC action Assets must be sufficient at time of filing and at the time of distribution or a Majority Owner signs a waiver of benefits Benefit Freeze may be done as a separate amendment in case something goes awry in PBGC termination process 16 8
Standard Termination Timeline: Notice to Intent to Terminate to Distribution Deadline This timeline shows the key steps in the standard termination process. Certain deadlines may be extended as provided in PBGC regulations. 17 Standard Termination Timeline: Post-Distribution Certification This timeline shows the key steps in the standard termination process. Certain deadlines may be extended as provided in PBGC regulations. 18 9
Steps for Standard PBGC Terminations 1. Notice of Intent to Terminate 2. Notice of Plan Benefits sent to Affected Participants 3. Notice of Standard Termination to PBGC (Form 500) 4. PBGC Review Period 5. Notice of Annuity Information 6. Plan Closeout 7. Post Distribution Certification (Form 501) 19 Standard PBGC Termination 1. Notice of Intent to Terminate Must be provided to affected parties at least 60, but not more than 90, days before effective date of termination Affected parties: participants, beneficiaries of deceased participants, alternate payees, unions if covered Contents Plan and Employer Information (Plan name, Plan number, Emloyer Name, EIN, contact information for questions related to the temination) Statements that: Plan is being terminated and that assets must be sufficient for termination to occur Benefit accruals will cease, but will continue if plan does not terminate at intended time (or that there is a separate freeze amendment that will stay in effect) Participants will be advised of their accrued benefits and any insurer that will provide them, and how to get a copy of the SPD 20 10
Standard PBGC Termination 2. Notice of Plan Benefits to Affected Participants Must be provided before or concurrently with Standard Termination Notice to PBGC Contents: If participant is NOT in pay status for at least a year, The information on which benefits are based and statement that the party can promptly correct any information If info not available, best available data and statement that info is unavailable and offering opportunity to provide it Amount and form of benefits payable at NRA in any one form permitted under the plan Alternative benefit forms, including those payable on participant s death 21 Standard PBGC Termination 2. Notice of Plan Benefits to Affected Participants (continued) Contents: (continued) Amount and form of benefits payable at the earliest benefit commencement date and whether the benefit commencing on such date is subject to future reduction Additional info if benefit to be paid in lump sum If benefits are in pay status: Amount and form of benefit payable at termination date Amount and form of benefits payable to beneficiary upon participant s death Amount and date of scheduled benefit increases or decreases and explanation Special notice for parties with valid elections in effect as of the termination date (but not yet in pay status) or de minimis benefits If intend to delay distributions until IRS FDL is received, must submit for IRS FDL before or concurrently with Standard Termination Notice to PBGC 22 11
Standard PBGC Termination 3. Notice of Standard Termination to PBGC Deadline: 180 days after termination effective date Filed by Plan Administrator Information about the termination Enrolled Actuary s Certification of Sufficiency (Form EA-S) Plan Adminstrator s Certification Notice of intent to delay distributions until plan has received FDL from the IRS 23 Standard PBGC Termination 4. PBGC Review Period PBGC notifies plan administrator of the date on which it received a complete termination package If package is incomplete, the PBGC may offer a chance to correct and retain plan termination date If correction sent within later of 180 days of proposed termination date; or 30 days after PBGC notice is dated PBGC may ask for additional information Once PBGC has received complete filing, it has 60 days to review the data If PBGC does not send out Notice of Noncompliance during the 60-day period, Plan Adminstrator should proceed to close out the plan 24 12
Standard PBGC Termination 5. Notice of Annuity Information The plan administrator advises participants of what entity will provide benefits If insurer is not known, must advise participants of such and tell them they will get a supplemental notice once insurer is selected If supplemental notice needed, it must be provided at least 45 days before distribution to affected party 6. Plan Closeout All benefits must be actually paid by the later of: 180 days after PBGC review period expires; or 120 days after the plan received FDL from the IRS if the letter was requested before the standard termination notice was filed with the PBGC If assets become insufficient, plan administrator must stop making distributions and notify the PBGC 25 Standard PBGC Termination 7. Post Distribution Certification Deadline: 30 days after distribution of last dollar from the plan Plan administrator must file Form 501 with the PBGC 26 13
Standard PBGC Termination Majority owner waiver If assets are insufficient, a majority owner may waive the portion of his benefit equal to insufficiency Majority Owner : Sole proprietor sponsor Owner of 50% or more of capital or profits interest of partnership Owner of 50% or more of voting stock or value of all stock of corporation 27 Distress PBGC Termination Used when plan assets are not sufficient to cover all benefits 4 possible criteria to permit 1. Bankruptcy filing for liquidation 2. Bankruptcy Chapter 11 filing (if unable to pay debts in re-organization and continue in operation unless plan is terminated) 3. Company demonstrates it cannot continue in business without termination of plan 4. Company demonstrates that the costs of the plan have become unreasonably burdensome solely as a result of declining covered employment under all single-employer plans to which the company contributes 28 14
Steps for PBGC Distress Termination 1. Notice of Intent to Terminate 2. Notice of Distress Termination to PBGC (Form 600) 3. PBGC Review 4. Benefit Payments 29 PBGC Distress Termination 1. Notice of Intent to Terminate Due not less than 60, nor more than 90, days before effective date of distress termination To all affected parties Includes statement as to whether assets are sufficient to cover all PBGCguranteed benefits, which benefits are covered, and why benefits may have reduced guarantees 2. Notice of Distress Termination to PBGC (Form 600) Deadline: Within 120 days of proposed termination date Also, file Form 601, information about plan benefits and adminstrator certification Also, file Form EA-D: Actuary s Certification Additional required documentation 30 15
Distress PBGC Termination 3. PBGC Review Determines if criteria are met Advises employer if approved Employer provides detailed participant and benefit information to enable PBGC to see what is covered and what must be provided by the PBGC 4. Benefit Payments If plan sufficient to pay guranteed benefits, plan makes the payments If insufficient, PBGC appoints trustee to handle the distribution Trustee will formalize claim against employer for insured but uncovered benefits Liability: Total amount of unfunded liabilities PBGC can get lien for up to 30% of net worth 31 Bankruptcy Termination Issues Reportable event PBGC claims against the bankruptcy estate Pre and Post petition claims PBGC liens Minimum funding claims 32 16
PBGC Instituted Involuntary Termination PBGC may institute plan termination without sponsor approval if: The plan has not met minimum funding standards The plan will be unable to pay benefits when due Substantial owner non-death distribution occurred and the plan is insufficient to pay benefits afterward The PBGC believes that its possible long-run loss with respect to the plan will increase unreasonably if the plan is not terminated PBGC takes over the plan and appoints trustee to terminate the plan and pay out benefits Similar to distress termination 33 IRS Determination Letter on Termination Do you need FDL on termination? You never need FDL, but it s a nice thing to have Recommended when: Plan documentation due to legal changes is in flux and cannot know for sure that language in plan is sufficient There will be a reversion of excess assets M & A situation There will be merger or rollovers to another plan of the employer Recipient plan protected from disqualification due to transferred assets only if the recipient plan administrator had reasonable belief that the old plan was qualified A special ruling on some issue is desired, Example: You are eliminating any distribution forms under defined benefit plan based on proposed regs 34 17
Final Determination Letter Process Must give Notice to Interested Parties Plan must be updated to conform to all qualification changes (required even if FDL not received) See Notice 87-57 File Form 5310 35 Distribution Issues Must distribute as soon as administratively feasible (Rev. Rule 89-87) How to handle illiquid assets Offer to all Liquidating trust Use PBGC Missing Participant Program 36 18
Surplus Assets in a Defined Benefit Plan Read the plan document to see whether surplus assets can revert to the plan sponsor If not, amend plan to allow for reversion If plan had mandatory employee contributions, employees must share in surplus 37 Tax Consequences of Reversions Reversion Tax: 50% Reduced to 20% if: Employer establishes or maintains a qualified replacement plan Plan provides benefit increases to participants in the terminating defined benefit plan Exemptions from reversion tax: Governmental plans Plans maintained by an employer exempt at all times from tax Beware of UBIT Beware of co-sponsorship of a plan with a non-exempt entity Plus Corporate Tax 38 19
Qualified Replacement Plan (QRP) Requirements At least 95% of the active participants in the terminating plan (who remain as employees after the termination) are active participants in the replacement plan Direct transfer is made from terminated plan to QRP If defined contribution is a QRP, amount transferred is allocated to participants over a period no longer than 7 years 39 How Much Must Be Transferred to a QRP? 25% of the potential reversion minus the present value of increases granted to participants Up to 100% of the potential reversion may be transferred to the QRP. Result: No reversion tax No corporate tax 40 20
Allocation of Surplus in a Defined Contribution QRP Move amounts out of QRP suspense account (1/7, 1/6, 1/5, etc.) Allocate up to 415 limit each year If amounts are unallocated, place in 415 suspense account After 7 years, QRP suspense should be at zero Continue allocation of 415 suspense account 41 Multiemployer Plan Terminations Multiemployer plans do not voluntarily terminate like single employer plans do, but termination effectively occurs when employers stop contributing to the plan Trustees continue with plan administration until annuities are purchased or assets are exhausted PBGC does not take over a multiemployer plan until it runs out of money and is unable to pay benefits Multiemployer plans have PBGC coverage, but at a lower level than for single employer plans: 100% of first $11 of monthly benefit 75% of next $33 of monthly benefit 42 21
Partial Plan Terminations 43 What is a Partial Plan Termination? Undefined in the law Generally, a decrease in participants that is sufficiently significant as to constitute a termination of the portion of the plan in which those individuals participate, causing 100% vesting Only terminated participants are affected by 100% vesting. Remaining participants are subject to normal vesting schedule 44 22
When Does a Partial Termination Occur? Nobody knows for certain Lots of litigation on this issue Rule of thumb (i.e., rebuttable presumption): 20% decrease in participants Facts and circumstances may rebut the presumption But what does a 20% decrease mean? 45 Horizontal Plan Termination Defined: A plan amendment creates a greater potential for reversion to employer (affecting possible vesting rights) Note: IRS has rejected that this is a defined contribution issue Defined Benefit: Reduction or freeze of benefits, but only if the plan is not under funded Can also occur if a plan amendment creates a significantly greater potential for discrimination Example: Plan amends forfeiture allocation formula in such a way so that most of the participants eligible for the allocation are HCEs 46 23
Amendment, Merger Amendment of defined benefit into defined contribution plan is considered to be partial termination of the defined benefit, and all participants become 100% vested Amendment of money purchase to profit sharing or freezing of money purchase does not result in 100% vesting Freezing of profit sharing does result in 100% vesting, because profit sharing must have recurring and substantial contributions 47 Latest Word on Partial Terminations 7 th Circuit Case: Matz v. Household Finance (Matz III) Court took the following positions: The fraction is based on all participants vested or not Created rebuttable and conclusive presumptions Matz presumptions: < 10% reduction: conclusively presumed not to be a PPT 10% - 20% reduction: rebuttably presumed not to be a PPT 20% - 40%: rebuttable presumed to be a PPT > 40%: conclusively presumed to be a PPT 48 24
Q & A 49 25