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Small Retirement Plans Face Funding Dilemma

Explore strategic options to realign your plan with current and future business needs.

May 2009
by James Podleski and Nicholas Paleveda/Journal of Accountancy

Many traditional defined benefit pension plans are underfunded due to market declines. As a result, barring congressional action, they could face future excise taxes ranging from 10 percent to 100 percent of the underfunded amounts as mandated by the Pension Protection Act of 2006 (PPA). Funding liabilities are especially difficult for smaller plans whose sponsors typically have fewer options to make up shortfalls caused by rapid declines in plan assets.

This article reviews key laws and regulations impacting defined benefit plans and explores options available to plan sponsors and their advisers.

Minimum Funding Standards

A plan must fully fund its funding target, although not in one year. The funding target is the present value of accrued benefits determined under IRS rules. To determine the funding percentage at the beginning of each plan year, a defined benefit plan’s funded level is measured by comparing the value of benefits earned as of that date with plan assets. Divide the assets by the value of benefits earned to determine a funded percentage, which is called the funding target attainment percentage (FTAP).

Example 1:   Market Value of Trust Investments = $2,000,000
    Present Value of Accrued Benefits = $2,000,000
    $2,000,000/$2,000,000 = 1 or an FTAP of 100%

In 2008, the S&P 500 lost 37 percent. If a 40 percent loss is applied to the assets in Example 1, the calculation becomes $1,200,000/$2,000,000 = 0.6 or an FTAP of 60 percent. Because the FTAP is below 80 percent, this pension plan would be subject to higher pension benefit guaranty premiums (the Pension Benefit Guaranty Corp. (PBGC) variable-rate premium) and higher quarterly contributions. In addition, there would be some benefit payment restrictions.

But for many employers, FASB Statement no. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, which moved plan losses (or gains) onto company balance sheets, will have an even greater effect (see also Perfect Storm Prompts Changes in Pension Accounting).

This article has been excerpted from the Journal of Accountancy. View the full article here.