When a portion of a defined benefit plan is spun off mid-year to a new or existing defined benefit plan, the plan sponsor, along with its consultants, may expect that no Pension Benefit Guaranty Corporation (PBGC) premiums are due for the initial short (in the case of a spinoff to a new plan) or remaining (in the case of a spinoff to an existing plan) plan year, because premiums had been or would be paid for the transferred participants with respect to the transferor plan for its plan year. Additional post-spinoff premiums for those same participants would seem like double payment. This would seem a reasonable expectation and, as we know from experience, not an uncommon one. To the contrary, however, PBGC regulations treat the post-spinoff transferee plan, whether new or preexisting, as a new plan for which prorated premiums are due for the initial short or remaining plan year. Depending on when the transferee plan sponsor learns of its obligation, and whether that realization is a matter of self-discovery or notice from the PBGC, the late payment penalties have at times been substantial. The PBGC has discretion to waive some or all of those penalties, but under PBGC guidelines, ignorance of the payment obligation is not reasonable cause for waiver.
Late Premium Payment Penalty Relief
The penalty burden in these (and other late payment) circumstances has recently been lightened. As background, late premium payment penalties are a percentage of the overdue amount multiplied by the number of full or partial months of the delinquency, subject to a cap. The percentage increases fivefold if the delinquency is not corrected before the PBGC gives notice of the underpayment.
The PBGC published final regulations in late September 2016 (effective in late October 2016 for plan years beginning after 2015) that reduce late premium payment penalties in two significant ways:
- The first reduction under the new regulations cuts the penalty percentages and caps in half. Going forward, the penalty for a self-corrected late payment is 0.5% per month, subject to a 25% cap. After the PBGC issues a notice of underpayment, the penalty increases to 2.5% per month, subject to a 50% cap.
- The second penalty reduction is a “good citizen” waiver of sorts. If (i) a plan has an unblemished five-year premium payment record (or, at least, has not been subject to a late payment penalty for five years), and (ii) the plan sponsor pays within 30 days after notice by the PBGC, 80% of the post-notice penalty (i.e., the 2.5% penalty) will be waived. In a mid-year spinoff situation, however, particularly a spinoff to a new plan, the regulations are not clear as to whether the transferee plan can take advantage of this reduction by relying on the transferor plan’s premium payment record. Any plan sponsor in that situation should be encouraged to engage the PBGC proactively and aggressively.