Sponsors of single‑employer defined benefit (DB) pension plans could be subject to higher-than-usual minimum funding contribution requirements over the next several years, for at least two reasons. First, the interest rates that many plan sponsors use to calculate such contributions (referred to as “MAP‑21” interest rates due to the 2012 legislation that originally provided interest rate stabilization for minimum funding purposes) may decline starting in 2020. Second, an economic recession and corresponding stock market decline is increasingly possible. In anticipation of potential minimum contribution increases, DB plan sponsors should consider whether they may be able to defer their minimum funding obligations at some point in the near future by obtaining a minimum funding waiver from the Internal Revenue Service (IRS).
Minimum Funding Levers
Single‑employer DB plans are subject to quarterly minimum contribution obligations, which are roughly a function of the excess of pension liabilities over plan assets. The obligation generally increases if interest rates or the plan’s asset values decline. To smooth out the impact of low interest rates, Congress established floor (i.e., minimum) and ceiling interest rates—the MAP‑21 rates—based on a percentage of a prior 25-year average. With interest rates at historic lows, the MAP‑21 rates act as a floor and therefore stabilize a DB plan sponsor’s minimum funding obligations when interest rates are low, as they are today.
The current MAP‑21 rates set a relatively high floor, which will remain in effect until 2020. Starting in 2021, the floor will be substantially reduced each year (through 2023) unless Congress extends the relief. Congress has twice extended the current level of interest rate relief under MAP‑21, in part to raise tax revenue (because lower pension contributions means lower income tax deductions for sponsors). Although there is no current proposal to extend the MAP-21 rate stabilization, recent history shows that Congress is willing to extend this relief, in large part because it can offset the cost of other government spending.
IRS Minimum Funding Waivers
With minimum funding obligations potentially increasing in the next few years, plan sponsors should consider whether they may be able to obtain a funding waiver from the IRS.
A funding waiver does not relieve a DB plan sponsor of its minimum funding obligations. Rather, if granted by the IRS, a waiver would allow the sponsor to defer, for up to five years, its minimum funding contributions for a particular plan year. To obtain a waiver, the sponsor must show that (1) both the sponsor and each member of its controlled group are unable to satisfy the minimum funding standard for the plan year without causing a temporary substantial business hardship, and (2) application of the minimum funding standard would be adverse to the interests of plan participants in the aggregate. The IRS is able to grant up to three waivers in any period of 15 consecutive plan years. In the absence of a waiver, a DB plan sponsor that does not meet its minimum funding requirement for a plan year will owe a 10% excise tax on the amount of the funding deficiency. If the funding deficiency is not corrected, the excise tax increases to 100% of the deficiency. In addition, missed quarterly or annual minimum funding contributions can trigger liens on corporate assets enforceable by the Pension Benefit Guarantee Corporation (PBGC).
To determine whether the “temporary substantial business hardship” requirement is met, the IRS looks at whether (a) the employer is operating at an economic loss, (b) there is substantial unemployment or underemployment in the trade or business and in the industry concerned, (c) the sales and profits of the industry concerned are depressed or declining, and (d) it is reasonable to expect that the plan will be continued only if the waiver is granted. In our experience, the temporary nature of the business hardship is the most challenging factor to prove. The IRS and PBGC have a strong interest in ensuring the continued funding (by the sponsor) of any DB plan, and will generally not grant a funding waiver unless they believe it will help the sponsor get back on its feet in the relatively near future.
To apply for a funding waiver, the plan sponsor must file a waiver request with the IRS by no later than two-and-a-half months after the end of the plan year for which the waiver would apply. In addition to providing detailed financial records (relating to both the sponsor and the plan) and executive compensation information, the sponsor must also give advance notice of the waiver request to plan participants and other affected parties. The request for waiver must also be reported to the PBGC. The IRS must consult with the PBGC regarding waiver requests, and the PBGC typically takes a very active role in the process. Although the IRS is not subject to a specific deadline in reviewing a waiver request, in our experience the IRS takes several months to make waiver decisions. If a waiver is timely applied for and ultimately granted, the 10% excise tax is waived.
The IRS can also impose various conditions when granting waiver requests. For example, the plan sponsor may be required to provide collateral for the benefit of the plan, and may also be prohibited from increasing benefits in its other retirement plans for a period of time.
Separately, the application for a waiver may be an event that requires reporting by the employer to its lenders, under the terms of a financing agreement, so an employer applying for a waiver must be mindful of the potential impact of the application on its outstanding indebtedness. If the IRS requires the plan sponsor to provide collateral, the sponsor might be required under the financing agreement to obtain lender consent. Also, a public company plan sponsor should consider whether the application needs to be disclosed on a Form 8-K filed with the US Securities and Exchange Commission, and any potential market impact of such a disclosure.
Given the uncertain outlook for interest rates, the US economy, and the stock market in general, DB plan sponsors that are facing burdensome minimum pension contribution requirements in the coming years should remember that funding waivers may be a viable option under the appropriate circumstances.