Single employer defined benefit plans are required to comply with limitations on accelerated benefits payments, future benefit accruals, and implementation of benefit increases triggered by plan underfunding or plan sponsor bankruptcy. Given the recent market and business disruptions, the following high-level review of these rules may be helpful, especially for plan sponsors of plans that use a non-calendar plan year.
Code Section 436 impacts payment of accelerated benefit distributions (prohibited payments) and plant shutdown or unpredictable contingent-event benefits. Prohibited payments are payments in excess of the monthly amount paid under a single life annuity (plus Social Security supplements described in the last sentence of Section 411(a)(9) of the Code) to a participant or beneficiary whose annuity starting date occurs during any period in which the limitation is in effect and any payment for the purchase of an irrevocable commitment from an insurer to pay benefits. The restrictions on prohibited payments would apply to lump sum payments in excess of $5,000 (lump sum payments of $5,000 or less are exempt from the restrictions). They would also apply to payments under a Social Security level income distribution option, installment payments over a fixed period of years, and annuities that include a lump sum payment feature. Annuity purchases (such as those involved in plan de-risking transactions) are also impacted.
The Section 436 funding-based limitations are based on the plan’s current year “AFTAP” (adjusted funding target attainment percentage). This is the funded status measure provided by the plan’s actuary calculated as the ratio of adjusted plan assets to the adjusted funding target as of the plan valuation date. The actuarial certification of a plan’s AFTAP for a given plan year is generally provided by the first day of the fourth month of the plan year. If the plan's actuary does not complete the certification before the first day of the fourth month of the plan year, the plan's AFTAP is presumed to be 10% less than the prior year's AFTAP until the certification is complete. If the AFTAP is not certified by the first day of the 10th month of the plan year, then the plan's AFTAP will be presumed to be below 60% for the remainder of the plan year.
Funding-based limitations. If a plan’s AFTAP for the plan year is less than 80% but at least 60%, the plan may not make a prohibited payment after the valuation date for the plan year that exceeds the lesser of 50% of the amount of the payment that would have been made absent application of Code Section 436 or the present value of the maximum PBGC guarantee with respect to the participant’s benefit. In addition, no amendment that would increase benefits under the plan may be implemented. If the plan’s AFTAP for the plan year is less than 60%, no prohibited payments may be made, additional benefit accruals cease, no amendment increasing benefits may be implemented, and no plan-provided plant shutdown benefits or other unpredictable-event contingent benefits may be provided for the plan year.
If an optional form of benefit normally available under the plan is not available because it is a prohibited payment, the plan must provide participants with an opportunity to bifurcate the benefit into restricted and unrestricted portions (applicable to plans that are at least 60% funded), and allow participants that elect to bifurcate their benefit to commence payment of the unrestricted portion in the otherwise-prohibited optional form, to commence the entire benefit in an unrestricted form, or to defer the payment to a later date.
Funding-based limitations may be avoided or cured during a plan year by the employer making additional contributions, with interest. If the contribution is made after the date the actuary has certified the plan’s AFTAP for the year, an updated AFTAP certification will be required to avoid or end application of the restrictions.
Bankruptcy triggered limitations. A Chapter 11 bankruptcy of a plan sponsor of a single employer plan will trigger a complete restriction on the payment of prohibited payments under the plan, regardless of the plan’s funded status.
Notice requirements. Single and multiple-employer plans are required to provide a funding notice no later than 120 days after the end of the plan year to which it relates. For a calendar year plan this is April 30. As part of the notice, the AFTAP is disclosed. Code Section 436 funding-based restrictions do not need to be disclosed in the annual funding notice, but the annual funding notice does serve as public notice of the AFTAP for the plan year on which restrictions may be based. A separate benefit restriction notice must be issued to participants and beneficiaries who are not already in pay status within 30 days of the plan’s becoming subject to a benefit restriction. If the notice is issued because benefit payments in certain payment forms are restricted, the notice needs to be provided within 30 days of the restriction that is triggered as of a specific valuation date for the plan. If the notice is issued because the plan's AFTAP has fallen to less than 60% and benefit accruals must cease, the notice must be given within 30 days of the valuation date for which the 60% AFTAP applies. This notice will also satisfy the plan’s notice obligations under ERISA 204(h) to provide advance notice of cessation of benefit accruals.