Strategies to Address PBGC Premiums
A Sibson Consulting Compliance Alert notes that these increases are in addition to increases introduced by the 2012 Moving Ahead for Progress in the 21st Century Act (MAP-21). Since premiums do not fund plan benefits or increase a plan’s funded status, plans sponsors and advisers may take steps to minimize the premiums payable, similar to taking step to avoid taxes.
Stu Lawrence, senior vice president and national retirement practice leader at Sibson in New York, says the PBGC is walking a fine line. “The agency has, by its own calculation, raised premiums because it has an unfunded liability,” he tells PLANADVISER. “If it raises them too much, employers will start to take actions to reduce their premium base, for example, by taking actions to get folks out of the plan.”
This seems counterintuitive to the PBGC’s goal to encourage and preserve DBs, Lawrence adds, and “if [the agency] continues to raise premiums, the premium becomes material, and if premiums become onerous, employers will end plans and there will be no premiums.”
Minimizing Variable-Rate Premiums
This year, the PBGC variable-rate premium is 1.4% of a plan’s unfunded vested liability, going up to at least 2.4% in 2015 and 2.9% in 2016, with indexing thereafter. For an underfunded plan, increasing pension plan contributions above amounts previously contemplated is the surest way to reduce the amount of the PBGC variable-rate premium payment, according to the Sibson Compliance Alert.
The company notes that making additional pension contributions generally provides a tax deduction and tax-free accumulation of investment earnings. “If an employer has cash lying around, why not put it into the plan; they will have to put cash in the plan eventually, so why not save on premiums?” Lawrence says.
Sibson contends that even employers lacking available cash to make additional contributions may decide it is advantageous to borrow money to do so. How is going in debt better than paying higher premiums? “Many companies have credit lines where the interest rate would be 2.9% or less, so if they don’t borrow, they will pay a PBGC premium at perhaps a higher percent,” Lawrence explains.
Organizations with frozen pension plans may be wary of making additional pension contributions, if they believe there is a possibility the plan could become overfunded if interest rates and/or investment returns turn out to be higher than the rate used for the variable-rate premium calculation, the Compliance Alert points out. Upon plan termination, overfunding that reverts to the plan sponsor will be subject to an excise tax of 50% of the reversion, as well as ordinary income tax.
“This is less of a concern for plans that are not frozen, because employees are continuing to accrue additional benefits for which the surplus will eventually be used,” Lawrence notes. “Frozen plans do not have this safety valve.”
However, Sibson says plan sponsors need not be overly concerned with the issue of overfunding. According to the Compliance Alert, “Even a frozen plan that is anticipated to terminate will likely need assets significantly more than the PBGC vested liability to purchase the annuities needed to terminate the plan.”
Employers may also consider accelerating contributions to minimize PBGC premiums. The Compliance Alert explains that while PBGC premiums for each plan year reflect the market value of assets as of the last day of the prior plan year, contributions can be reflected (at a discounted amount) for premium purposes in many cases if they are paid within eight and one-half months after the plan year. Thus, for calendar-year plans, this could allow the inclusion of contributions paid as late as September 15, 2014, in determining the 2014 premium. For example, if a contribution that is otherwise due on October 15, 2014, is accelerated by 30 days, it would be counted in the computation of the unfunded liability for PBGC premium purposes.
Sibson says plan sponsors should consult with an actuary to make sure there are no unintended consequences from accelerating contributions. “There are some very complex rules, for example, about plan credit balances, so plan sponsors should seek an adviser’s help,” Lawrence adds.
Minimizing Flat-Rate Premiums
This year, the PBGC flat-rate premium will be $49 per participant, going up to $57 in 2015 and $64 in 2016, with indexing thereafter. One way plan sponsors can reduce participant count is to offer lump-sum windows.
According to the Compliance Alert, by law, a plan cannot require a terminated participant to take a distribution as a lump sum if the amount of the lump sum exceeds $5,000. Rather, a lump sum can be available only as an optional form of payment that is offered with an alternative annuity payable at the same time, and only with spousal consent if the participant is married. Although DB plan sponsors can offer lump sums as a standard option, it has become more popular to offer lump sums only during a one-time window period. This avoids creating a protected right to the lump-sum option in the future, and may produce a higher acceptance rate than an option that is a permanent plan feature.
Plan sponsors should compare the financial implications of the cash-out to that of maintaining the obligation of paying monthly benefits; the two options involve calculations based on different assumptions. They should also determine whether a cash-out is significant enough to reach the threshold for “settlement” treatment under accounting rules. (For more considerations when deciding to offer a lump-sum window, see “DB Lump-Sum Windows Require Much Preparation”.)
Multiemployer Plan Premiums
In a separate Compliance Alert from Segal Consulting, the firm notes that while the two-year budget agreement includes a significant increase in the PBGC premiums for single-employer plans, it does not include any increases in the multiemployer premium. Multiemployer plans were given a significant raise in premiums in the 2012 Moving Ahead for Progress in the 21st Century Act (MAP-21)—which raised multiemployer premiums from $9 to $12 in 2013.
According to Segal, it is possible, however, that multiemployer premiums will be increased again by legislation in the next several years, as the PBGC is looking for more money. Lawrence says there is nothing multiemployer plan sponsors can do in anticipation of a premium increase since it is just speculation for now.