The Internal Revenue Service (IRS) recently released guidance on how a multiemployer defined benefit plan may elect to temporarily freeze its “green zone,” “yellow zone” or “red zone” status from the prior plan year; and/or extend its funding improvement plan or rehabilitation plan by an additional three years.
The relief applies to plan years beginning on or after October 1, 2008, and not later than September 30, 2009. For calendar year plans, these elections must be made by April 30, 2009.
Background: Funding Rules Under the Pension Protection Act
The Pension Protection Act of 2006 (PPA) enacted new funding rules for multiemployer defined benefit plans. Each year, the plan’s actuary must certify the plan’s funded status as critical (red zone), endangered (yellow zone) or neither (green zone). The endangered yellow zone status applies when either the plan is less than 80 percent funded, or the plan has an accumulated funding deficiency (the credit balance has been exhausted) or is expected to have a deficiency in any of the next six plan years (taking into consideration any amortization extensions). A plan that meets both of the yellow zone conditions is a seriously endangered “orange zone” plan. The critical red zone status applies if any of the following conditions apply:
The plan is less than 65 percent funded, and the sum of the plan’s assets and present value of contributions for the current and next six plan years is less than the present value of non-forfeitable benefits projected to be paid from the plan during the current and next six plan years.
The plan has an accumulated funding deficiency (not taking into consideration any amortization extensions),
The plan is expected to have an accumulated funding deficiency in any of the next three plan years (next four plan years if plan is 65 percent or less funded) (not taking into consideration any amortization extensions),
The plan’s normal cost for the current plan year, plus interest on unfunded benefit liabilities, exceeds the present value of anticipated employer contributions for the current plan year; the present value of non-forfeitable benefits of inactive participants is greater than the present value of non-forfeitable benefits of active participants; and the plan has an accumulated funding deficiency for the current plan year or is projected to have an accumulated funding deficiency for any of the four succeeding plan years (not taking into consideration any amortization extensions).
The sum of the plan’s assets and present value of anticipated employer contributions for the current plan year and the four succeeding plan years is less than the present value of all benefits projected to be payable during the current plan year and the four succeeding plan years.
An endangered yellow zone status plan must adopt a funding improvement plan to increase, over a period of 10 years, its funded status by 33 percent of the difference between its first endangered yellow zone status and 100 percent. A seriously endangered orange zone status plan has a 15-year funding improvement plan, and the plan must be designed to improve its funded status by 20 percent of the difference between its first endangered yellow zone status and 100 percent. A critical red zone status plan must adopt a rehabilitation plan to emerge, over a period of 10 years, from critical status.
To achieve these ends, the funding improvement and rehabilitation plans may include reductions in plan expenditures, a reduction in future benefit accruals (if bargaining parties agree) or a combination of both. The plans include sets of contribution schedules that the actuary certifies are reasonably calculated to meet the funding standards required. For plans in critical red zone status, until the rehabilitation plan contribution schedules are implemented, each contributing employer is subject initially to a 5 percent surcharge and then to a 10 percent surcharge after one year. While a plan is under a rehabilitation plan, it may be amended with respect to participants not in pay status to decrease early retirement subsidies, eliminate disability benefits and alter other adjustable benefits. A plan in critical red zone status cannot be amended to increase benefits and cannot pay lump-sum benefits (or purchase annuities) other than lump-sum payments that do not require spousal consent.
Worker, Retiree, and Employer Recovery Act of 2008
Prior to leaving office, President Bush signed the Worker, Retiree, and Employer Recovery Act of 2008 (WRERA), which provides temporary relief from certain PPA funding requirements. For multiemployer plan sponsors, WRERA provides the opportunity to temporarily “freeze” a plan’s status. Specifically, WRERA allows a multiemployer plan sponsor to elect to maintain the prior year’s plan status for the first plan year beginning between October 1, 2008, and September 30, 2009. For calendar year plans, a multiemployer plan can maintain the 2008 plan year funding status for the 2009 plan year. Therefore, a plan that slipped from a green zone status and made the required WRERA election would not be required to adopt a funding improvement plan or a rehabilitation plan. Similarly, a plan that slipped to a critical red zone status and made the required WRERA election would not be required to limit lump sums and would not subject contributing employers to surcharges.
If the plan was not in green zone status in the prior year and the plan sponsor makes the WRERA election, the sponsor is not immediately required to update its funding improvement plan, rehabilitation plan or schedules as otherwise required. In addition, WRERA also provides temporary relief by allowing the sponsor of a multiemployer plan in endangered or critical status to extend the plan’s funding improvement or rehabilitation period by three years.
IRS Notice 2009-31
On March 27, 2009, the IRS released Notice 2009-31, which provides instructions for plan sponsors related to the timing, submission and content of elections to freeze a plan’s status. Notice 2009-31 also contains special notice requirements for plans that are not in endangered yellow zone or critical red zone status as a result of their freeze election.
If a plan sponsor elects to freeze the multiemployer plan’s status, the plan sponsor must do so by April 30, 2009, or 30 days after the annual certification of the plan’s status is due, whichever is later. For calendar year plans, the election must be made by April 30, 2009.
If a plan sponsor elects to extend the plan’s funding improvement or rehabilitation plan period by an additional three years, the election must be made by the earlier of the last day of the plan year in which the election is being made or the date a funding improvement plan, rehabilitation plan or update is adopted that takes into account the election. However, under no circumstances must the plan sponsor make the election before April 30, 2009.
If the plan sponsor makes either of the above elections, the election must be submitted to the IRS (electronic filing is permitted). The submitted election must be signed by an authorized trustee and contain basic plan information, such as the plan sponsor’s Employer Identification Number, contact information and a description of the election being made.
Notice Requirements for Plans in Neither Endangered Nor Critical Status as a Result of an Election to Freeze
If a plan sponsor elects to freeze a multiemployer plan’s green zone status, the plan sponsor must provide a special notice to plan participants and beneficiaries, collective bargaining parties, the Pension Benefit Guaranty Corporation (PBGC) and the secretary of labor. The special notice can be provided in either paper or electronic format, and must be provided no later than 30 days after the election or actuarial certification for the election year is made, whichever is later. The special notice must contain basic plan information, a description of the election and its temporary effect, the plan’s actual funded status and the need to improve the plan’s funding situation in the future.
For a plan that is not in critical red zone status, a WRERA election to freeze the multiemployer plan’s prior year funding status will relieve the contributing employers from surcharge assessments and perhaps allow the plan more time to design and rapidly implement any rehabilitation plan in the future. Nevertheless, such an election will prohibit the plan from decreasing adjustable benefits for participants not yet in pay status, which would be permissible for a plan in critical red zone status. Plan sponsors and contributing employers should be aware that plans will be accruing additional liability during the zone freeze period, without the ability to decrease adjustable benefits and thereby decrease funding liability.
Despite positive investment returns in March 2009, U.S. indices had double digit declines for the first quarter. A temporary one-year funding status freeze may have limited effect for most multiemployer plans. For example, a plan that would have been in critical status for the first time, but for the WRERA election, may not (based on current market indicators) have the ability to rebound to an endangered yellow zone or green zone status by the next actuarial certification. In essence, the plan sponsor and contributing employers may only receive a one-year reprieve, while continuing to accumulate benefit liabilities. In addition (and potentially more important in the long term), a plan that freezes its funding status and then moves to another funded status category next year (i.e., moves from green to yellow or red, or from yellow to red) will have lost the ability to make an election to extend its funding improvement or rehabilitation plan by an additional three years.
In determining the best course of action for each plan, as well as each contributing employer, consultation with legal counsel, actuaries and accountants is important.