It is not uncommon for employers to face cash flow challenges that make it difficult, if not impossible, to fund their defined benefit (DB) plan in a timely way. In this second part of our series on unaffordable pensions, we provide an overview of two options—funding waivers and in-kind contributions—that can alleviate the immediate need to use operating cash to make minimum required contributions.
Employers facing a temporary business hardship that prevents them from funding their DB plan may want to consider applying to the Internal Revenue Service (IRS) for a funding waiver. A funding waiver reduces the employer’s minimum required contributions for a single year. It essentially acts to defer the funding obligation, and the waived contributions then must be repaid over the following five years. The IRS can grant a waiver for up to three of any 15 consecutive plan years.
An employer can obtain a funding waiver if it is able to demonstrate that it, and its controlled group members, are “unable to satisfy the minimum funding standard for a plan year without temporary substantial business hardship” and “application of the standard would be adverse to the interests of plan participants in the aggregate.” The IRS generally considers whether or not: 1) the employer is operating at an economic loss; 2) there is substantial unemployment or underemployment in the trade or business and in the industry concerned; 3) the sales and profits of the industry concerned are depressed or declining; and 4) it is reasonable to expect that the plan will be continued only if the waiver is granted, though other factors can be considered. In practice, the IRS is primarily concerned with the “temporary” nature of the business hardship and on demonstrating that waiving the current minimum funding requirement will ultimately help the plan’s long-term viability.
Funding waivers can be helpful in certain circumstances, but the application process can be challenging. The employer must supply a considerable amount of information about its financial condition, executive compensation arrangements and the pension plan itself. The employer also must notify plan participants of the waiver request and consider written comments from them (if any). Once submitted, the IRS then notifies the Pension Benefit Guaranty Corporation (PBGC) of the waiver submission, and gives PBGC a chance to comment on it. In our experience, PBGC plays an active role in analyzing waiver requests, and the IRS gives substantial weight to PBGC’s analysis and recommendations.
There are further challenges, as well. For example, the IRS has no deadline to respond to a funding waiver submission, and also has taken the position that it cannot waive contributions that were actually made. This means plan sponsors may have to make the difficult choice to either make contributions that are due while the waiver request is pending—even though doing so reduces the amount of the waiver—or fail to make contributions and risk the consequences. Additionally, the IRS often imposes various conditions on funding waivers that can make taking advantage of the relief more complicated.
Another option for employers is to make an in-kind contribution of property to the pension instead of, or in addition to, a cash contribution. That allows the employer to conserve cash, which may alleviate pressures caused by economic or other conditions. However, employers should be aware that the process is subject to a variety of complex rules and restrictions.
In particular, the Department of Labor (DOL) takes the position that in-kind contributions are prohibited transactions, so they are only permissible if an exemption is available. There is a statutory exemption that permits a plan to acquire “qualifying employer securities” (e.g., stock and some employer debt instruments) or “qualifying employer real property” (e.g., real property and related personal property leased by a plan to the plan sponsor or its affiliates). The exemption imposes additional requirements that demand careful scrutiny. The DOL has granted individual prohibited transaction exemptions (PTEs) for in-kind contributions that do not meet the conditions for the statutory exemption.
There are also fiduciary implications to making an in-kind contribution. For example, plan fiduciaries will have to consider the terms under which the plan will accept the contribution. Additionally, plan sponsors will have to carefully consider the tax consequences of the contribution, as in-kind contributions may not always be tax-deductible.
Michael Kreps (email@example.com) and Mark Carolan (firstname.lastname@example.org) practice at Groom Law Group, Chartered, where they counsel employers on pension plan funding and restructuring, as well as other issues.
This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Strategic Insight or its affiliates.