CARES Act May Help DB Plans Avoid Funding-Based Limitations

Plan sponsors with single-employer defined benefit (DB) plans may benefit from recently enacted legislation when it comes to funding-based limitations.

In early April, the Coronavirus Aid, Relief and Economic Security (CARES) Act released guidance amending Internal Revenue Code (IRC) Section 436—also known as the look-back rule—which affects payments of accelerated benefit distributions and other benefits. The rule allows plans to use 2019’s adjusted funding target attainment percentage (AFTAP) instead of 2020’s.

The rule is especially important, given that certain benefit restrictions apply if a plan falls below a certain funded status. Althea R. Day, partner at Morgan Lewis, explains that if a plan has a funded ratio of 80% or more, it is deemed financially sound. However, anything less than 80% would require a 50% reduction in accelerated payments, and if a plan was 60% funded or less, it would result in a total prohibition of accelerated benefit payments. There are also limitations for future benefit accruals and implementation of benefit increases triggered by plan underfunding or plan sponsor bankruptcy. Details of funding-based limitations are outlined in a blog post on law firm Morgan Lewis’ website.

The market downturn attributed to COVID-19 will likely adversely affect most plans, and many will struggle to recover. However, if employers use last year’s AFTAP number, as long as their funding level was 80% or higher in 2019, it won’t trigger benefit reductions for 2020, says Day.

“If they’re above the 80% funded mark and they’ve got their AFTAP certification for that plan year that says they’re above that limit, then they’re good for this year,” she adds. However, no guidance has been released on what employers will do when it’s time to calculate funded ratios for 2021.

To avoid a potential low funded ratio for next year, Day recommends plan sponsors make contributions throughout 2020 and, if possible, increase funded status and avoid the limit. “It’s really sort of the perfect storm,” she says. “Because it is going to be tough for some of these companies to come up with additional cash to put into their DB plans to avoid restrictions.”

It is important to add that under the CARES Act, employers can waive their quarterly contributions, but they must do so no later than January 1, 2021, says Charles Clark, director of Employee Benefits Research at Milliman. The contributions will not be completely waived, however, and employers will need to make payments before or on the first day of the new year, he warns.

These rules apply to both calendar and non-calendar plans. Those with starting dates of March 1, April 1 and May 1 may have experienced abysmal investment returns, so using the previous year’s AFTAP can save these plans from restrictions.

“What we anticipate is that there may be some hardships for the plans that have the ERISA [Employee Retirement Income Security Act] and tax code measurement dates post-pandemic. Despite the recovery in the financial markets, these plans could be more inclined to use the look-back rule that the CARES Act provides,” Clark says. 

For example, if a plan’s Section 436 funded ratio measurement was 85% in 2019 but fell to 75% in 2020 due to COVID-19 market effects, they can use the look-back rule to deem their funded ratio as the past year’s, which in this case is 85%. If a company was close to facing bankruptcy as a result of the pandemic, depending on what part of the company capitalization the pension plan stacks up to, it may use the look-back rule as well, Clark adds.

DB plan sponsors with non-calendar year plans—which reset on dates in accordance to the plan—can also look at using their funded ratio statuses from 2019, Day notes.