But What If a Pension Fund is Overfunded? Can local governments put excess pension fund assets to good use?

• Author: Tatum, James L., III

Currently, the consensus is that if a pension fund is less than 100 percent funded, it is underfunded. (1) In other words, if the pension fund does not presently have all the assets needed to pay liabilities in the future [and without consideration of future contributions to the pension fund], the pension fund and retiree benefits are theoretically imperiled. So, out of concern for "underfunded" pension funds, of which there are many, there have been innumerable research papers, news articles, and worried finance directors.

But what if a pension fund is overfunded? Scarcely a word. While the number of pension funds that are underfunded outnumber those that are overfunded, more than a word or two should be spared for the topic.

The City of Ferndale, Michigan, has approximately 171 employees and two defined-benefit plans: the Employees' Retirement System [ERS] and the Police and Fire Retirement System [PFRS]. ERS was closed in 1996.

Since FY 2002, the latest available data, ERS has had no net pension liability, and consequently, the city has not had to make contributions to the pension plan. From FY 2005 [the latest available data] onward, ERS has had a funded ratio [the ratio of pension fund assets to liabilities] of more than 100 percent. Between F Y 2005 to FY 2022, ERS funding was at its lowest--140.8 percent--in FY 2005, and at its most flush--408.3 percent--in FY2022.

SECTION 401(H) AND THE INTERNAL REVENUE CODE

In FY 2020, 105 plan beneficiaries remained in ERS, as did $20 million in pension fund assets relative to $6.7 million in liabilities. Comparably, PFRS was 78.7 percent funded. (2) Could the city transfer assets from ERS to PFRS? No. Nor could the city withdraw excess pension fund assets held in ERS to pay for public services. But maybe, the city's Finance Department concluded, those excess assets held within ERS could be used to pay for retiree healthcare benefits.

In addition to its pension plans, the city sponsors other post-employment benefits [OPEB] and had set aside $21.9 million in assets to meet $50.6 million in liabilities. ERS had too much money; the city had too little for OPEB [retiree healthcare benefits]. So, on March 3, 2020, the city's Finance Department submitted a request for city council action to authorize the city to create an Internal Revenue Code [IRC] [section]401[h] account and transfer excess assets into the account from ERS.

Later that year, on November 4, the city received a memorandum from retained...