Current developments in employee benefits.

• Author: Kundin, Elizabeth A.
• Position: Part 1

This two-part article provides an overview of recent developments in employee benefits, qualified retirement plans and executive compensation. Part I, below, focuses on current developments affecting qualified retirement plans, including the pension provisions included in the General Agreement on Tariffs and Trade (GATT) and the Uniformed Services Employment and Reemployment Rights Act of 1994 (USERRA), Employee Retirement Income Security Act of 1974 (ERISA) issues and various IRS releases providing guidance on qualified plan design. Part II, to be published in December, will focus on executive compensation and employee benefits issues, including IRS initiatives with respect to Sec. 403(b) plan compliance, the Financial Accounting Standards Board's statement on stock compensation, the Department of Labor's (DOL) Delinquent Filer Voluntary Compliance Program, and ERISA developments.

GATT

The GATT financing legislation adopted the Retirement Protection Act of 1994 (RPA), which included rounding rules for various pension cost-of-living adjustments, eliminated the quarterly contributions requirement for fully funded single-employer defined benefit plans, extended through 2000 Sec. 420 defined benefit pension asset transfers to fund retiree medical benefits, increased funding rates for uncertain plans less than 90% funded and expanded the data-gathering powers of the Pension Benefit Guaranty Corporation (PBGC).

Both the Code and ERISA impose minimum and maximum funding requirements on defined benefit plans. GATT's pension provisions are aimed at improving the funding of single-employer defined benefit plans and reducing the PBGC's exposure, at reducing or eliminating the PBGC's operating deficit and at reducing the defined benefit system's unfunded liabilities, for which the Federal government is potentially responsible.

Under prior law, the dollar limit on defined benefit plans under Sec. 415(b), the limit on elective deferrals under qualified cash or deferred arrangements under Sec. 402(g)(5), and the minimum compensation limit for determining eligibility for participation in a simplified employee pension (SEP) under Sec. 408(k)(2) were adjusted annually for inflation. Under RPA Section 732(b)(1), (c) and (d), GATT's simplified rounding rules, the dollar limit on benefits under defined benefit plans (currently, $120,000) and defined contribution plans (currently, $30,000) will be indexed in $5,000 increments, the limit on elective deferrals under Sec. 402(g) (currently, $9,240) will be indexed in $500 increments, and the minimum compensation limit for SEP participants (currently, $400) will be indexed in $50 increments.

Under Sec. 415(d)(2), as amended, the cost-of-living adjustment for any calendar year is to be based on the increase in the applicable index as of the close of the calendar quarter ending September 30 of the preceding calendar year, so that the adjusted dollar limits will be available before the beginning of the year to which they apply. RPA Section 732(e)(2) provides that no annual limit i reduced below the limit in effect for plan year beginning in 1994.

RPA Section 731(a) extends Sec. 420, originally scheduled to expire at the end of 1995, to Dec. 31 2000. This provision permits employers to transfer funds from defined benefit plans with assets in excess of 125% of current liability to pay for current retiree health benefits. There are also modifications to the maintenance-of-effort requirement and the rule relating to the set-aside of prior amounts to pay qualified retiree health liabilities.

Under RPA Section 754, effective for plan years beginning after Dec. 8, 1994, sponsors of single-employer defined benefit plans with assets equal to 100% of current liability in the prior plan year are not required to make quarterly estimated contributions during the current plan year. Pre-RPA Sec. 412(m)(1) had required quarterly installments, with the full minimum funding contribution due no later than 8 1/2 months after the last day of the plan year.

GATT will also have a dramatic impact on the calculation of benefits paid in a lump sum. Before GATT, the present value of the nonforfeitable accrued benefit was calculated under Sec. 417(e)(3)(a)(i) using an interest rate no greater than the rate that would be used (as of the distribution date) if the vested accrued benefit (using that rate) did not exceed $25,000, or 120% of such rate if the vested accrued benefit exceeded $25,000.

Under RPA Section 767(a)(2), the present value (PV) of a participant's nonforfeitable accrued benefit must be no less than the PV using the Treasury-prescribed mortality table based on the "prevailing commissioners' standard table" used to determine reserves for group annuity contracts issued on the date as of which is determined. Currently, the prevailing commissioners' standard table is the 1983 Group Annuity Mortality Table (GAM 83) prescribed by the National Association of Insurance Commissioners. PV for these purposes must be no less than the PV determined by using the annual interest rate on 30-year Treasury securities for the month before the distribution date, or such earlier time as provided in regulations.

RPA Section 767(d)(1) indicates that these changes are generally effective for plan years beginning after 1994, except that an employer can elect to treat them as being in effect after Dec. 7, 1994. Under a transition rule, RPA Section 767(C)(3)(B), PV may be calculated as under prior law until the earlier of (1) the first plan year beginning after 1999 or (2) the later of when a plan amendment applying the provision is adopted or made effective.

Under pre-RPA Sec. 412(e)(1), a special funding rule applied to underfunded defined benefit plans. Generally, the minimum required contribution was the greater of the amount determined under the normal funding rules, or the sum of (1) normal cost, (2) the amount necessary to amortize experience gains and losses over five years and gains and losses resulting from changes in actuarial assumptions over 10 years and (3) the deficit reduction contribution plus the amount required to fund contingent benefits. The contribution amount could not exceed the amount needed to increase the funded ratio of the plan to 100%. The RPA includes two exceptions to the special funding rules for underfunded plans. First, RPA Section 751(a)(1) provides that the underfunding rules do not apply to a plan with a funded liability percentage of at least 90%. Second, under RPA Section 751(a)(1)(b), adding Sec. 1412(l)(9), pension plans with funded current liability ratios of at least 90% for two immediately preceding years are exempt from deficit reduction contribution charges and participant notification requirements if the plan's funded ratio is at least 80% in the current year.

RPA Section 751(a)(3) substantially altered the calculation of the deficit reduction contribution for underfunded plans under Sec. 412(1)(2). The deficit reduction contribution is the sum of the unfunded old liability amount, the unfunded new liability amount, the expected increase in current liability due to benefits accruing in the plan year, and the amount needed to amortize the increase in current liability due to certain future changes in the required mortality tables. Under Sec. 412(1)(1), flush language, the minimum required contribution cannot exceed the amount needed to increase the funded current liability percentage of the plan to 100%, taking into account all charges and credits to the funding standard account and the expected increase in current liability attributable to benefits accruing during the plan year. RPA Section 751(a)(7)(a) lowered the maximum interest rate under Sec. 412(1)(7)(c) that can be used to determine the current liability, and all underfunded plans must use the same mortality table (currently, GAM 83).

Under pre-RPA Sec. 1412(c)(7)(a), pension assets had to equal the lesser of 100% of accrued liability or 150% of current liability to the extent the plan was at the full funding limit and no contribution was required under the minimum funding rules. "Current liability" is all liabilities to participants and beneficiaries under the plan, determined as if the plan terminated; it represents only benefits accrued to date, and does not depend on the actuarial funding method.

The RPA modified the way in which defined benefit plan sponsors determine the full-funding limit to conform to IRS practice. RPA Section 751(a)(10) retains the Sec. 412(c)(7) rules relating to determining the full-funding limit, but also provides that the expected increase in current liability due to benefits accruing during the plan year must be included in determining the employer's current liability. The RPA allows plans to determine their 150% of current liability limit for full-funding purposes without regard to the RPA changes in the interest rate and mortality assumptions; under Sec. 412(c)(7)(e)(i)(I), the fullfunding limit is not less than 90% of the plan's current liability (using the RPA-modified interest rate and mortality assumptions). To determine if a plan is at the 90% limit, Sec. 412(c)(7)(e)(ii)(II) provides that plan assets are not reduced by credit balances in the funding standard account.

In general, See. 404 limits the amount of annual deductible contributions. Pre-RPA plan sponsors maintaining both defined contribution and defined benefit plans that cover some of the same employees were limited to deducting the greater of 25% of compensation or the contribution needed to meet the defined benefit plan's minimum funding requirements. A 10% excise tax was imposed by Sec. 4972 on contributions that exceeded the deduction limit. Under RPA Section 755(a), amending Sec. 4972(c)(6), contributions to defined contribution plans that are nondeductible because they exceed the 25% limit on combined contributions are not subject to the excise tax, if the contributions to such plans do not exceed 6% of...