The Pension Protection Act of 2006 required faster funding of defined benefit plans, generally funding shortfalls over 7 years. These new requirements began to phase in just as asset values plunged and employers became strapped for cash in the recession. Employer groups have been pressing Congress to provide relief since the new rules became effective.

The Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act of 2010 (the Act) was finally signed by President Obama on June 25, with a significant catch that ties funding relief to expenditures for taxable executive compensation over $1 million and payments to shareholders. In general, to use the funding relief, extra pension contributions will be required equal to the amount of these payments.

Canadian companies with U.S. subsidiaries need to know that the Act does not look only at compensation and shareholder payments of the U.S. entities, but also at all affiliated entities – generally, the parent and all subsidiaries, which are at least 80% owned. For example, taxable compensation paid to U.S. citizens outside the U.S. may trigger additional contribution requirements in the Act.

Pension Relief Choices

  • A plan sponsor may elect to pay interest only on the shortfall amortization base for two years, and then amortize the principal over the succeeding 7 year period; or
  • A plan sponsor may elect to extend the 7 year amortization period to 15 years.

The funding relief is available for one or two plan years beginning in 2008 through 2011. The plan sponsor must notify participants and the Pension Benefit Guaranty Corporation of its irrevocable election to use this relief.

Cash Flow Adjustment for Excess Executive Compensation

The Act imposes a "cash flow" rule that requires an additional matching contribution equal to taxable "excess compensation" over $1 million attributable to service after February 28, 2010 plus amounts used to fund a rabbi trust after that date. There is no limit on the number of executives whose compensation must be counted, but only compensation that is subject to U.S. taxation is counted. However, non-qualified deferred compensation, restricted stock, stock options and stock appreciation rights paid or granted under a binding written contract in effect on March 1, 2010 and new restricted stock awards that vest over at least 5 years are excluded.

Cash Flow Adjustment for Dividends and Redemptions

Extraordinary dividends and certain stock redemptions after February 28, 2010 are also required to be matched, but dividends within a controlled group and redemptions by an employee benefit plan or on account of death or termination of employment of an employee or shareholder are disregarded.

Plan Ahead

The cash flow adjustments apply for 3 years (for 2/7 relief) or 5 years (if 15 year relief is selected). Plan sponsors considering this relief should evaluate the extent to which their compensation practices will limit or be limited by it. For example, they may wish to grant future equity awards in the form of restricted stock subject to a 5 year vesting schedule so that it will not count in the compensation calculation. Benefit advisers will also need to coordinate with the corporate lawyers to make sure that corporate action does not inadvertently require significant matching contributions to the pension plan that could completely eliminate any pension funding relief.

Carol Buckmann has practised in the employee benefits field for over 25 years, advising clients on all aspects of employee benefits and retirement plans, including questions relating to 401(k), defined benefit and employee stock ownership plans, welfare plans, fiduciary responsibility, prohibited transactions and plan asset issues arising in investment fund formation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.