Welcome back to Cash Balance Corner (CBC) after a brief summer hiatus. We thought you deserved a break after all the math we threw at you in the last few entries. This is the 15th installment for CBC, which started with cash balance plan basics and progressed to the complexities of nondiscrimination testing. Our plan is to wind up CBC by the end of the year by discussing some very important administrative tasks that are sometimes overlooked until it is absolutely necessary, or in some cases, too late.
Today’s entry dives into Pension Benefit Guaranty Corporation (PBGC) coverage and premiums. If your plan covers only owners or your company is a small professional services company (i.e. never more than 25 plan participants), then you get another month off as PBGC coverage does not apply to you. We take a in-depth look at which plans are covered here; however, if you are not sure what a professional company is, you might want to keep reading.
The PBGC was created in 1974 as part of ERISA. Before the PBGC existed, participants in plans that terminated with insufficient funding did not receive their full, promised benefits. Do a search on Studebaker + unfunded pension and you will find stories about one of the most famous cases that helped solidify the need for pension insurance.
In that original law was a provision that allowed small professional companies to be excluded from PBGC coverage. The reasoning for this exclusion was based on the assumption that the majority of the liabilities for professional company plans would be for the owners. There is a long list of professions that meet this exclusion – as defined in the law – like doctors, dentists, engineers, even actuaries! However, keep in mind that this list was created almost 50 years ago.
Recently, professions that did not always qualify for the exclusion have received a notice of non-coverage from the PBGC. The determination is based on a rather long list of variables, but the most important seems to include the level of difficulty required to obtain the credentials necessary for the services provided.
Another exclusion from PBGC coverage happens when only owners are eligible for the plan. This exclusion happens for all types of businesses where ownership is at least 10% for each participant. Attribution creates situations where spouses and children under age 26 can be included in the plan without triggering coverage.
What happens when a plan is covered by the PBGC? There are two main requirements that come into play – the payment and filing of annual premiums and required notifications.
Plan sponsors must pay their annual premiums electronically to the PBGC no later than October 15th of the following plan year (the 15th day of the 10th month, for non-calendar year plans). The premium is made up two components:
- Flat rate premium ($86 per participant for 2021 and indexed for inflation each year), and
- Variable rate premium (more on this below).
The flat rate premium applies to the total number of plan participants with benefits as of the last day of the previous plan year. For new plans, the determination date is the first day of the first plan year. Since the participant count is based on the number of participants with a benefit, in most cases, the first year filing is $0. This is due to the fact that, as of the first day of first plan year, all accrued benefits are $0. However, the sponsor must still file electronically.
The variable rate premium is more or less risk-based (on unfunded vested liabilities). Since there are typically no benefits at the start of the first plan year, the variable rate premium is also usually $0. However, starting with the second year and depending on the contribution made and investment return, there is the possibility of a variable rate premium.
We will spare you the details of the calculation; however, for most small plans, the variable rate premium is limited to $5 times the number of participants times the number of participants. No, that is not a typo. Congress actually wrote into the law that the cap is based on the number of participants, which is then multiplied by the number of participants. For example, for a plan with 7 participants, the variable rate premium cap is ($5 x 7) x 7 = $245. The flat rate premium is $86 x 7, or $602, which equates to a total premium due of $847. The PBGC premium is tax deductible for the plan sponsor.
The second requirement that the company must notify the PBGC of certain events. Most of the requirements are related to large plan issues – mergers, spin-offs and underfunding. The notifications that are most pertinent to small plans happen when a plan sponsor fails to deposit the minimum required contribution in a year and at plan termination. We will go in-depth on terminating a PBGC-covered plan in a later installment of CBC. We know…you’re on the edge of your seat, aren’t you?
So, as you can see, there are some additional requirements and costs when a small cash balance plan is covered by the PBGC. There is one bright spot, however. As we describe here, a plan sponsor with a PBGC-covered cash balance plan is not subject to the 6% tax deduction cap on company contributions made to the 401(k) profit sharing plan that applies to non-covered plans. In other words, the company deduct up to the maximum in both the 401(k) and cash balance plans with no combined limit.
Tune in next time when we discuss amending cash balance plans. Until then, have a great rest of the summer.