The steep stock market declines since 2000 and the sharp fall in long-term interest rates have combined to cause many defined-benefit pension plans to become seriously underfunded and in need of greater (in some cases much greater) employer contributions in order to meet the minimum funding requirements in ERISA and the Internal Revenue Code.

While Congress considers legislative solutions and actuaries continue to tinker with actuarial assumptions to reduce near-term funding requirements, plan sponsors can take a number of steps that will provide immediate relief from pension plan funding requirements.

Funding Waiver

An employer that is experiencing a temporary substantial business hardship may apply to the Internal Revenue Service (IRS) for a waiver of the minimum funding requirements otherwise applicable to the employer's defined benefit pension plan.  In determining whether the hardship warrants funding relief, the IRS will consider whether (i) the employer is currently operating at a loss, (ii) substantial unemployment exists in the employer's business and industry, (iii) the sales and profits of the employer's business area generally are depressed, and (iv) there is a reasonable expectation that the pension plan will be continued only if the funding waiver is granted.  Perhaps most significantly, the employer must be able to demonstrate to the IRS that the employer's existing substantial business hardship is temporary, i.e., it is reasonable to believe that the employer's business will recover.

In some instances, a funding waiver application may be retroactive, thereby providing immediate and substantial cash flow relief to the plan sponsor, i.e., the funding waiver applies to a plan year that is already completed.

To apply for a funding waiver, the plan sponsor must provide written notice of the application to plan participants.  If the pension plan covers employees who are covered by a collective bargaining agreement, the written notice must be provided to the union representative and it may be necessary to bargain with the union regarding the waiver application.

If the IRS grants the funding waiver, the employer is typically required to repay the waived amount (plus interest) to the pension plan over a five-year period.  In some circumstances, the employer will be required to post a bond to protect the plan and the Pension Benefit Guaranty Corporation (PBGC) in the event the employer does not repay the waived amount and the PBGC eventually becomes responsible for the plan's unfunded liabilities.  No more than three waivers may be granted during any 15-year period.  Pension plan amendments increasing the plan's liabilities are generally prohibited during the period that a funding waiver is in effect. 

Freezing Benefit Accruals

An employer may "freeze" its defined benefit pension plan by amending the plan to provide that no additional benefits will accrue under the plan after a specific date.  Plan participants must be given advance written notice of such an amendment.  If any of the employees covered under the pension plan are covered by a labor agreement, the employees' union representative must be notified of the freeze; in addition, the employer may be required to obtain the union's consent to freezing benefit accruals.

By freezing benefit accruals, an employer can substantially reduce its current and future funding costs, often achieving immediate cash flow relief and "buying time" to fund the pension plan's existing unfunded liabilities.

Distress Termination

An employer that can demonstrate to the PBGC that it will be unable to continue in business or that its pension costs will be unreasonably burdensome unless it can transfer its unfunded pension liabilities to the PBGC may undertake a "distress termination" of its defined benefit pension plan.  (A distress termination may also be undertaken if the plan sponsor is in bankruptcy.)  In a distress termination, the PBGC assumes the plan's liabilities and assets and typically become responsible for all or a significant portion of the plan's unfunded liabilities.  The PBGC in turn receives a claim against the plan sponsor equal to the difference between the present value of the pension plan's liabilities and the value of the plan's assets.

In order to undertake a distress termination, the plan sponsor and all members of its "controlled group" (generally requiring an 80% or greater ownership interest) must meet the criteria for a distress termination.  Similarly, the plan sponsor and its controlled group are jointly and severally liable to the PBGC for the plan's unfunded liabilities following a distress termination.

A plan sponsor commences the distress termination process by filing a "Notice of Intent to Terminate" with the PBGC at least 60 days, but not more than 90 days, before the proposed termination date.  Notice of the proposed distress termination must be provided to plan participants and, if the plan includes participants who are covered by a collective bargaining agreement, to the employees' union representative.  The plan sponsor may be required to bargain with the union regarding the proposed distress termination.  Additional filings must be made with the PBGC as the distress termination proceeds.  Additional communications with plan participants and other affected parties are required as well.  A plan sponsor that is undertaking a distress termination will likely want to seek a determination from the IRS that the termination of the pension plan does not adversely affect the plan's tax-qualified status.