Many employers provide defined benefit pension plans for their workers. The idea is to guarantee certain benefits, usually money, for workers after they retire. Everyone wins. Employers can take tax deductions for money they contribute or pay into the plans. Workers aren't taxed on their shares until they actually get paid - after retirement.
There are two basic types of plans:
- Multi-employer - two or more employers, and a labor union, work together to provide retirement benefits
- Single-employer - only one employer sets up and runs the plan
The trick is to figure out how much money an employer needs to contribute to a plan to cover the benefit payout for each year. For single-employer plans (and other plans, too), the federal government made rules to help make sure they're properly funded so retirees get the retirement benefits they earned and need.
Minimum funding requirements for single-employer plans are set by the Pension Protection Act (PPA). How much an employer is required to pay into the plan each year is based on the value of the plan's assets as compared to the funding target for the year.
The funding target is 100 percent of the present value of all benefits earned by workers during the year.
Assets Equal To or More Than Target
If the plan's assets are equal to or are more than the funding target, the minimum required contribution is the target normal cost, minus the amount the plan assets exceed the funding target. The target normal cost is the present value of all benefits earned by workers during the plan year.
Assets Less than Funding Target
If the plan's assets are less than the funding target, the minimum required contribution for the year is equal to the plan's target normal cost plus the amortization of the funding shortfall. A funding shortfall is the difference between the plan's funding target and the plan's assets. Amortization lets the employer pay off the shortfall over a period of years.
New rules give employers longer amortization periods for 2010 and 2011.
Payment Due Date
The due date for the payment of a minimum required contribution for a plan year is generally eight and a half months after the end of the plan year. Interest may be charged on the minimum required contribution if it's not made on the valuation date (usually the first day of the year).
If the minimum required contribution isn't paid by the deadline, the employer will be charged an excise tax. For single-employer plans, the tax is 10 percent of the unpaid contribution. This tax is on top of the interest charged for a late payment.
Accelerated Quarterly Contributions for Underfunded Plans
Quarterly contributions are required if the plan had a funding shortfall for the prior year. The payments are the lesser of 25 percent of:
- 90 percent of the minimum required contribution for the current plan year
- 100 percent of the minimum required contribution for the preceding plan year
For most plans, the installment payments are due on April 15, July 15 and October 15 of the plan year and January 15 of the following year.
This is a very brief overview of the rules for minimum required contributions for single-employer plans, and as you can see, they're complicated. The IRS and Department of Labor compiled tools and resources to help you figure things out. A tax lawyer can help you if you have any questions.
Questions for Your Attorney
- How do you calculate the value of a single-employer defined benefit pension plan's assets?
- Can I terminate or cancel my single-employer benefit plan?
- How is interest calculated on a late quarterly payment?