What if I already have a pension?

Overfunded can mean different things, and each has its own rule: plan assets above the funding target under section 430, which shrinks the minimum contribution; a contribution above the deduction ceiling in section 404(o), which is not deductible that year; or assets above the cost of paying every benefit when the plan ends, which leaves a surplus.

A plan can be overfunded in the first sense and still have no surplus at termination, because the price of buying annuities for every participant differs from the funding target.

Not on overfunding. The 50 percent rate is an excise tax on surplus an employer takes back when a plan ends, and it applies only if the employer neither keeps a qualified replacement plan nor grants pro rata benefit increases. With either one the rate is 20 percent. Income tax is due on the amount as well.

Investment gains inside a running plan are not taxed; they reduce future contributions. A contribution above the deductible ceiling is taxed at 10 percent each year it stays nondeductible. An unpaid minimum contribution is taxed at 10 percent, then 100 percent if not corrected. A funding shortfall is made up over 15 plan years, not all at once.

Read Schedule SB of the plan’s last Form 5500. The enrolled actuary reports the plan’s assets, its funding target and its funding target attainment percentage there, and those show whether assets exceed the funding target. Whether the plan would have a surplus at termination needs the actuary’s termination valuation, because annuity prices differ from the funding target.

Funded status is a fact on the filing, not a guess about the stock market. A plan that did well in a strong market can still show no surplus once the actuary prices its benefits as they would be settled at termination. Schedule SB is filed with Form 5500 by the last day of the 7th calendar month after the plan year ends, so the most recent one describes a year already closed.

While the plan runs, the surplus stays in the plan. Contributions fall, because the minimum is reduced by the excess, and benefits can rise by amendment within the section 415 limit and the nondiscrimination tests. Publication 560 says of a running plan, “As a general rule, the assets can't be diverted to the employer.”

A benefit increase cannot take effect while the plan’s adjusted funding target attainment percentage is below 80 percent, or would fall below it with the amendment. Section 420 allows a narrow transfer of assets well above the funding target to pay retiree health benefits or retiree life insurance, and to pay nothing else. When the plan ends, surplus can raise benefits pro rata, move to a qualified replacement plan, or return to the employer, which pays the reversion tax and income tax.

How do I end the plan?

Only when the plan ends. Section 4980(d) lets an employer transfer part of the surplus to a qualified replacement plan, such as a 401(k) or profit sharing plan, and pay the lower reversion rate of 20 percent on what it takes back. No current law lets a running defined benefit plan move surplus into a 401(k).

A qualified replacement plan must meet tests in section 4980(d)(2), including how many of the ended plan’s active participants it covers and how much of the surplus moves into it before any reversion.

Can I keep my 401(k) too?

A contribution above the deduction ceiling in section 404(o) is not deductible that year, and section 4972 taxes it at 10 percent for each year it stays nondeductible, though it can be carried forward and deducted later. The enrolled actuary’s yearly maximum exists to keep a contribution under that ceiling.

The ceiling for a single-employer plan is the greater of the plan’s funding target plus normal cost plus a cushion, less assets, or the section 430 minimum. Publication 560 puts the rule in one line: “Defined benefit plans. The deduction for contributions to a defined benefit plan is based on actuarial assumptions and computations. Consequently, an actuary must figure your deduction limit.”

A pension buyout, often called pension risk transfer, means buying annuities from an insurance company to settle plan benefits. For a small plan, a buyout is part of ending the plan: each participant who does not take a lump sum receives an annuity from an insurer in place of the plan’s promise.

Choosing the insurer is a fiduciary decision. The Department of Labor requires the fiduciary choosing the insurer to seek the safest annuity available, unless doing otherwise would be in the participants’ interest, and says reliance solely on ratings from insurance rating services is not enough.

The PBGC’s count covers only plans that file PBGC premiums. The PBGC does not cover a professional service employer’s plan that has never had more than 25 active participants at any time after September 2, 1974, or a plan maintained only for substantial owners, meaning owners of more than 10 percent of the business, so those plans are not in the count.

A business that already sponsors a defined benefit plan can amend it, merge it with another plan, or end it and start another. Section 415(f) treats all of an employer’s defined benefit plans, ended or not, as a single plan for the benefit limit, so benefits from an earlier plan count against the limit in a new one.

A new plan started soon after an old one ends must stand on its own business reason under the permanence rule in 26 CFR 1.401-1(b)(2). Whether the existing plan has a surplus is read from its own Schedule SB and the actuary’s valuation, never assumed from how the markets have done.

How do I end the plan?