Step-By-Step Overfunded Defined Benefit Pension Plan Guide

History of the Problem

In the 1980s, several large companies with defined benefit retirement plans whose assets exceeded the present value of participant benefits terminated their plans and recaptured the excess amount as a plan reversion. Since the government views plan funds as belonging to participants, an excise tax of 50% was ultimately imposedon plan reversions. Employers sponsoring a defined benefit plan with only a few participants, especially ones where the benefits have been frozen, are at an increased risk of overfunding. Recent gains in stock market values have increased this possibility.

Preventing the Problem

The main method to prevent overfunding is by terminating the plan before it becomes overfunded and distributing benefits to plan participants. These distributions canbe rolled over into IRAs. Frequent comparison of the value of plan assets to plan benefits is advisable. This monitoring should be done at least annually and more oftenas the gap between the value of plan assets and benefits narrows. As plan assets approach the value of the maximum benefits allowed under Section 415 of the Internal RevenueCode consideration should be given to replacing equity investments with fixed income ones. Additional attention should be given to situations in which the owner is nearingretirement age.

Acknowledging the Overfunding

When the plan sponsor believes an overfunding problem may exist, now or shortly, discussions should be held with the actuary or service provider of the planto clarify the situation. Procrastination can be costly.

Confirming the Overfunding

Given the financial implications, confirming that an overfunding problem exists is essential. Even if the employer believes the current actuary may not havebeen monitoring the funding status satisfactorily, he/she should be retained at least for the short term. However, it is recommended that an independent, highly-credentialed actuary (e.g., a member of the Society of Actuaries) who has with significant experience working with overfunding situations, be retained. Ideally, such individual will limit his/her involvement to addressing the overfunding and not seek additional income from performing the annual administrative work for the plan nor from plan investments. Such an individual should play a key role in addressing the overfunding problem. He/she should first confirm the funding status. This will involve relatively complicated and accurate actuarial calculations. If the overfunding is substantial the plan should be carefully reviewed for any other existing problems. The current actuary should be eager to help and provide any data and documents needed, especially if he/she has failed to monitor the funding status closely in the past.

Stabilizing the Situation

Since little can generally be gained from any substantial increase in plan asset once the plan is fully funded, investments in fixed income assets rather than equities should be considered.

Examining the Possibility of Increasing Benefits to Absorb the Overfunding

The employer generally should first try to increase benefits to plan participants to the extent possible under Section 415 of the Internal Revenue Code.

Examining the Possibility of Hiring Family Members to Absorb the Overfunding

Generally, the next approach to consider is employing family members since, as participants, they will accrue plan benefits under the plan,reducing or eliminating the overfunding. However, compliance issues, such as satisfying plan eligibility requirements, may arise. Simply putting a spouse on the payroll with significant compensation and limited company involvement is not advisable. The possibility that hiring family members may weaken family relationships need also be considered.

Examining Other Options in Which the Overfunding is Relatively Small

If the overfunding problem still exists but is relatively small, several approaches, including the establishment of a defined contribution pension plan to absorbexcess assets should be considered. Of course, it is important to ensure that the funding status is carefully monitored and controlled if immediate action is not taken.

Examining Other Options in Which the Overfunding is Significant

Restructuring the company may be the best approach to reducing a significant overfunding although this frequently will require substantial time and expense.The alternatives under this method include expanding the existing business by adding employees directly or through the acquisition of another company, merging the company into another one or selling it.


Solving the overfunding problem may not be easy but delay in addressing it may prove very costly.

Please call us at 718-793-9885 to speak with our actuary or submit your concerns on our short form.