Overpaying PBGC Premiums -- Money You'll Never See Again

Earlier this week, October Three released what may have been the most comprehensive study ever on payment of PBGC premiums. The study analyzed premium payments of nearly every mid-sized or large defined benefit plan in the country over the period from plan years 2010 through 2015 (leaving out plans with fewer than 250 participants).

The key results were shocking:

• During that six-year period, companies overpaid variable rate premiums by more than $700 million in the aggregate. That is, using techniques designed to lessen variable rate premiums, they could have paid $700 million less.
• For the 2015 plan year, more than 65% of plans that paid variable rate premiums, and did not have their premiums limited by the so-called per participant cap, paid more than they needed to.

If we think about this particular pension expenditure, one could consider it among the worst of all sins. For example, if you contributed more than you needed to in 2015, then your future required contributions will be lower, your PBGC premiums may have been lower and your pension expense will have been lower. So, while you may have had other uses for the money, at least you got some benefit from those contributions.

On the other hand, suppose you paid a larger variable rate premium than you needed to. What benefit have you gotten or will you have gotten from that overpayment? Zero. Zilch. Nada. Nihil. Niets. Niente. Rien. They're all the same. You will have received absolutely no benefit from your overpayment and neither will your employees. In fact, the only beneficiary of your overpayment will have been the PBGC.

Don't get me wrong. There are some good people, some nice people at the PBGC. I have friends at the PBGC. But, that said, there is no reason to give them more money than you need to under the law.

If you've made it this far, I'm going to leave you with an analogy. PBGC premiums are a lot like taxes. You pay money to a quasi-governmental corporation (PBGC) as a condition of sponsoring a defined benefit plan. Similarly, you pay taxes to the federal government when your company turns a profit.

Here is where they diverge. Your company probably has a Tax Department. If it does, its primary function is to ensure that your company properly pays its taxes, but in as small amount as legally allowable. That is, their job is to reduce your tax burden.

Your Tax Department may be pretty big. How big is your PBGC Premium Department? Oh, you don't have a PBGC Premium Department? You know you could.

409A and the Reverse Haircut

No, you didn't read the title incorrectly. I used the term "reverse haircut." Don't go scouring google for it, though. I made it up, or at least I think I did.

What happened is that I was catching up on reading and in going through documents that I had received from a number of sources, my eyes fell on Chief Counsel Advice 201645012. I know -- it's not one of the biggies that caught your eyes. So, that's why I'm reporting it here.

Here are the salient facts from the Memorandum:

• On November 1, 2014, an employee entered into an agreement to defer $15,000 of the employee’s salary that would otherwise have been paid during 2015, with payment of the deferred amount to be made as a lump-sum payment on January 1, 2018, but only if the employee continues to provide substantial future services until December 31, 2017.
• Under the agreement the employee’s salary is reduced by $600 each biweekly pay period (so 26 x $600 or $15,600) and the employer credits matching amounts to the employee’s deferred compensation account of 25% of each salary reduction (so 26 x ($600 / 4) or $3,900) for a total amount deferred of $19,500.
• The matching amounts are credited each time a salary reduction amount is credited, which is the time the salary reduction amount would otherwise be paid as salary.

The issue here is whether the potential loss of the 25% matching contributions represented a substantial risk of forfeiture as compared to a risk of forfeiture. And, that is the reverse haircut approach. That is, the employee will receive those matching contributions only by providing future services.

People used to the qualified plan world may be a bit mind-boggled at this point. To them, this looks like a vesting condition, walks like a vesting condition, and quacks like a vesting condition, so it must be a vesting condition. And, the potential failure to vest must represent a substantial risk of forfeiture -- a term that doesn't exist in the qualified plan world.

Suppose, however, that the 25% was less, say 20%. Then what? Perhaps there would still be a substantial risk. Or, perhaps there would just be a risk. How about 15%? How about 10%? 

At what point would the potential diminution in compensation be so insufficient that its loss would not be material and therefore there would fail to exist a substantial risk of forfeiture? Or put differently, at what point would enough hair be returning to our hero's head that its loss would leave him wondering how he could go through the rest of his life so improperly coiffed?

What we know is that in this particular case, 25% was deemed by Treasury to be sufficient. In fact, the Chief Counsel Advice included the following language:

Yes, an amount that an employee could have elected to receive as salary may be treated as subject to a substantial risk of forfeiture under section 409A if the employer provides a matching contribution resulting in a 25% increase in the present value of the amount deferred.

How useful is that to you and me? Not very. CCA's cannot be relied upon for any precedential value. While Treasury is usually consistent in its administration of such issues, there exists no requirement that it be. We also don't know if, for example, 20% would have been sufficient. Or 15%. Or 10%. To any attorneys reading this, it must feel like a hypothetical in their law school contracts class.

We also don't know if the deferral period in question had anything to do with the decision of Chief Counsel.

What we do know is that roughly 6 months ago, based on all of the facts and circumstances of this particular situation, Chief Counsel deemed that the 25% reverse haircut was a material incentive and that such materiality did create a substantial risk of forfeiture.