IRS Issues Further Guidance on the CARES Act’s Changes to Single-Employer Defined Benefit Plan Funding Rules

The U.S. Internal Revenue Service (IRS) has published Notice 2020-61, which provides detailed guidance on the changes to single-employer defined benefit plan funding rules for calendar year 2020 that were enacted by the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act). 

The CARES Act delays the due date of all 2020 required minimum pension plan contributions (including quarterly installment payments) until January 1, 2021, and permits plan sponsors to use the plan’s prior year adjusted funding target attainment percentage for 2020. The funding relief is intended to alleviate the burden on single-employer pension plan sponsors that could be caused by the market turmoil associated with the COVID-19 pandemic. However, as explained below, Notice 2020-61 indicates that interest must be paid on the delayed payments and clarifies that the tax deduction for the contribution may be delayed. 

Delay of Minimum Required Contributions

Background on Minimum Required Contributions

Section 430 of the Internal Revenue Code (the Code) generally requires sponsors of single-employer defined benefit pension plans to make annual contributions to the plan no later than 8½ months after the end of the plan year to which such contributions relate (September 15 for calendar-year plans). Where a plan had a funding shortfall during the prior plan year, plan sponsors must make their annual contributions in four quarterly installment payments, which are due on April 15, July 15, October 15, and January 15. 

The consequences for missing a required minimum contribution differ depending on whether quarterly installment payments are required. If no quarterly payments are required, interest will continue to accrue with respect to the missed contribution at the plan’s effective interest rate for the year in which the contribution relates. Where the plan sponsor is required to make quarterly installment payments, interest accrues at the plan’s effective interest rate plus 5 percent. In each case, missed contributions are subject to an excise tax imposed under Section 4971 of the Code. The plan sponsor may also be required to report the missed contribution to the Pension Benefit Guaranty Corporation (the PBGC), and, in certain cases, a lien on the assets of the plan sponsor and the members of its controlled group could arise in favor of the PBGC.

Guidance on How Interest Will Accrue on Required Minimum Contributions 

Because the CARES Act delays all due dates for minimum required contributions until January 1, 2021, a plan sponsor will not be treated as having missed any contribution that was due during 2020 if such contributions, plus interest, are made by January 1, 2021. 

Notice 2020-61 provides the following clarification as to how interest on delayed required minimum contributions should be calculated: 

• Interest will accrue from the valuation date through the original due date at the plan’s effective interest rate for 2019. 
• Interest will accrue from the original due date through the payment date at the plan’s effective interest rate for 2020. 
• If payments are not made by January 1, 2021, interest will continue to accrue under the normal rules for missed contributions until payments are made (including the 5 percent increase with respect to missed quarterly installment payments).  

Interest on delayed payments can potentially result in much larger required contributions than originally planned. Plan sponsors should consult with the plan’s actuary to determine how much their required contributions will increase before deciding whether to delay required contributions until January 1, 2021.

Guidance on Plan Asset Valuation and the Tax Deductibility of Contributions

Notice 2020-61 clarifies that contributions made by January 1, 2021, but after the original due date for such contributions will be taken into account for purposes of valuing the plan’s assets for a plan year following the year for which the contributions were made. This is consistent with the normal rule on the impact of required contributions on the value of a plan’s assets and confirms that in this regard, the delayed due date will simply be substituted for the original due date. 

However, Notice 2020-61 confirms that the delayed due date enacted by the CARES Act will not affect the timing by which plan sponsors must make the contributions in order for them to be tax deductible for the year to which the contributions relate. Plan sponsors who wish to deduct contributions made during the current year on their prior year’s tax returns should still make such contributions no later than their tax-filing deadline. 

Election to Use a Plan’s Prior Year Adjusted Funding Target Attainment Percentage

Section 436 of the Code requires single-employer defined benefit plans to impose restrictions on distributions (and, in certain cases, to cease benefit accruals) if the plan falls below certain funding levels, as measured by the plan’s “adjusted funding target attainment percentage” (AFTAP). The AFTAP is generally determined by comparing a plan’s assets to its funding target and must be certified each year by the plan’s actuary. 

A plan’s funding level is heavily influenced by the market performance of the plan’s investments. Therefore, the market downturn caused by the COVID-19 pandemic could have a significant detrimental effect on the plan’s AFTAP for 2020. The CARES Act attempts to alleviate this issue by permitting plan sponsors to use a plan’s AFTAP for the last plan year ending before January 1, 2020, as the plan’s AFTAP for plan years that include 2020. 

To elect to use the plan’s prior year AFTAP, plan sponsors must notify the plan’s actuary and plan administrator. Notice 2020-61 clarifies that even where a plan sponsor elects to use the prior year AFTAP, the plan’s actuary generally must still certify an AFTAP for 2020 and should still report the AFTAP on Schedule SB of the plan’s Form 5500. 

Plan sponsors should be aware that the election to use the prior year’s AFTAP is not automatic, and they should work with the plan’s actuaries to determine whether making such a selection would be prudent.