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There is one strategy that sponsors of underfunded plans can use to reduce PBGC variable-rate premiums (VRPs) that simply involves an acceleration of contributions otherwise due in 2025/2026. By frontloading contributions that, in any case, must be paid to the plan within the next 1-5 months, a sponsor of an underfunded plan can (generally) reduce real, out-of-pocket VRP costs.
Background
To understand how this strategy works, we need to review the interaction of ERISA minimum funding rules and the calculation of PBGC VRPs:
Sponsors of underfunded plans generally must “fund underfunding” over 15 years. And an approximation of each year’s contribution (the lesser of 90% the current year’s, or 100% of the preceding year’s, funding obligation) must be paid quarterly. For 2025, underfunded plans must make these quarterly funding payments by April 15, July 15, and October 15 of 2025 and by January 15 of 2026.
Any shortfall in a given year’s contributions must be paid by September 15 of the following year, e.g., any remaining funding shortfall for 2024 must be paid by September 15, 2025. We’re going to call this the “true-up contribution.”
For any year, a sponsor may make additional contributions, above the ERISA-required minimum amount, by September 15 of the following year. These additional amounts are treated as a funding credit and may generally (and with certain exceptions) be used to satisfy future funding obligations.
For any year (e.g., 2025), the amount of PBGC VRPs owed are 5.2% of the plan’s underfunding (its “unfunded vested benefits” or UVBs) as of the end of the prior year (2024), taking into account any contributions made by September 15 of the following year (2025) “for” the prior year (2024). To say this in English: a sponsor may make a contribution by September 15, 2025, for 2024, and have that contribution reduce the amount of the plan’s UVBs for purposes of calculating 2025 VRPs.
These rules present the sponsor with the opportunity to (in certain circumstances) to make contributions for the prior year, generating a credit that can be used to satisfy its (current year) quarterly contribution obligation while at the same time reducing UVBs and the current year’s VRP obligation.
The least complicated version: accelerating the October 15 quarterly to September 15
The easiest example works this way: A sponsor may accelerate its October 15, 2025, quarterly contribution by one month, to September 15, 2025, count that as a contribution for 2024, generating a “temporary funding credit” which it can then use to satisfy its October quarterly contribution obligation. That contribution will also reduce the plan’s UVBs and thus the plan’s VRPs, which in turn reduces the plan’s 2025 minimum required contribution.
The math for this is pretty easy. Let’s assume the October quarterly contribution is $1M and the sponsor’s “net cost of capital” (that is, its cost of borrowing minus what it can earn in the plan on the borrowed money) for one month is 0.5% (6% per year). Then, oversimplifying somewhat, the analysis looks like this:
Cost of capital: $5,000 (0.5% * 1 month * $1M)
VRP savings: $52,000 (5.2% * $1M)
Gain: $47,000
The calculation is tighter – the tradeoff between cost of capital and VRP savings may not always work – for the January 15 quarterly contribution, which must be accelerated four months. Using our (simplified) numbers:
Cost of capital: $20,000 (0.5% * 4 months * $1M)
VRP savings: $52,000 (5.2% * $1M)
Gain: $32,000
Where there is no true-up contribution obligation, re-label the April 15 and July 15 quarterlies
The process for the April 15 and July 15 quarterly contributions is even simpler, so long as there is no obligation to make a true-up contribution. In that case, getting credit against UVBs is (literally) just a matter of labelling – the contribution is made on the usual date (April 15 or July 15) but labelled “for” 2024, generating a “temporary funding credit” that is immediately used to satisfy the quarterly contribution obligation.
Where there is a true-up contribution obligation, it must be paid off first
But, where there is a true-up contribution obligation, it must be paid off before additional contributions can be made to generate a “temporary funding credit.” Let’s assume our plan/sponsor still owes $2M for 2024 and wants employ our strategy for the April 15 and July 15 quarterly contributions:
Cost of capital: $50,000 (0.5% * 5 months * $2M)
VRP savings (5.2% or $2M): $104,000
Gain: $54,000
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Except in the simplest case, there are a lot of moving parts to this analysis. And there are situations in which this strategy cannot be used. Sponsors of underfunded plans will want to discuss this strategy with their advisors before going forward with it.
We will continue to follow this issue.