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Overfunding Issues

Cash Balance and Defined Benefit Plans

How They Arise and How They Can Be Fixed

Overfunding your cash balance or defined benefit plan can cause serious issues. Plans become
overfunded when the plan sponsor funds more than the contribution amount recommended by
Corvus Pension Actuaries, LLC, or the plan assets grow more aggressively than the pension
plan’s actuarial interest rate (usually set to 5% annually).

Maximum Distributable Limit
The maximum distributable limit or maximum lump sum is the largest lump sum value that a
participant is allowed to receive as a distribution from a pension plan. The maximum lump sum
is calculated according to a formula defined in the pension plan rules and regulations and
factors in a participant’s age, the average of the participant’s highest 3 consecutive years of
wages, years of service, interest rates, mortality rates, and other IRS defined limits.

This illustration below shows maximum lump sum amounts for a participant aged 62 with
various years of participation and average wage amounts:

Maximum Distributable Limit

As the illustration shows, a business owner, sponsoring a pension plan, can distribute $3.5
million from the plan at retirement age, if they have a high-3 wage average of more than
$300,000 and have participated in the plan for at least 10 years.

The plan sponsor should develop a funding and investment strategy that keeps the value of plan
assets less than the total maximum lump sum.

Reversion, the Worst-Case Scenario
When a plan, that is overfunded above the participants’ total maximum lump sum amount,
terminates it reverts the overfunded assets to the company sponsoring the plan. Reverted plan
assets are considered taxable income to the company in the year of reversion. This means 20%
- 48% of the reverted assets will be paid to the IRS in the form of taxes, depending on the
company’s tax situation. Additionally, there is a 50% excise tax assessed on reverted assets.

Between the income tax and excise tax, 70% - 98% of the reversion will be paid to the IRS in
taxes. Obviously, plan sponsors want to avoid a reversion of plan assets.

Solving Overfunding Issues
Below are solutions to solve overfunding issues starting with the simplest and moving to more
complex solutions.

The best solution for overfunding is avoiding it altogether. Plan sponsors who do the following
with avoid becoming overfunded:

  • Develop a conservative investment strategy: Every pension plan has an actuarial interest rate. This rate is usually between 4 - 5.5% annually. Plan sponsors should know their actuarial interest rate and work with their financial advisor to develop a conservative investment strategy that targets the actuarial interest rate.

  • Fund recommended contribution amounts: Every year, Corvus Pension Actuaries, LLC prepares an actuarial valuation for each pension plan and provides the allowable funding range for the plan year. Additionally, we provide a recommended funding amount that will fully fund the plan benefits. Plan sponsors shouldn’t fund more than the recommended contribution amount. Plans that are funded above the recommended contribution amount will become overfunded.

Pay Fees from Plan Assets
Plan sponsors can pay Corvus Pension Actuaries, LLC’s fees from the pension plan assets. By
paying our fees from the plan, companies can lower their expenses and the amount of plan

As seen in the illustration above, a participant’s maximum lump sum increases as their years of
plan participation increase. If participants have less than 10 years of participation, their
maximum lump sum amounts will increase by waiting and accruing additional years of

Increase Wages
The maximum distributable limit considers the average of a participant’s highest 3 consecutive
years of wages (high-3 average). If participants haven’t taken maximum wages in previous
years and the company is able to pay them higher wages in the future, increasing wages will
increase the maximum lump sum. The company should plan to pay high wages for 3
consecutive years. Once the new high-3 average is established, the company can lower the
participants wages in the following years.

Adding Family Members to the Plan
Business owners can hire and pay their spouses, children, parents, siblings, etc. to establish a
pension plan benefit for them. The benefits accrued to family members will reduce the
overfunding in the plan while providing them with additional retirement security.

Qualified Replacement Plan

The IRS allows plan sponsors to roll the overfunded assets into a qualified replacement plan.
The qualified replacement plan is a 401(k) plan that covers participants from the pension plan.
The overfunded assets are rolled into an unallocated account in the 401(k) Plan and are
allocated to participants over 7 years. This solution requires plan sponsors to open and sponsor
a 401(k) plan until the unallocated assets are fully allocated. Our office has used this approach
as a solution for $500,000 to $1,500,000 in overfunding.

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