What information does the Annual Funding Notice for a defined benefit (DB) plan reveal and why is it important?
ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in Missouri is representative of a common question related to DB plan Annual Funding Notices.
Highlights of Discussion
The Annual Funding Notice is one of several important retirement plan notifications that should be considered as part of a comprehensive financial planning process. It is one of the best tools for a participant and his or her advisor to measure the solvency or health of a DB plan.
The law requires sponsors of all DB plans that are subject to Title IV of the Employee Retirement Income Security Act of 1974 (ERISA) to provide an Annual Funding Notice to each DB plan participant and beneficiary, as well as other entities. Businesses that fail to provide an Annual Funding Notice each year face a Department of Labor (DOL) penalty of $110 per day of delay, up to a maximum of $1,100 per request. (See related final DOL Regulations, which include a model notice, at Annual Funding Notice for Defined Benefit Plans.) 
The notice provides participants with information about
- How well the pension plan is funded, measured by the funding target attainment percentage (FTAP);
- The value of pension plan’s assets and liabilities;
- How a pension plan’s assets are invested; and
- Employer events taking place during the current year that are expected to have a material effect on the plan’s liabilities or assets
- The legal limits on how much the Pension Benefit Guaranty Corporation (PBGC) can pay participants if the PBGC (the federal agency that insures private-sector DB plans) determines it is in the participants’ best interest to step in and take control of the plan.
The first thing to focus on when looking at an Annual Funding Notice is the FTAP, which is a measure of how well the plan is funded to meet liabilities on a particular date. This figure is the best single indicator of the current health of a DB plan. The FTAP must be reported for the current year and two preceding years. In general, the higher the percentage, the better funded the plan and the better able the plan is to pay promised benefits. The FTAP is a determinant as to whether the plan is considered “at risk.”
If a plan’s FTAP for the prior plan year is below 80 percent that is the first indication the plan may be entering at-risk status. The plan’s actuary calculates whether a plan is at risk using the FTAP and a multi-step process. At-risk plans require more funding by the employer because they are required to use actuarial assumptions that result in a higher value of plan liabilities. The annual funding notice must state whether the plan has been determined to be in at-risk status, and must reflect the increased at-risk liabilities due.
Beyond the FTAP, Annual Funding Notices must include important information regarding a DB plan’s assets and liabilities. For example, notices must include a statement of the value of the plan’s assets and liabilities on the same date used to determine the plan’s FTAP. Notices also must include a description of how the plan’s assets are invested as of the last day of the plan year.
Annual Funding Notices must disclose “material effect events,” which are plan amendments, scheduled benefit increases (or reductions) or other known events having a material effect on the plan’s assets and liabilities if the event is taken into account for funding purposes for the first time in the year following the notice year. If an event first becomes known to a plan administrator 120 days or less before the due date of a notice, the plan administrator is not required to explain, or project the effect of, the event in that notice.
Finally, Annual Funding Notices must include a general description of the benefits under the plan that are guaranteed by the PBGC, along with an explanation of the limitations on the guaranteed benefits and the circumstances under which such limitations apply.
Some DB plan sponsors must provide supplements to their plans’ standard Annual Funding Notices if all three of the following circumstances are true:
- The funding target is less than 95% of the funding target determined without regard to the adjusted interest rates of MAP-21 and HAFTA, and
- There is a funding shortfall greater than $500,000, and
- There are 50 or more participants on any day during the preceding plan year. (See supplemental Notice Guidance FAB 2013-01 and FAB 2015-01. )
With the information on this supplement, participants will be able to compare the FTAP, funding shortfall in dollars, and minimum required contributions in dollars calculated with the adjusted interest rates of MAP-21/HAFTA and without MAP-21/HAFTA adjusted interest rates for the applicable plan year and the two preceding years. The most conservative approach to evaluating this information from a retirement planning standpoint is to focus on the numbers “without adjustment,” which in recent years have resulted in lower funding levels than calculations made using the MAP-21/HAFTA adjusted interest rates.
The Annual Funding Notice is one of several important retirement plan notifications that should be considered as part of a comprehensive financial planning process. It reveals important information about the overall health of a DB plan, such as how well the plan is funded, assets and liabilities, the plan’s investment policy, business events that may affect the plan and whether the plan is considered at risk.