Funding Rabbi Trust - Impact of the Financial Crisis

Overview of Non-Qualified Plan Funding Restrictions

In general, during any "restricted period", if an employer maintains both a qualified defined benefit pension plan and a non-qualified deferred compensation arrangement, the ability of the employer to set aside or transfer funds to Rabbi trusts to fund the non-qualified plan will be restricted. Any such set aside or transfer to such a trust for the non-qualified plan during this restricted period will trigger adverse taxation to certain executives covered by the plan.

For purposes of these rules, the term "restricted period" covers any of the three periods:

1. The time when the qualified defined benefit plan sponsor is a debtor in bankruptcy.

2. Six months before or after the date that an underfunded defined benefit plan is terminated, or

3. Any period during which a qualified defined benefit plan is "at risk" under section 430(i).

At-Risk Rules

A qualified defined benefit plan will be at-risk for a particular plan year if, for the preceding plan year, its assets for both less than 80% of the funding target (subject to phase-ins) using an actuarial assumption, and two, less than 70% of its funding target using certain special actuarial assumptions.

For purposes of the 80% threshold, there is a transition rule, which provides that the applicable funding threshold for determining at risk status is 65% for 2008, 70% for 2009, and 75% for 2010.

Small Plan Exemption or Exception

The at-risk rules generally do not apply to small qualified plans, which are defined as qualified plans that, on each day during the preceding plan year, have 500 or fewer participants. For purposes of this exception, all qualified defined benefit plans maintained by the same employer will be treated as one plan.

Non-Qualified Plan Funding Restrictions

The non-qualified plan funding restrictions restrict assets being "set aside or reserved in a trust or transferred to such trust or other arrangement" in order to pay to non-qualified deferred compensation. These restrictions also apply if a non-qualified deferred compensation plan provides that assets will become restricted to the provision of benefits under the plan in connection with the restricted period with respect to the qualified defined benefit plan or if the assets are, in fact, so restricted. If a transfer is made to a Rabbi trust or other funding vehicle during the restricted period, then the amounts transferred are treated as a transfer of property under Section 83 (regardless of whether the amounts are available to satisfy the claims of creditors), and therefore would be subject to a taxation if vested. The amounts so included would also be subject to an additional 20% tax and interest at the IRS underpayment rate plus 1% from the date of the initial deferral or vesting under Section 409A.

Impact of the Financial Crisis

The assets set aside to fund defined benefit plans have decreased sharply during the past months of this financial crisis. Because the non-qualified plan funding restrictions only apply during a restricted period, if a company anticipates that as of January 1, 2009, the assets in a defined benefit plan may cause the funding percentage to be 70% less; consideration should be given to what the company wishes to set aside money in a Rabbi trust or other similar arrangement for the covered executives to avoid the impact of these restrictions, and if so when does the company need to make that transfer.

As always, you should consult with your defined benefit plan sponsor and legal and tax counsel to tackle this complex question. However, in light of the absence of any definitive guidance in this area, a number of companies are considering transferring assets to Rabbi trusts for the end of 2008 with the intention of avoiding these restrictions.

Please feel free to contact an EBN Producer for more information on this important matter.