Understanding Section401(a)(9)

Section401(a)(9) of the Internal Revenue Code governs the minimum funding rules for definedbenefit pension plans. It sets the requirements that plan sponsors must follow to keep a plan adequately funded and to protect participants accrued benefits.

Purpose of Section401(a)(9)

The statutes primary goal is to ensure that a definedbenefit plan maintains a funding level that is sufficient to meet promised benefits. By establishing a minimum funding standard, the law protects participants from the risk that a plan will become underfunded and that benefits will have to be reduced or delayed.

Key Concepts and Definitions

Plan Assets The total value of all investments, cash, and other assets held by the plan.
Liabilities The actuarially determined present value of all benefits accrued to participants.
Funding Standard The minimum level of assets that must be maintained relative to liabilities.
Employer Contributions Mandatory contributions required each year to keep the plan within the funding standard.

Understanding these terms is essential before tackling the detailed requirements of the code.

Minimum Funding Requirements

Section401(a)(9) imposes an annual minimum funding test. The test compares the plans funded status (assets divided by liabilities) to the minimum required funded status (MRFS), which is calculated using a statutory formula. If a plans funded status falls below the MRFS, the sponsor must make a minimum required contribution (MRC) to raise the plan back into compliance.

A plan that fails the minimum funding test is required to make contributions that are sufficient to bring the funded status up to at least the MRFS within the next 12 months.

Actuarial Values Used in the Test

The calculation relies on three actuarial values that must be updated at least once every three years:

Actuarial Accrued Benefit Obligation (AABO) The present value of benefits accrued to date, plus a youngworker floor adjustment.
Actuarial Normal Cost (ANC) The cost of benefits accrued during a single plan year.
Actuarial Value of the Normal Cost (AVNC) The present value of ANC discounted at the statutory rate.

These values feed directly into the MRFS formula, which determines how much a plan must be funded to be considered compliant.

Funding Methods: Traditional vs. Integrated

Plans may choose either a traditional method, which uses only the plans own assets, or an integrated method that incorporates Social Security benefits into the calculation. Integrated plans must follow a separate set of actuarial assumptions and must consider the integration factor that reflects the expected Social Security offset.

Most large corporate plans use the traditional method because it provides clearer control over funding levels, but many publicsector plans adopt integration to reflect the role of federal pension benefits.

Employer Contributions Required by 401(a)(9)

There are three types of contributions a sponsor may be required to make:

Minimum Required Contribution (MRC) The amount needed to satisfy the minimum funding test.
Required Contribution (RC) A greater amount that may be mandated if the plans underfunded status is significant. The RC is calculated using a supplementary formula that considers the plans underfunded status and a correction factor.
Discretionary Contribution An additional contribution the sponsor may elect to make to improve the funded status beyond the minimum.

All contributions must be made by the contribution deadlinegenerally the tax filing date for the plan year, plus extensions.

Benefit Corrections and Participant Rights

If a plan is underfunded, participants have limited rights to demand immediate benefit increases. However, the Internal Revenue Service (IRS) and the Pension Benefit Guaranty Corporation (PBGC) monitor plans to ensure that participants accrued benefits are protected.

When a plan fails the minimum funding test, the sponsor must provide written notice to participants, explaining the shortfall, the corrective actions being taken, and any impact on the plans future benefit accruals.

Penalties, Safeguards, and Disqualification Risks

Failure to meet the 401(a)(9) requirements can trigger several adverse consequences:

Tax Penalties The IRS may impose excise taxes on the sponsor for late or insufficient contributions.
PBGC Premium Increases An underfunded plan pays higher insurance premiums, increasing costs for the sponsor.
Plan Disqualification Repeated or severe noncompliance can lead to the loss of the plans taxqualified status, making contributions nondeductible and benefits taxable.

To avoid these outcomes, sponsors often adopt funding policies that aim for a funded status well above the MRFS.

Practical Steps for Plan Sponsors

Annual Funding Review Conduct a funding analysis each year before the contribution deadline. Use a qualified actuary to determine the AABO, ANC, and AVNC.
Maintain Updated Assumptions Review mortality tables, discount rates, and salary growth assumptions at least every three years, or sooner if market conditions change dramatically.
Document Contribution Decisions Keep written records of the calculations, the contribution amount chosen, and the rationale for any discretionary contributions.
Communicate with Participants Provide the required notice on funding status and any corrective actions. Transparency can reduce participant concerns and potential litigation.
Monitor PBGC Premiums Track how funding levels affect insurance premiums and incorporate these costs into budgeting.
Plan for Contingencies Establish a reserve or a smoothing technique (allowed under certain circumstances) to mitigate the impact of market volatility on annual funding results.