Retirement Plan Rescue Story #1 : Keeping an "Overfunded" Pension Plan from Being Terminated
The Challenge
A business owner came to us after receiving confusing news from their retirement plan actuary.
Their Defined Benefit (Cash Balance) Plan had performed exceptionally well over several years; strong investment returns seemed to have created what’s called an overfunded Plan. While it seems like a positive name, an overfunded plan can create excessive and unexpected tax liabilities.
So, their actuary recommended terminating the Plan by transferring the excess assets into the company's other Plan, a 401(k)/Profit Sharing Plan, before eventually closing both Plans, a lengthy and complicated process.
The Hidden Risk
The recommendation seemed straightforward. But something just didn't feel right to our team. While it would solve the immediate overfunding issue, it would also create several new problems.
First, once participants reached their maximum allowable benefit levels, excess assets could revert back to the employer and be subject to heavy taxes. In similar situations, employers often lose the overwhelming majority of excess assets to taxes.
Second, while the original cash balance plan primarily benefited key executives and owners, the intention was for the replacement plan to cover the entire employee population. That meant that excess assets transferred into the replacement plan had to be allocated according to that plan's rules—not simply redirected to the executives.
The recommendation solved one problem while potentially creating two much larger ones.
The Rescue
So, instead of simply asking, "How do we get rid of the excess assets?" we asked a different question:
"What happens if we keep the assets?"
Our team projected the plan several years into the future, instead of focusing solely on its current position.
Their analysis revealed something important.
Defined benefit plans are generally designed around predictable, long-term returns—not years of exceptional market performance like this plan had achieved. So, if the employer adjusted the investment strategy toward more stable, conservative returns and simply allowed the plan to continue operating, something else would naturally occur over time.
Namely, IRS benefit limits would continually increase with annual cost-of-living adjustments, gradually “absorbing” much of the excess funding over the coming years.
In other words, with good proactive planning, the problem could naturally resolve itself.
The Outcome
So, rather than terminating the plan, the employer was able to choose a much simpler path: retain the existing plan, adjust the plan’s investment strategy to better align with actuarial assumptions, and allow future benefit increases to naturally reduce the surplus over time, thus avoiding unnecessary taxes or having to reallocate any assets.
The Lesson
Most importantly, they avoided making a permanent decision based on a temporary situation.
Sometimes the best solution isn't taking immediate action—it's understanding how today's decisions will affect the next five or ten years.
Retirement plans should never be managed by looking only in the “rearview mirror”, i.e., what happened last year. Good retirement plan management also isn't just about calculating numbers correctly. It's knowing that patience is often a key part of the strategy.
