Practitioner questions – Reverse spinoff
On July 25, 2018, PBGC staff addressed a multitude of practitioner-submitted questions on a variety of topics. One of these topics, under the “Premiums” section, specifically raises the issue of a “two-step transaction” to reduce variable-rate premiums:
PBGC’s premium regulations (29 CFR Part 4006) provide that:
- A single-employer plan exiting the defined benefit system (via a standard termination) is exempt from the variable-rate premium (VRP) in its final year, and
- Premiums are pro-rated for new plans created as the result of a spinoff from another plan if the new plan’s initial plan year is a short plan year (i.e., less than 12 months).
In each of these situations, the plan owes a significantly lower PBGC premium that it would have had the applicable special rule not applied.
Some plans are considering a strategy to avoid paying a significant portion of the statutory VRP by doing a two-step transaction under which (1) most plan participants are spun off late in the year into a new plan that is virtually identical to the old plan, but with a new name, EIN, and plan number, leaving only a small group of retirees in the original plan and (2) what’s left of the original plan is terminated (i.e., annuities are purchased for the remaining retirees). If the premium rules noted above apply to plans doing these transactions, the aggregate premium would be significantly lower than the premium that would have been owed had the plan remained intact and simply purchased annuities for that group of retirees. Do the special premium rules noted above apply in this situation?
PBGC staff responses
While the PBGC does issue a disclaimer before its staff responses, the PBGC staff response addresses three overarching concerns in this approach:
- ERISA section 4006 does not specifically provide for premium reductions in these situations.
- These special rules were adopted to address very specific one-time scenarios.
- The PBGC is concerned that this approach is form over substance.
Given the language used in the PBGC staff response, even considering the disclaimer from the PBGC, there is significant cause for concern upon thorough examination of the reverse spinoff approach.
While a qualified ERISA attorney may be needed to dissect the exact text of ERISA section 4006 and its corresponding implications, let’s examine the theoretical approach from the practitioner’s perspective followed by the shortcomings of the approach from the PBGC’s perspective.
From the practitioner’s perspective, assuming that reduction in variable-rate premium is paramount, consideration is only given to navigating the exact rules as described in ERISA section 4006. The “two-step transaction” will create a new plan near the end of the plan year while terminating the old plan. The new plan essentially continues the life of the old plan except that the first year for the new plan is considered a short plan year. Therefore, the variable-rate premium would be prorated to reflect the short plan year (as well as the flat-rate premium). The terminating old plan purchases annuities and ceases to exist, and so no variable-rate premium is due. The end result is that effectively all of the variable-rate premium is avoided for the current plan year.
From the PBGC’s perspective, this transaction encourages form over substance in its exploitation of rules without proper consideration of the underlying principles. The old plan purchases annuities and no longer has variable-rate premium obligations. The participants in the new plan still have accrued/accruing benefits with corresponding assets that are still less than the present value of the future benefit obligations on the PBGC’s mortality and interest rate basis. The intention of the variable-rate premium exemption for the terminating plan is to recognize the reality that a standard plan termination requires a plan to be fully funded, thereby negating the need to levy a premium on the unfunded liability at the beginning of the year.
While the PBGC did not issue formal guidance on the reverse spinoff approach, its concern and likely denial of any filing manipulated in this manner highlights the need to consider any PBGC premium reduction approach carefully. Many ERISA counsels and practitioners also share PBGC concerns because it seems to follow the legal concept of a “step transaction” to circumvent valid PBGC premiums. The reality is that this strategy does not reduce the risk to the PBGC system unlike fully terminating a plan. Further, the PBGC was especially suspicious of this approach as it theoretically could be repeated annually to continuously avoid variable-rate premiums, which supports the position that it is a “step transaction” from a legal perspective.
There are retirement plans that have potentially already used this approach to achieve the premium savings. Many interpret this PBGC guidance to mean that plans sponsors that have already completed a “reverse spinoff transaction” may have underpaid their PBGC premiums and could be subject to penalties.
As more approaches continue to emerge in the ongoing battle to reduce expenses for retirement plans, it is vital to consider whether any approach is appropriately addressing the issue at hand. Any approach to reduce premiums needs to consider how it is satisfying regulations under a rules-based as well as a principles-based lens.