Underfunded Defined Benefit Plan: §436 Restrictions, LDI, and Contribution Strategy
Harbor Machine Works sponsors a single-employer defined benefit pension plan covering 1,800 participants. As of the January 1, 2026 valuation, the plan has a funding target of $48.0 million, assets of $37.4 million, and a funding shortfall of $10.6 million. The actuary reports a funding target attainment percentage of 78%, an at-risk FTAP of 71%, and a 2026 minimum required contribution of $3.1 million. The plan assumes a 5.10% discount rate and a 6.75% expected return on assets. The investment policy is 65% equities and 35% bonds. The company is considering a lump-sum window for terminated vested participants, shifting to a liability-driven investment portfolio, and electing an amortization extension. It has no prefunding or carryover balance. The PBGC variable-rate premium applies to the $10.6 million unfunded vested benefits. Harbor's cash flow is volatile because of cyclical capital spending.
1. What benefit restrictions under IRC §436 apply at a 78% FTAP, and how do they affect the proposed lump-sum window?
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A funding target attainment percentage of 78% is below 80%, so the plan is in the §436 benefit-restriction zone. At an FTAP of at least 60% but less than 80%, lump-sum payments are restricted: the plan cannot pay a lump sum greater than 50% of the benefit that would otherwise be payable, and other accelerated benefit options are limited. Because the at-risk FTAP is 71%, still above 60%, the plan is not in the harshest zone, but the lump-sum window cannot be implemented as a full unlimited window. The plan also cannot adopt new shutdown or unpredictable contingent event benefits while below 80%. For the proposed window, I would confirm the AFTAP certification, limit lump sums to the §436 maximum, and exclude participants whose payments would exceed the limit. If the goal is de-risking, a window may still work for small balances, but it will not be a full liability settlement. The actuary should also confirm whether the at-risk rules change the FTAP used for §436.
2. Evaluate the LDI proposal. What are the trade-offs for contribution volatility, PBGC premiums, and funded status?
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The 65/35 equity/bond portfolio has substantial funded-status risk: a 20% equity decline could wipe out a large part of the $37.4 million asset base and push the FTAP below 60%, triggering harsher restrictions. An LDI shift would better match liability duration and reduce the chance of contribution spikes and PBGC variable-rate premium increases. The trade-off is lower expected return, which may raise the accounting expense and, over time, require higher contributions if the plan is not fully funded. But because the plan is only 78% funded, a full LDI move now would lock in a low expected return while the plan still has a $10.6 million shortfall. I would recommend a partial glide path: move perhaps 20-30% of assets into long-duration bonds now, with triggers that increase the LDI allocation as the FTAP reaches 90% and 100%. Keep some growth assets to close the shortfall. Also model the PBGC variable-rate premium: reducing unfunded vested benefits through contributions or asset performance lowers the VRP, but investment volatility can raise it.
3. Recommend a funding strategy for 2026, including whether to use the amortization extension and how to address the PBGC variable-rate premium.
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The 2026 minimum required contribution is $3.1 million, and the plan has no prefunding or carryover balance to offset it. An amortization extension can lower the current-year cash contribution, but it extends the shortfall amortization and increases total future contributions; it is most useful if Harbor's cash flow is temporarily constrained. Given volatile capital spending, I would not automatically elect the extension. First, compare the cash savings with the added future cost and the PBGC VRP effect. Each $1 million of contribution reduces unfunded vested benefits and, at the current VRP rate, saves roughly $52,000 of variable-rate premium, so contributions have a secondary return. I would fund at least the $3.1 million minimum, consider a modest additional contribution if cash flow allows, and adopt a formal funding policy with a target FTAP of 90% over five to seven years. For the lump-sum window, proceed only within §436 limits. For investments, adopt the partial LDI glide path rather than an all-at-once shift.