Defined Benefit Pension Plan Overfunding Strip
It is not unusual for defined benefit pension plans to have assets that exceed their actuarial liabilities. These excess assets are commonly referred to as overfunding. To directly access the overfunding, also known as the direct reversion, the shareholders of the company that sponsors the plan are subject to 50% nondeductible excise tax, corporate taxes, state and local taxes on the overfunding. This leave between 11% and 29% of the overfunding for the shareholders depending on the state and city where the corporation resides. There are several other techniques for accessing or using the overfunding with less egregious taxation. These include qualified replacement plan, adding participants, health insurance, strategic sale with underfunded plan and strategic sale strip. The strategic sale with underfunded plan has an actual underfunded defined benefit plan and the strategic sale strip does not, despite claims to the contrary.
For the strategic sale with underfunded plan strategy the purchase price for a company sponsoring an overfunded defined benefit plan almost never reflects 100% of the stated surplus. The economic value of the overfunding is its amount net of tax disallowance, excise‑tax exposure, PBGC/ERISA constraints, and legal and transactional costs. After applying these adjustments, only approximately 20–30% or less of the surplus represents realizable value. In many real transactions it is close to zero or even negative (i.e., The buyers may require that sellers pay them to assume the plan). This is not a viable strategy and can produce results far worse than a direct reversion.
In the strategic sale strip strategy transactions, no underfunded plan exists, no deficit is corrected, and no contribution is made. The shareholders of the sponsor of the overfunded plan typically realize only 70–80% or less of the surplus’s stated value through the purchase price. The sponsor is ultimately sold to another defined benefit plan, the plans are merged, and the surplus becomes an asset of the buyer’s plan. The surplus effectively finances the acquisition, while the structuring parties capture 100% of the discount between the surplus’s face value and its realizable economic value. Furthermore, approval of such a strategy by ERISA counsel may be difficult to obtain. The diagrams below show how the strategic sale strip works.
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Definitions
Legacy Plan Sponsor Shareholders of the sponsor of the overfunded defined benefit plan.
Legacy Plan Sponsor The corporation that originally sponsored the overfunded defined benefit plan.
Legacy DB Plan The seller’s overfunded defined benefit pension plan.
Buyer AcquisitionCo Shareholders Shareholders of the buyer’s acquisition company.
Buyer AcquisitionCo The company used by the buyer to acquire the Legacy Plan Sponsor.
Buyer Plan Sponsor The buyer’s company that sponsors the buyer’s defined benefit plan.
Buyer DB Plan The buyer’s defined benefit plan that purchases the stock of the sponsor of the overfunded defined benefit plan.
Strategic Sale Strip Conclusion
In summary, strip transactions provide no meaningful economic benefit; the activity consists entirely of legal and administrative processing rather than genuine pension funding. Assertions that the facilitating entity sponsors an underfunded defined benefit plan requiring additional contributions are not credible, as only 20–30% or less of the overfunding’s stated value is typically realizable. Intermediaries promoting these structures commonly charge fees equal to 20–35% or more of the overfunding and retain those fees in full. These parasitic firms operate as extractive intermediaries, prioritizing their own compensation over any legitimate effort to assist sponsors of underfunded defined benefit plans. The companies engaged in this practice operate to benefit themselves alone, capitalizing on a tax structure originally meant to protect defined benefit pension plans rather than exploiting it for private gain. Moreover, obtaining ERISA counsel approval for such a strategy may be quite difficult.