Understanding Minimum And Maximum Funding Levels For Defined Benefit Plans

By: Bryan Uecker, QPA, QPFC, AIF, AIFA

Defined Benefit (DB) plans are a cornerstone of retirement planning for many employers and employees. These plans promise a specific benefit amount to participants upon retirement, making them a reliable source of income. However, maintaining a DB plan requires careful attention to funding levels, as both minimum and maximum funding requirements are heavily regulated to ensure solvency and compliance with federal laws. In this article, we’ll explore the concepts of minimum and maximum funding levels, why they matter, and how they impact plan sponsors.

Minimum Funding Levels: Ensuring Plan Solvency

What Are Minimum Funding Requirements?

Minimum funding levels are the least amount of contributions that an employer must make to a DB plan to ensure it remains solvent and capable of meeting its future obligations. These requirements are governed by the Employee Retirement Income Security Act (ERISA) and enforced by the IRS. The goal is to protect plan participants by ensuring that the plan has enough assets to pay promised benefits

How Are Minimum Contributions Calculated?

Minimum contributions are determined based on actuarial calculations that
consider:

For example, the Pension Protection Act of 2006 (PPA) requires plans to become 100% funded over time, meaning the plan’s assets must equal its liabilities. If a plan falls below this threshold, the employer must make additional contributions to close the funding gap.

Consequences Of Falling Below Minimum Funding

If a DB plan is underfunded, the employer may face:

Maximum Funding Levels: Avoiding Overfunding

What Are Maximum Funding Limits?

While minimum funding ensures solvency, maximum funding limits prevent employers from over-contributing to a DB plan. Overfunding can lead to tax complications, as contributions to a DB plan are tax-deductible only up to certain limits. The IRS sets these limits to prevent excessive tax sheltering.

How Are Maximum Contributions Determined?

The maximum funding level is based on the actuarial value of the plan’s liabilities and the IRS-imposed limits on benefits. For 2025, the maximum annual benefit for a participant is the lesser of:

Employers must work closely with actuaries to ensure contributions do not exceed these limits.

What Happens If A Plan Is Overfunded?

Overfunding can create challenges for plan sponsors, especially if the plan is terminated. Excess assets in the plan may be:

Reallocated to participants in a non-discriminatory manner, though owners may not benefit if their formula is maxed out.
Transferred to a 401(k) plan and used as profit-sharing contributions for up to seven years.
Reverted to the employer, but this triggers taxation as corporate income and an excise tax of 20-50%.

Balancing Minimum And Maximum Funding

Underfunding can jeopardize the plan’s ability to meet its obligations, while overfunding can lead to inefficiencies and tax penalties. Proper funding ensures:

Strategies For Managing Funding Levels

Regular Actuarial Reviews: Actuaries can help monitor funding levels and adjust contributions as needed.
Liability-Driven Investing (LDI): This investment strategy matches plan assets with liabilities, reducing volatility and maintaining consistent funding levels.
Funding Relief Measures: Legislation like the American Rescue Plan Act (ARPA) and the Infrastructure Investment and Jobs Act (IIJA) has provided funding relief by lowering minimum contribution requirements and extending interest rate smoothing provisions.

Conclusion

Defined Benefit plans require careful management of funding levels to ensure compliance with federal regulations and the long-term stability of the plan.

You’re on our updated website — refreshed for a better client experience.

Who We Are

Blog

Newsletter

Client Spotlight

Tax Insights

Blog

Newsletter

Tax Insights

Understanding Minimum And Maximum Funding Levels For Defined Benefit Plans

Minimum Funding Levels: Ensuring Plan Solvency

What Are Minimum Funding Requirements?

How Are Minimum Contributions Calculated?

Consequences Of Falling Below Minimum Funding

Maximum Funding Levels: Avoiding Overfunding

What Are Maximum Funding Limits?

How Are Maximum Contributions Determined?

What Happens If A Plan Is Overfunded?

Balancing Minimum And Maximum Funding

Strategies For Managing Funding Levels

Conclusion

Blog

Newsletter

Client Spotlight

Tax Insights

Client Portal

DRDA Payroll Services

Make a Payment

Support