A firm currently has an overfunded defined benefit pension plan and is short of cash. The chief financial officer (CFO) is considering terminating the defined benefit plan to recapture the “excess assets.” The firm will replace the defined benefit plan with a defined contribution plan to continue to provide pension benefits to its employees. Briefly compare these alternatives to a termination. Defined benefit pension plans are funded according to actuarial formulae and an overfunded plan is one that is funded by an amount that exceeds the present value of the firm’s expected liability to its employees. A pension plan termination involves setting aside sufficient assets to satisfy the present value of the firm’s liability to its employees with the employer-corporation keeping the excess assets. Most terminations are accompanied by the firm replacing the terminated defined benefit plan with a defined contribution plan.

a. What are the tax and nontax costs and benefits of the CFO’s planned action?

b. What alternatives to the termination are available to the firm?

c. What are possible tax consequences of terminating the lan and capturing excess pension assets? Name the tax act with the year and the rate.

d. What are consequences in terms of vesting employee benefits? How do employees feel about the change?

e. Identify 3 alternatives to a pension plan termination to recover the excess assets below?