A defined benefit pension plan with more assets than it needs to pay promised benefits gives the sponsor a menu of options for an overfunded defined benefit plan: pause employer contributions, sweeten participant benefits, use the surplus to shed pension risk through lump-sum windows or annuity buyouts, move excess assets into a retiree health or life insurance account under a narrow tax carve-out, terminate the plan and take a reversion at a heavy tax cost, or leave the cushion in place. Which options are actually open depends on how far above 100% funded the plan sits.
When a Plan Counts as Overfunded
A plan is overfunded when its assets exceed the present value of accrued benefits. That ratio is the funding target attainment percentage, or FTAP. An enrolled actuary sets the funding target each year using the interest rate and mortality assumptions locked in by the Pension Protection Act of 2006, and those assumptions often produce a higher liability figure than a sponsor’s corporate accounting numbers do.
A plan at 101% funded has a paper surplus and little else. The strategies below generally need real headroom above 100%, and several have hard thresholds of 110%, 120%, or 125% before they open up.
Stop or Reduce Employer Contributions
The most immediate use of a surplus is to stop funding the plan. When assets exceed the funding target, the minimum required contribution drops to zero and the sponsor takes what is informally called a contribution holiday. Cash that would have gone into the trust can go to operations, debt reduction, or shareholder returns. The holiday lasts as long as the surplus does; a market drop or a demographic shift can end it.
Sponsors that keep contributing above the minimum can elect a prefunding balance under IRC Section 430(f). The balance earns interest at the plan’s actual rate of return and can be applied against future minimum required contributions, effectively banking today’s overpayment for later use.1eCFR. 26 CFR 1.430(f)-1 – Effect of Prefunding Balance and Funding Standard Carryover Balance It sits between a full holiday and continued funding at prior levels, and it can absorb some of the volatility that comes with a pure holiday.
Improve Participant Benefits
A sponsor can direct surplus toward richer benefits. Common moves include adding a cost-of-living adjustment for retirees and raising the accrual rate for active employees. Any improvement takes a formal plan amendment and, once adopted, is irrevocable. The actuarial value of the new benefits consumes part of the surplus and lowers the FTAP.
Benefit improvements also show up as a strategic tool during plan termination, where they can qualify a sponsor for the lower excise tax rate on a reversion.
De-Risk With Lump Sums and Annuity Buyouts
A surplus gives the sponsor the cushion needed to move pension obligations off the balance sheet without triggering a new funding call.
Lump-Sum Windows
The sponsor opens a time-limited window, typically 60 to 90 days, during which terminated vested participants can elect a one-time payment in place of a future monthly pension. Each acceptance removes that participant’s liability from the plan. Plans below 80% funded can’t pay lump sums under the Pension Protection Act’s benefit restriction rules; overfunded plans have no such barrier.
Annuity Buyouts
The sponsor buys a group annuity from an insurer, which then takes over paying benefits to a defined group of retirees. Investment risk and longevity risk shift to the insurer. The premium comes out of plan assets, and the surplus lets the sponsor fund it without a fresh contribution obligation.
Both strategies permanently shrink the plan’s headcount and liability. A sponsor with enough of a surplus can run them together, offering lump sums to deferred vested participants and buying annuities for current retirees, winding down risk without a formal termination.
Transfer Surplus to Retiree Health or Life Insurance Accounts
IRC Section 420 is a narrow exception that lets a sponsor move excess pension assets into a retiree health benefits account or a retiree life insurance account, sidestepping the reversion excise taxes. The transferred funds pay current retiree health or life insurance costs, and the transfer is excluded from the employer’s gross income.2Office of the Law Revision Counsel. 26 USC 420 – Transfers of Excess Pension Assets to Retiree Health Accounts
A standard qualified transfer requires plan assets above 125% of the funding target plus target normal cost. Only one transfer per taxable year qualifies, though a single transfer can go to both a health account and a life insurance account and still count as one. The amount is capped at what the plan reasonably expects to spend on qualifying retiree benefits during the transfer period. After the transfer, the employer has to keep retiree health spending at or above the prior level for a cost maintenance period of five taxable years starting with the transfer year.2Office of the Law Revision Counsel. 26 USC 420 – Transfers of Excess Pension Assets to Retiree Health Accounts Cutting benefits inside that window triggers penalties. Anything transferred and unused during the transfer period goes back to the pension plan and is treated as an employer reversion subject to a 20% excise tax.
Qualified Future Transfers
A qualified future transfer spreads the transferred amount over between two and ten consecutive taxable years starting with the transfer year. The funding bar is slightly lower, at more than 120% of the funding target plus target normal cost.2Office of the Law Revision Counsel. 26 USC 420 – Transfers of Excess Pension Assets to Retiree Health Accounts Sponsors carrying large ongoing retiree medical costs get a longer runway to work down the surplus this way.
The SECURE 2.0 De Minimis Option
SECURE 2.0 added a de minimis transfer with a lower threshold. A plan that has been at least 110% funded for the current year and the two preceding years can transfer up to 1.75% of plan assets to a retiree health or life insurance account, even if it doesn’t clear the 125% bar.2Office of the Law Revision Counsel. 26 USC 420 – Transfers of Excess Pension Assets to Retiree Health Accounts The trade is a longer cost maintenance period of seven taxable years rather than five. SECURE 2.0 also extended the sunset for all Section 420 transfers to December 31, 2032.
Terminate the Plan and Take a Reversion
The most aggressive option is an employer reversion, where the sponsor removes surplus assets from the plan and takes them as corporate cash. It’s available only through ERISA’s standard termination process, and the tax structure is built to make it a last resort.
The Tax Cost
IRC Section 4980 imposes a 20% excise tax on any employer reversion from a qualified plan. That rate rises to 50% unless the employer either sets up a qualified replacement plan covering at least 95% of the terminated plan’s active participants or amends the terminated plan to provide a pro rata increase in accrued benefits.3Internal Revenue Service. Revenue Ruling 2003-85 Employers that do neither face the 50% rate.
On top of the excise tax, the reverted amount is included in the employer’s gross income under IRC Section 61.3Internal Revenue Service. Revenue Ruling 2003-85 At a 21% corporate rate, a sponsor paying the 50% excise plus income tax keeps roughly 29 cents on the dollar. Even at the 20% rate, combined federal tax takes about 37 cents on the dollar.
Qualifying for the 20% Rate
Two conditions unlock the lower rate through a qualified replacement plan. At least 95% of the active participants from the terminated plan who remain employed have to become active in the replacement plan. And the employer has to transfer 25% of the maximum potential reversion directly from the terminated plan into the replacement plan before taking anything out as a reversion.3Internal Revenue Service. Revenue Ruling 2003-85 That transferred amount isn’t taxed as income and isn’t treated as a reversion.
Alternatively, the employer can amend the terminating plan within 60 days before termination to provide a pro rata benefit increase that takes effect at termination. The value of those increased benefits reduces the reversion, and what remains is taxed at 20%.
What Termination Requires
A reversion requires a standard termination, which means the plan must have enough assets to satisfy every benefit obligation. All accrued benefits are settled through lump-sum payments or irrevocable annuity contracts from a licensed insurer, with participant notices and PBGC filings along the way.4Pension Benefit Guaranty Corporation. Standard Terminations Between notice periods, actuarial work, benefit distributions, and PBGC review, the process commonly runs beyond a year before the sponsor sees any cash.
Leave the Surplus in Place
Doing nothing is a real option. A large surplus buffers the two biggest risks a defined benefit plan faces: investment losses and participants living longer than the mortality tables project. A plan 120% funded today can absorb a significant market drop without falling below 100% and triggering mandatory contributions or benefit restrictions.
Keeping the cushion also preserves optionality. A well-funded plan can move on de-risking transactions or benefit improvements on the sponsor’s timing rather than under regulatory pressure. Investment returns on the surplus compound, potentially funding future obligations with no further employer contributions.
Reporting Duties That Come With a Surplus
An overfunded status doesn’t remove disclosure obligations; it changes what gets disclosed. Plan administrators file Schedule SB with the annual Form 5500, reporting the market value of assets, the funding target, and the FTAP to the IRS and Department of Labor.
Participants get an annual funding notice under ERISA Section 101(f). It has to disclose whether the FTAP is at least 100% for the current and two preceding plan years, along with total assets, liabilities, participant demographics, the plan’s funding policy, and its asset allocation.5eCFR. 29 CFR 2520.101-5 – Annual Funding Notice for Defined Benefit Plans Administrators generally have 120 days after the close of each plan year to furnish the notice, and SECURE 2.0 revised the format starting with the 2024 plan year, so single-employer plans should confirm their notices track the updated template.6U.S. Department of Labor. ERISA’s Annual Funding Notice Requirements Following SECURE 2.0