Highway Funding Bill Maps Directions for Pension Plan Interest Rates
By Mark Johnson, J.D., Ph.D.
Pension funding guidelines travelled an unusual road this summer as part of the transportation bill “Moving Ahead for Progress in the 21st Century Act” (also known as MAP-21), which was signed into law on July 6, 2012.
Taking a detour from the normal highway reauthorization programs funded by the Highway Trust Fund, MAP-21 also contained a mile post known as Section 40312, Pension Funding Stabilization. This section amends subparagraph (C) of section 430(h)(2) of the Internal Revenue Code of 1986, as well as the Employee Retirement Income Security Act of 1974 (“ERISA”).
Treasury Department Issues New Pension Segment Rates
Interest rates to be used in calculating pension funding obligations are now required to be established by the Treasury Department on an annual basis. Technically speaking, these pension interest rates are known as 25-year average segment rates and adjusted 24-month average segment rates. Accordingly, three new segment rates of 6.15%, 7.61% and 8.35% were released by the Treasury Department on August 16, 2012 in IRS Notice 2012-55 (see www.irs.gov/pub/irs-drop/n-12-55.pdf).
Section 430 specifies the minimum funding requirements that generally apply to single-employer defined benefit pension plans pursuant to § 412. Section 430(h)(2) specifies interest rates that are used for purposes of calculating the minimum required contribution.
Section 40211(a) of MAP-21 adds § 430(h)(2)(C)(iv), generally effective for plan years beginning on or after January 1, 2012.
The Treasury and the Internal Revenue Service intend to issue additional guidance in the near future on other issues relating to the application of the MAP-21 amendments, including guidance relating to benefit restrictions and transition issues.
Implications of MAP-21 for Pension Plan Funding
The new segment rates average to an effective interest rate of 7.37%, which compares favorably to the previous average of 5.3%.
The rate of return assumed in calculating future pension obligations plays a critical role in determining current taxpayer liabilities, even though the longer term commitments remain fixed. As the published guidelines for rates of return increase, current funding requirements decrease. Conversely, a lower assumed rate of return requires a higher current funding level in order to meet future obligations.
An actuarial rule of thumb is that when the funding valuation discount rate changes by 1%, a pension plan’s liability drops by approximately 10%, according to CFO.com.
MAP-21 provides sponsors of single employer plans with greater interest rate predictability by establishing a floor and a ceiling for variable interest rates based on the average annual segment rates over a 25-year period.
Confirmation of a lower average pension funding rates allow businesses to move forward in planning capital investments, acquisitions, and job creation, according to the American Benefits Council, a public policy organization representing principally Fortune 500 companies.
Milliman, in a recent report titled “Milliman analysis: July’s $120 billion funded status decline pushes pension deficit to a record $533 billion,” states:
While several plan sponsors have announced reduced contributions, we feel that a majority of the Milliman 100 companies will continue to prudently fund the pension deficits in their respective plans and presumably continue with their existing pension de-risking funding strategies rather than lower their contribution level to satisfy minimum standards.
Briggs & Stratton Corporation, H.J. Heinz Company, and others are beginning to disclose the impact of MAP-21 on expected future pension funding contributions in SEC filings and other public announcements.
Impact of MAP-21 on PBGC Premiums
The Pension Benefit Guaranty Corporation (“PBGC”) issued “Technical Update 12-1: Effect of MAP-21 on PBGC Premiums” on August 28, 2012 (see www.pbgc.gov/res/other-guidance/tu/tu12-1.html).
Effective beginning in 2013, MAP-21 changes the PBGC flat and variable premium rates and puts a cap on the variable-rate premium.
The guidance in this Technical Update supersedes any inconsistent guidance in PBGC’s 2012 premium instructions and will be reflected in the 2013 premium instructions.
“Moving Ahead for Progress in the 21st Century” (MAP-21) offers plan sponsors some welcome short term relief through greater predictability of interest rates at a higher level and within a prescribed range. Since pension obligations remain unchanged in the long run, however, plan sponsors must weigh potential short term funding relief against the goal of narrowing what remains a significant unfunded liability gap for many.
ABOUT THE AUTHOR: Mark Johnson, Ph.D., J.D., is a highly experienced ERISA expert. As a former ERISA Plan Managing Director and plan fiduciary for a Fortune 500 company, Dr. Johnson has practical knowledge of plan documents as well as an in-depth understanding of ERISA obligations. He works as an expert consultant and witness on 401(k), ESOP and pension fiduciary liability; retiree medical benefit coverage; third party administrator disputes; individual benefit claims; pension benefits in bankruptcy; long term disability benefits; and cash conversion balances.
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