Publications

Overview

On July 6, 2012, President Obama signed into law the Moving Ahead for Progress in the 21st Century Act (Act), which contains important "Pension Funding Stabilization" provisions. These provisions will impact employer-sponsored defined benefit pension plans. This bulletin summarizes the provisions and their impact on pension plans and identifies various action items employers who sponsor these types of plans will need to consider.

Executive Summary

Effective generally with the 2012 plan year, the Act has the effect of reducing, at least in the short term, minimum required pension contributions that generally have become increasingly high due to the low interest rate environment. However, effective with the 2013 plan year, the Act significantly increases premiums that all plans must pay to the Pension Benefit Guaranty Corporation (PBGC), the federal agency that insures pension benefits, with even higher premiums for underfunded plans. Employers will need to analyze both the short- and long-term implications of the Act, including whether the slower funding offered by the Act is advisable due to higher PBGC premiums for underfunded plans.

Pension Funding Stabilization Provisions

New 25-Year Average Interest Rates

Effective with the 2012 plan year (with a one-year optional delay), the Act incorporates 25-year average interest rates into existing segment interest rate determinations under current law, which allows only a maximum 24-month average of interest rates. As a result, the Act increases interest rates used to value pension liabilities at a time when rates are low, which reduces the plan's overall pension liability (i.e., the present value of all pension obligations), thereby reducing required contributions to the plan. The IRS will begin to publish 25-year average interest rates. This change in law is permanent. However, for the 2013 through 2016 plan years, the Act annually "widens" the minimum and maximum percentages applied to the 25-year average interest rate for the plan year, "phasing out" its effect over the near term. The following table illustrates the effect the Act will have on interest rates:

Act Minimum and Maximum Percentages and Illustration

Under prior law, assume the so-called "first segment" corporate bond yield rate (for 0-5 years) is 2% for a plan for its 2012 calendar plan year, using a 24-month average of the rates. The Act adjusts this rate to be no less than 90%, nor more than 110%, of the 25-year average of the same rate. Accordingly, the Act increases or "props up" this 2% rate to become 4.05% for 2012, as illustrated in the table below. Thereafter, for 2013 through 2016, the Act annually widens these minimum and maximum percentages applied to the 25-year average interest rate in effect for the year.

Under the Act, the 4.05% interest rate above for the 2012 plan year would be used instead of 2% as the plan's first segment rate to be used with the other segment rates to value the plan's overall pension liability for its actuarial valuation as of January 1, 2012. As a result, the plan's overall liability as of January 1, 2012 will be less and thereby result in lower required pension contributions to the plan.

Applicability of 25-Year Average Interest Rates

The Act's new 25-year average interest rate provision applies to determine the value of a plan's overall pension liability, including for required pension contributions. It also applies for purposes of the pension funding benefit restrictions under Code Section 436, such as restrictions on lump sum payments. However, the Act's new 25-year average interest rate provision does not apply for other plan funding-related requirements. Following is a list of the particular requirements for which the new 25-year average interest rate provision applies and does not apply:

The new 25-year average interest rate provision is not applicable to maximum deductible contributions. Accordingly, an employer can continue to make higher contributions than are required by the Act, which may be advisable due to higher PBGC premiums for underfunded plans. If an employer does make additional contributions over and above the required pension contributions now reduced by the Act, a so-called "credit balance" would result that can be used to offset future contributions.

Optional 2013 Plan Year Effective Date

The Act's new 25-year average interest rate provision is effective for the 2012 plan year, but employers have the option to delay compliance until the 2013 plan year. Employers also have the option of using the new provision effective for the 2012 plan year, but delaying its applicability solely for the pension funding benefit restrictions under Code Section 436 until the 2013 plan year (to avoid disruption of existing benefit restrictions currently in place for a plan for the 2012 plan year).

Employers should consider the financial effect of commencing use of the new 25-year average interest rate provision in the 2012 versus the 2013 plan year. The Act widens the minimum percentage from 90% to 85% in 2013, which would lessen the impact of the law for 2013 as compared to 2012, depending on where interest rates end up for 2012 and 2013. Accordingly, it may be more beneficial for an employer to commence the new rates effective for the 2012 plan year.

Annual Funding Notice

For each applicable plan year (as defined below), beginning with the 2012 plan year, the Act requires the plan's annual funding notice to contain the following additional disclosures regarding the effect of the 25-year average interest rate on the plan's funding:

• A statement that the Act modified the method for determining the interest rates used to calculate the actuarial value of benefits earned under the plan, providing for a 25-year average of interest rates to be taken into account in addition to a two-year average.
• A statement that, as a result of the Act, the plan sponsor may contribute less money to the plan when interest rates are at historical lows.
• A table that shows (determined both with and without regard to the new 25-year average interest rate provision) the plan's funding target attainment percentage, funding shortfall and minimum required contribution for the plan year and each of the two preceding plan years (but for any plan year before 2012 being determined without regard to new 25-year average interest rate provision).

"Applicable plan year" means the 2012 through 2014 plan years for which: (i) the plan's funding target, determined using the new 25-year average interest rate provision, is less than 95 percent of the funding target determined without regard to new 25-year average interest rate provision; (ii) the plan has a funding shortfall greater than $500,000, determined without regard to the new 25-year average interest rate provision; and (iii) the plan had 50 or more participants on any day during the preceding plan year, determined after application of certain aggregation rules under existing law.

Increased PBGC Premiums

Effective beginning with the 2013 plan year, the Act significantly increases premiums that all plans must pay to the PBGC, with even higher premiums for underfunded plans.

Flat Rate Premiums

The Act increases the "flat rate" premium from the current $35 per participant rate to $49 by 2014, as follows:

• 2013 plan year: $42 rate (per participant).
• 2014 plan year and thereafter: $49 rate (per participant).

Beginning with the 2015 plan year, the foregoing $49 rate will be increased for inflation.

Variable Rate Premiums

The Act increases the "variable rate" premium from the current $9 per $1,000 of plan underfunding to at least $18 by 2015, as follows:

• 2013 plan year: $9 rate increased for inflation.
• 2014 plan year: the prior year's rate increased for inflation, plus $4, to equal a minimum $13 rate.
• 2015 plan year: the prior year's rate increased for inflation, plus $5, to equal a minimum $18 rate.

Beginning with the 2016 plan year, the foregoing variable rate as in effect for 2015 will be increased for inflation. However, beginning with the 2013 plan year, a new $400 per participant cap will apply to the PBGC variable rate premium, as increased for inflation thereafter.

The new 25-year average interest rate provision does not apply to the determination of the PBGC variable rate premium. Accordingly, a plan's underfunding will continue to be greater as a result of current historical low interest rates for PBGC variable rate premiums, which should be taken into account by an employer in deciding whether to make a contribution in excess of the minimum required contribution.

Action Items

• Employers should consider the short- and long-term implications of the Act, including whether the slower funding offered by the Act is advisable in light of higher PBGC premiums for underfunded plans.
  
  
• Employers must decide whether to commence compliance with the Act's new 25-year average interest rate provision effective for the 2012 or 2013 plan year.

Note: Employers will need to consider the widening minimum percentage from 90% to 85% in 2013, which will lessen the effect of the law for 2013 as compared to 2012, depending upon the overall effect of interest rates for 2012 and 2013.

• Employers who decide to commence compliance with the Act's new 25-year average interest rate provision effective for the 2012 plan year should consider whether to delay its applicability for the pension funding benefit restrictions under Code Section 436 until the 2013 plan year rule (to avoid disruption of existing benefit restrictions currently in place for a plan for the 2012 plan year).

Note: The asset depleting effect of a lifting of restrictions on lump sum distributions and/or benefit increases and/or accruals needs to be carefully weighed against the reduction in PBGC premiums associated with the reduction of the plan's participant count and overall pension liability.

• Employers should project future PBGC variable rate premiums over the next seven years, with and without the Act's new 25-year average interest rate provision, to determine whether the slower funding offered by the provision is advisable due to higher PBGC variable rate premiums for underfunded plans. Accordingly, an employer still may wish to contribute higher amounts to avoid higher PBGC premiums.

Note: An employer may wish to consider offering lump sum payments to participants, including possibly those in pay status, as a means to reduce both the plan's participant count and overall pension liability, which will reduce all PBGC premiums, including the PBGC flat rate premium per participant.

• Employers should consider the effect of the slower funding offered by the Act on various other funding-based requirements applicable to a plan, such as:
• • Pension funding benefit restrictions (IRC §436). A plan generally cannot pay lump sum payments more than 50% if the plan is less than 80% funded.
  • ERISA Section 4010 filings to PBGC (ERISA §4010). The Section 4010 filing to the PBGC (which includes employer financial and plan funding information) must be made if a plan is less than 80% funded (determined pre-Act) and the controlled group's aggregate pension plan underfunding is at least $15 million.
  • Pension funding "at risk" status (IRC §430(i)). A plan that is in at risk status for a plan year requires more accelerated funding with higher required pension contributions.
  • NQDC funding upon at risk status (IRC §409A(b)(3)). When any pension plan in the controlled group is in at risk status for a plan year, the employer is prohibited from funding its nonqualified deferred compensation plans, such as with contributions to a rabbi trust.
• Employers who took advantage of the Pension Relief Act of 2010 (PRA) should address any implications of the Act's new 25-year average interest rate provision and incorporate its election under PRA into its actuarial projections using the Act's new 25-year average interest rate provision.
  
  
• Employers who made an election under IRC §430(h)(2)(D) (use of corporate bond yield curve instead of segment rates) will be permitted to revoke this election (without approval of the Treasury Secretary) if revocation occurs by July 6, 2013.
  
  
• Employers should review and may decide to revise investment policies and strategies (including asset allocation), taking into account decisions regarding the funding of the plan, required pension contributions as affected by the Act's new 25-year average interest rate provision, and ultimate decisions regarding the time and manner of contributions to the plan.
  
  
• Employers may want to consider other Act changes that extend until 2021 the opportunity for a plan to transfer excess assets to retiree health plans under Code Section 420. Further, the Act permits a plan to transfer excess assets for retiree life insurance purposes in the same manner as retiree health.

For More Information

Please contact John H. Wendeln or any member of our Employee Benefits & Executive Compensation practice group for more information.

Disclosure

This advisory may be reproduced, in whole or in part, with the prior permission of Thompson Hine LLP and acknowledgement of its source and copyright. This publication is intended to inform clients about legal matters of current interest. It is not intended as legal advice. Readers should not act upon the information contained in it without professional counsel. This document may be considered attorney advertising in some jurisdictions.