Required Contributions to Defined Benefit Plans
On July 6, 2012, the Moving Ahead for Progress in the 21st Century Act (MAP-21) was signed into law. As part of this highway construction bill, provisions for defined benefit pension plan funding relief were included.
As many of our DB clients know, beginning in 2008, pension plans were subject to new funding rules under the Pension Protection Act of 2006. These new rules dramatically changed the basis for determining the contribution which plan sponsors are required to make to their plan. The change which has probably had the greatest impact on the minimum required contributions was the mandate specifying the interest rates used for calculating plan sponsor contributions. The mandated rates are based on a corporate bond yield curve. There was a provision to smooth these rates by the use of a 24-month average of a three segment yield curve.
Shortly after the new rules became effective, the economic downturn began, with the value of plans assets dropping and interest rates declining, both significantly. In addition, the Federal Reserve adopted policies to maintain low interest rates for the next few years. The combination of the reduced assets and the lower interest rates resulted in significant increases in the minimum required contribution to defined benefit plans.
Changes to your DB plan after MAP-21: The corridor
What MAP-21 does is to create a corridor around the 3-tiered segment rates used to determine your minimum required contribution. This corridor is determined using a 25 year average of the segment rates. Beginning with the plan year which starts in 2012, the 24-month average segment rates must be within the specified rate corridor. This corridor is as follows:
It is estimated that the rates for determining your minimum required contribution will increase between 100 and 150 basis points which may result in a 10-15% reduction in your plan liability and a reduction in your minimum required contribution.
The benefit of this change will be felt in the next couple of years due to the narrow corridor and the current low interest rates. After 3 or 4 years, there may be little or no benefit from this funding relief and, depending on interest rates, it is possible that your minimum required contribution at that time may be higher than under the current rules.
The use of this corridor is voluntary for plan years beginning in 2012 and mandatory for plan years beginning in 2013 and thereafter.
MAP-21 changes only the basis for determining the minimum required contribution; it does not change the basis for determining the maximum tax deductible contribution thereby increasing the flexibility for you to choose the amount of contributions to make to the plan.
Other changes from MAP-21
In addition to the change in funding rules, the act provides for an increase in PBGC premiums beginning in 2013. The flat rate portion of the premium will increase from the current $35 per participant to $42 per participant in 2013, $49 per participant in 2014 and will be adjusted for inflation beginning in 2015. The variable rate portion will increase from the current amount of $9 per $1,000 in unfunded liability to at least $13 per $1,000 in 2014, and at least $18 per $1,000 in 2015. These rates per $1,000 will also increase with inflation, but that increase is not reflected in these numbers. There will be a $400 per participant limit on the variable rate portion of the premium and the current cap on the variable rate portion for small plans remains unchanged.
In addition there are additional reporting requirements which apply to plans:
• With more than 50 participants, and
• The plan’s funded status is less than 95% before the application of the corridor rates, and
• The plan’s unfunded liability is more than $500,000
The Act did not provide relief from the requirement of Internal Revenue Code Section 417(e) relating to the minimum value of lump sum payments.
Ongoing Recommendations for Defined Benefit Plans
We continue to be sensitive to the issues of Defined Benefit Plans, including:
• The need to keep funding above the minimum level to maintain contribution stability, and
• The fact these new rules don’t really impact the desirability of risk reduction. (The relief is temporary, the accounting rules don’t change, and the long term nature of the liability doesn’t change.), and
• Continuing your conversation with your actuary to determine the exact impact to your plan.
We look forwarding to continuing, and facilitating, these discussions.