[author: Emily Meyer, New York, +1 212 556 2312 , emeyer@kslaw.com.
The Moving Ahead for Progress in the 21st Century Act (“MAP-21”), signed by President Obama on July 6, made significant changes to the funding requirements for single employer defined benefit plans. Beginning with 2012 plan years, the legislation modifies the method for calculating “segment” interest rates for purposes of minimum required contributions. These changes are expected to significantly reduce minimum required contributions in the short term. MAP-21 also sharply increases flat- and variable-rate Pension Benefit Guaranty Corporation (“PBGC”) premiums.
Pension Funding Stabilization
MAP-21 modifies the method for calculating segment interest rates used to calculate funding targets and target normal costs, a change that is expected to significantly reduce minimum required contributions in the short term. Under the new method for determining segment rates, the IRS must calculate and publish annually 25-year average segment rates, which are used to “adjust” the otherwise applicable segment rates determined (under pre-MAP-21 law) using the 24-month average yield on corporate bonds (the "non-stabilized segment rates"). If the non-stabilized segment rates do not fall within a corridor around the new 25-year average segment rates, they are replaced by “stabilized rates.” Stabilized rates are the interest rates at the lower or upper bound (whichever is closer) of the applicable corridor, as specified by MAP-21. The corridor is 90-110% for the 2012 plan year, 85-115% for 2013, 80-120% for 2014, 75-125% for 2015 and 70-130% for plan years after 2015. Given that current yields are lower than historical averages, the lower bound of the corridor will determine stabilized rates in the short term.
Beginning in 2013, stabilized rates must be used to calculate minimum required contributions, funding target attainment percentage ("FTAP") and adjusted funding target attainment percentage ("AFTAP"). For the 2012 plan year, plan sponsors that have been using segment rates may 1) elect to stay with non-stabilized rates for all purposes; 2) elect to stay with non-stabilized rates for purposes of calculating the plan’s AFTAP only (which would allow the plan sponsor to leave funding-based benefit restrictions in place); or 3) switch to stabilized rates for all purposes for which they will apply in 2013.
The first set of stabilized rates was published by the IRS in Notice 2012-55 earlier this month. The Notice states that the IRS may change the method by which it calculates the 25-year average rate (and the applicable stabilized rate) with respect to future plan years. The Notice also announced that the IRS intends to issue additional guidance related to benefit restrictions in the near future.
Stabilized rates are not substituted for non-stabilized segment rates in performing any other calculations, such as determining lump sum benefit or other accelerated payments, PBGC variable rate premiums or the amount of surplus pension assets that may be used to fund retiree health accounts or life insurance under Code Section 420. Stabilized rates also are not used in determining the tax deductibility of plan contributions or the need for reporting under ERISA Section 4010 (which is required when the plan’s FTAP is less than 80%, missed contributions exceed $1 million or a minimum funding waiver in excess of $1 million granted to a member of the plan’s sponsor’s controlled group is outstanding in whole or part).
MAP-21 does not affect monthly yield curve interest rates (which plan sponsors may elect to use as an alternative to segment rates). As a result, liabilities calculated using the yield curve will, in the short term, almost certainly be higher than liabilities calculated using segment rates. To address this imbalance, MAP-21 provides that plan sponsors that have been using the full yield curve may elect to switch to segment rates before July 6, 2013 without obtaining IRS approval.
Annual Funding Notice Changes
Certain plans must include information about MAP-21’s impact on required contributions in their annual funding notices for the 2012-2014 plan years. If, with respect to the 2012, 2013 or 2014 plan years, a plan’s funding target using stabilized segment rates is less than 95% of the funding target using non-stabilized segment rates, the funding shortfall determined using non-stabilized segment rates is more than $500,000, and there were 50 or more participants in the plan on at least one day in the prior plan year (determined by aggregating all single employer defined benefit plans maintained by the same employer), the plan’s annual funding notice for the year must include the following additional information: (i) a statement that MAP-21 modified the method for determining the interest rates used to determine the actuarial value of benefits earned under the plan, providing for a 25-year average of interest rates in addition to a two-year average; (ii) a statement that as a result of MAP-21, the sponsor may contribute less money to the plan when interest rates are at historic lows; (iii) a table showing the FTAP, the funding shortfall and the minimum required contribution for the current and two preceding plan years, determined using stabilized and non-stabilized segment rates. (For plan years beginning before January 1, 2012, the amounts shown must be determined using non-stabilized segment rates.) MAP-21 directs the DOL to issue updated model annual funding notices to reflect these new content requirements.
PBGC Premium Requirements
MAP-21 increases PBGC premiums for both single and multiemployer plans. Flat-rate PBGC premiums for single employer plans will increase from the current $35 per participant to $42 in 2013 and $49 in 2014 (indexed for wage inflation thereafter). The premium rate for multiemployer plans will increase from the current $9 per participant to $11 in 2013.
Variable-rate premiums paid by underfunded plans, currently at $9 per $1000 of unfunded vested benefits, will be indexed for inflation beginning in 2013 and will increase by $4 in 2014 and by $5 in 2015. They will be capped, however, at $400 per participant (indexed for inflation) beginning in 2013.
Given that MAP-21 will lower defined benefit plan contribution requirements and thereby increase the risk of underfunded plan terminations, it is not surprising that the legislation also included PBGC premium increases for single employer plans - the premiums are meant to create a fund from which the PBGC can draw when it must take over an underfunded defined benefit plan. Oddly, however, the Congressional Budget Office analysis of the bill classified the premium increases as general revenue and did not account for increased costs associated with underfunded plan terminations.
PBGC Governance Changes
MAP-21 made a number of changes to the governance and powers of the PBGC. Among other reforms, MAP-21:
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Provides that, with certain exceptions protecting confidentiality, minutes of PBGC board meetings must be made public;
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Provides that the PBGC’s director and board must not participate in decisions in which they have a direct financial interest;
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Establishes risk management officer and participant and plan sponsor advocate positions and requires the participant and plan sponsor advocate to report to Congress annually;
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Requires the PBGC to obtain annual peer review of its insurance modeling systems; and
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Repeals the PBGC’s $100 million line of credit.
Transfers from Well-Funded Plans
MAP-21 extended the availability of Code Section 420 transfers, which allow plan sponsors to use surplus pension assets to fund retiree health accounts, through the end of 2021. (Under previous law, such transfers would not have been permitted after 2013.) The legislation also expanded Code Section 420 to allow transfers of surplus pension assets to fund retiree life insurance.
Next Steps
Though it provides welcome relief to plan sponsors struggling to fund their defined benefit plans, MAP-21 also complicates the funding process for all plan sponsors. Because the new rules are effective with respect to the 2012 plan year, plan sponsors must quickly decide whether and to what extent to switch to the new stabilized segment rates. Given that the stabilized segment rates are artificially low, plan sponsors that can afford to should consider whether to make contributions higher than the minimum required. To minimize the effect of PBGC premium increases, sponsors also may wish to offer cash-outs to terminated vested or retired participants and to increase the mandatory distribution threshold to $5000.
King & Spalding would be pleased to assist you in analyzing the implications of MAP-21 for your plans.
