As we have now come to expect, the latest pension-related legislation to come out of Washington was largely designed to pay for items having nothing to do with pensions. In this case, sponsors of defined benefit pension plans received the funding relief they had sought, but only because the added tax revenues will help pay for transportation projects and prevent student-loan interest rates from doubling.
These disparate provisions – and many others – were included in the “Moving Ahead for Progress in the 21st Century Act” (or “MAP-21”). In the pension arena, MAP-21 eases the negative effect of what the Joint Taxation Committee described as “historically low” interest rates. (Low interest rates produce higher pension funding obligations.) At the same time, MAP-21 increases the premiums that pension plans must pay to the Pension Benefit Guaranty Corporation (“PBGC”) and – for those rare pension plans that are actually overfunded – extends and broadens an existing provision allowing for tax-free transfers of excess pension assets to fund retiree welfare benefits.
Pension Funding Relief
The 2006 Pension Protection Act required the use of 24-month averages for each of the three “segment rates” (short-, medium-, and long-term) used to measure a pension plan’s annual funding obligation. At that time, however, no one could foresee the 2008 “Great Recession” or that the Federal Reserve would attempt to stimulate the economy by holding interest rates at a near-zero level for many years. These low interest rates have substantially increased the minimum funding obligations of pension plan sponsors.
While retaining the 24-month averaging concept, MAP-21 softens its impact by creating a “corridor” of permissible rates on either side of a 25-year average. Such a long-term average produces far less funding volatility. If a 24-month average would fall outside of this corridor (as is currently the case), a sponsor may use the 25-year average that is closest to the 24-month average but within the corridor.
This corridor starts out being fairly narrow, with only a 10% variance on either side of the 25-year average for plan years beginning in 2012. However, the corridor then widens by 5% per year over the next 4 years. Thus, by 2016, each segment rate may be as low as 70% (or, far less likely, as high as 130%) of its equivalent 25-year average.
The MAP-21 funding relief should be substantial, particularly for the 2012 and 2013 plan years. This is because 90% (for 2012) or 85% (for 2013) of each of the 25-year averages should still be substantially higher than the 24-month average. In fact, some have estimated that 2012 minimum funding requirements could be reduced by as much as 10 to 25%. This funding relief will be less significant in later years, however, as the corridor widens and the three segment rates could be as low as 70% of their 25-year averages.
Note that these segment-rate corridors apply only for certain purposes. Aside from determining a plan’s minimum funding obligation, they will apply when determining whether the funding-based amendment and distribution restrictions of Code Section 436 apply to a plan. They will not apply, however, for any of the following purposes:
- Calculating minimum lump-sum payments.
- Adjusting the Code Section 415 limits.
- Determining a plan’s variable-rate PBGC premium.
- Calculating an employer’s maximum deductible contribution.
- Determining a sponsor’s eligibility to make a tax-free transfer of excess pension assets to a retiree welfare account (as described below).
- Applying the PBGC “reportable event” rules of ERISA Section 4010.
These MAP-21 funding rules are generally effective for plan years beginning in 2012. A sponsor may elect, however, to defer their application to 2013 – either for funding and Section 436 purposes, or only for applying the Section 436 restrictions.
Higher PBGC Premiums
As noted above, MAP-21’s new segment rate corridor will not apply when calculating a plan’s variable-rate premium obligation to the PBGC. As a result, a sponsor that takes advantage of the funding relief to defer making certain contributions may thereby increase the amount of its variable-rate premium.
Quite apart from this indirect premium increase, however, MAP-21 directly increases PBGC premiums. It does so for both single-employer plans and multiemployer plans. Moreover, in the case of single-employer plans, it increases both the flat-rate premium and the variable-rate premium. These increases take effect at different times.
As shown in the following table, these PBGC premium increases could be substantial – particularly for underfunded, single-employer plans:
PBGC Premiums After MAP-21
Plan Years Beginning in . . .
Flat Rate Premium*
Variable Rate Premium#
* Per participant.
# Per $1,000 of unfunded liabilities.
~ As adjusted for inflation.
Transfers of Excess Pension Assets
Under the law in effect before MAP-21, sponsors of substantially overfunded pension plans could transfer some of those excess assets to a separate account dedicated to the provision of retiree medical benefits. By complying with numerous constraints laid down in Section 420 of the Tax Code, such a transfer could be made on a tax-free basis. Although this transfer option was slated to expire at the end of 2013, MAP-21 extends it through the end of 2021.
In addition, a Section 420 transfer may now be made to provide for retiree life insurance. The same restrictions that currently apply to medical-benefit transfers will apply to these life-insurance transfers, and only $50,000 of each retiree’s group-term life insurance may be funded in this fashion. Nonetheless, any employer lucky enough to sponsor a substantially overfunded pension plan may wish to consider these tax-free alternatives for funding retiree medical and/or life insurance benefits.