Pension Provisions in Moving Ahead for Progress in the 21st Century

On Friday, July 6, 2012, the President signed into law the Moving Ahead for Progress in the 21st Century Act (MAP-21), which makes significant changes in the interest rates used to determine the minimum required contributions for single-employer pension plans and raises premiums payable to the Pension Benefit Guaranty Corporation (PBGC). MAP-21 also adds additional disclosures to the annual funding notice, allows transfers of excess pension assets to fund group-term life insurance for retirees, and makes important changes in administration of the PBGC.

Single-employer Plan Funding Rules

The minimum funding standards for single-employer pension plans are generally based on the value of the benefits earned in a plan year (the target normal cost) and an amount to amortize the difference between the value of benefits earned at the beginning of the plan year (the funding target) and plan assets. Current law generally requires that the funding target be calculated using interest rates that are based on a 24-month average of the rates on high-grade corporate bonds.1 Because the interest rates used to determine the target normal cost and funding target have declined over the past few years, the value of the benefits has increased substantially. As a result, the minimum required contribution has increased.

MAP-21 seeks to dampen the effect of short-term changes in interest rates. It does so by comparing the interest rates calculated under the current funding rules by the average interest rates for the 25 years preceding the plan year for which the minimum contribution is being determined. If the current interest rates are lower or higher than a corridor created by the law, the interest rate used to determine the target normal cost and funding target is adjusted to the minimum or maximum value of the corridor, whichever is applicable. The minimum and maximum percentages of the 25-year average applicable for plan years are as follows:

Plan Year beginning in Minimum Maximum
2012 90% 110%
2013 85% 115%
2014 80% 120%
2015 75% 125%
2016 or later 70% 130%

For example, a plan with a January 1 plan year using the existing interest rate structure discounts payments the first five years at 1.98%, payments the next 15 years at 5.07%, and payments longer than 20 years at 6.19%.

We estimate that the minimum interest rates under MAP-21 will be about 6.4%, therefore each of the segment rates will be increased if they fall below the final minimum value. The actual rates used will be published by the Treasury.

This increase in the minimum discount rate will reduce the target normal cost and funding target by 15% to 30%, depending on the make-up of the population and the plan provisions.

Cheiron Observation: A plan that is 80% funded under the current rules could easily become fully funded under the revised interest rates, thereby eliminating any amortization charge for the current plan year.

Effective Date - The new limits on interest rates are effective for plan years beginning after 2011 and do not apply to the determination of minimum lump-sums, the maximum lump-sum that may be paid under the section 415 limit on benefits, the limit on employer deductions to pension plans, the calculation of PBGC variable rate premiums, or the determination of events reportable to PBGC.

An employer may elect not to use the new interest rate limits for a plan year beginning in 2012 either for all purposes, or only for application of the benefit restrictions. Thus, an employer may elect to use the new interest rate limit for reducing its required contributions while at the same time using the old rules for applying the restrictions on benefits.

Annual Funding Notice

MAP-21 generally modifies the Annual Funding Notice by requiring disclosure of the plan's funded status and required contributions for plan years beginning after 2012, including a statement that use of the 25-year average may reduce the contribution the employer is required to make to the pension plan. The Department of Labor is instructed to issue a new model annual funding notice to incorporate the added disclosures.

PBGC Premium Increases

MAP-21 raises PBGC premiums beginning for the 2013 premium year. The single-employer and multiemployer flat rate premium, which are currently indexed by increases in the Social Security wage base, are increased. The single-employer flat-rate premium is raised from $35 per participant to $42 for 2013 and $49 per participant for 2014. The multiemployer flat-rate premium, currently estimated to be $10 per participant for 2013, is increased to $12.

The variable rate premium, which applies only to single-employer plans, currently $9 for each $1000 in underfunding per participant, is indexed in 2013. It is raised by an additional $4 in 2014 and another $5 in 2015. The amendments to the law also provide that the total variable rate premium may not exceed $400 per participant, such cap to be indexed to average wages. By the time the variable rate reaches at least $18 per participant in 2015, a $400 per participant variable premium is reached when the underfunding is $22,223 per participant.

We expect that additional information will be forthcoming in releases from the DOL, IRS, and PBGC. In the meantime, Cheiron consultants can assist you in determining the effect of the changes upon your plan.

Cheiron is an actuarial consulting firm that provides actuarial and consulting advice. However, we are neither attorneys nor accountants. Therefore, we do not provide legal services or tax advice.

1The funding standards use three different interest rates (referred to as segment rates) depending on when benefits are payable. The first interest rate applies to benefits payable within the first 5 years after the valuation date, the second rate applies to benefits payable between 5 and 20 years after the valuation date, and the third rate applies to benefits payable more than 20 years after the valuation date. Plans may choose to use one of four reference months for averaging the three rates, or they may opt to use the yield curve for the month preceding the date of the valuation.