Notice 2012-61 (9/11/12) fleshes out the “pension funding stabilization” rules that were enacted as a tiny part of last July’s mammoth highway bill. The law took effect retroactively, for plan years beginning after 12/31/11. The immediate effect of the stabilization provisions (dubbed “MAP-21” after the bill’s acronym) is to let defined benefit pension plans employ higher interest rates in valuing their liabilities. The higher rates lower the value of the plans’ liabilities, which lead in turn to lower minimum required contributions. The mechanism is a comparison of the “segment rates” prescribed by PPA’06, which are based on average corporate bond yields over the past 24 months, to 25-year averages. In 2012, segment rates cannot be lower than 90% of the 25-year average. There is an upper bound of 110%, which is of purely theoretical interest for the present (and very likely for the distant future). After 2012, the permissible range will increase annually by five percentage points on each side (e. g., to 85% to 115% in 2013) through 2016, when the lower bound will be 70% of the 25-year average and the upper bound 130%. At some point, unless the economic conditions of the next few years are truly anomalous, MAP-21 will cease to have a practical impact. The current consensus guess for the crossover point is approximately 2019.
MAP-21’s short-term impact is striking. Notice 2012-56 (9/10/12) presents the adjusted and unadjusted rates as of September 2012:
Click here to see rates.
Notice 2012-61 discusses, in some detail, where the MAP-21 rates do and do not apply. For several important purposes, the unconstrained pre-MAP-21 rates remain in effect:
- Deduction limitations (IRC, §404(o)): The limitation on deductible contributions is based on the plan’s funding target and target normal cost, both of which are calculated using segment rates. The pre-MAP-21 rates make both of these numbers higher, raising the limitation. The practical effect is minor, though, because the PPA’06 deduction limitations are far higher than what any company wants to contribute to its plan under normal circumstances.
- Transfers of surplus assets to fund retiree health benefits or group term life insurance (IRC, §420): The surplus assets available for transfer must be computed without employing the MAP-21 rates. Here the effect is to prevent an increase in the transferable amount.
- Lump sum cash outs (IRC, §417(e)(3)): The segment rates are part of the formula for determining the minimum distribution that a participant must receive when his pension benefit is converted into a lump sum and cashed out, voluntarily or involuntarily. MAP- 21’s higher segment rates would make cash outs smaller, so Congress naturally excluded them from the new rules.
- PBGC variable rate premiums (ERISA, §4006(a)(3)(E)): The MAP-21 rates would reduce the PBGC’s income, so they do not apply here either.
- Special reporting to the PBGC by poorly funded plans (ERISA, §4010): Employers are required to furnish extensive financial and actuarial information to the PBGC if they maintain any plan that is less than 80% funded and their unfunded plans have, in the aggregate, unfunded liabilities of over $15 million. The 80% threshold is determined without reference to MAP-21. The PBGC’s Technical Update 12-2 (9/11/12) contains additional information about the effect (or non-effect) of MAP-21 on this reporting requirement.
There are a few subtleties to these exclusions. Three are of significance:
- When determining minimum funding requirements – as opposed to the amount of distributions – plan actuaries may continue to disregard the possibility that a benefit may become payable in lump sum form (the so-called “annuity substitution rule”). Some actuaries feared that, because cash out calculations cannot use MAP-21 rates, valuations of potential lump sum benefits would be subject to the same restriction.
- Many cash balance plans base their interest crediting rates on segment rates. They will be allowed, pending final regulations (which will not be effective before 2014), to either recognize or ignore the MAP-21 adjustments. Surprisingly, this decision may be implemented without a plan amendment. Documentation apparently can wait until the remedial amendment period for the to-be-issued regulations.
- Whenever the value of plan assets must be reduced by funding standard carryover balances or prefunding balances, the balance amounts are determined using MAP-21 rates. The reason is that, in the IRS’s view, keeping track of these balances using two different rate sets would be unduly complicated and would have little net impact.
MAP-21 affects only segment rates, not the “full corporate yield curve” that underlies them. Employers whose plans utilize the yield curve will not receive a benefit from the new law. They may, however, elect to switch to segment rates. IRS consent is not required if the election is made by July 5, 2013. All that is required is written notification to the actuary and the plan administrator. The election is thereafter revocable only with the IRS’s consent.
Employers have the right to opt out of MAP-21, either for all purposes or solely for determining whether the funding-based restrictions on distributions and benefits (IRC, §436) will apply during the 2012 plan year. It is hard to fathom why anybody would want to bow out of MAP-21 completely, but disregarding it for §436 purposes may be expeditious for plans that have already implemented restrictions for the current year; undoing them is possible but involves some administrative effort. Either a full or a partial opt-out election must be made by the date of filing of the plan’s Form 5500 series report for the plan year beginning in 2012 (or by the due date, including extensions, if the form is not filed on time). The election is irrevocable and is made by notifying the actuary and the plan administrator.
Plans that have elected to use the “full yield curve” in lieu of the segment rates are unaffected by MAP-21 and thus will get no benefit from its valuation interest rate increases. To put them on par with other plans, they are permitted to switch to segment rates without the normally required IRS consent. The deadline for this election is July 5, 2012. Like an opt-out from MAP-21, it is irrevocable and is made by notifying the actuary and plan administrator.