Among many other things, the MOVING AHEAD FOR PROGRESS IN THE TWENTY-FIRST CENTURY ACT (“MAP – 21”), which became law last month, changes the minimum funding rules for single-employer defined benefit pension plans. Your actuary can help to determine the effect of  these changes on your company in the short and long run.

Background. Since 2001, the IRS has published rates for determining minimum contributions for each month.  These rates are based on the prior month’s current short-, medium- and long-term corporate bond yields.  Until enactment of MAP-21, a plan could either apply the current month’s full yield curve or use a smoothing technique that blends the rates published over the prior 24 months. In the current low interest rate environment, these rules require very high minimum contributions. This has been mitigated so far by means of short-term patches.

What MAP-21 does. MAP-21 gives longer-term relief by permitting use of rates based on 25-year averaging. There is no change in the plan sponsor’s overall funding obligation, but now the obligation can be spread over a longer time period.

How the new rules work. A plan can still use the IRS’ current yield curve with no averaging.  For plans that use the averaged rates, MAP-21 creates a collar for the minimum and maximum rate in each range (short, medium and long), based on a 25-year average of the IRS published rates, as follows:

2012 90%-110%

2013 85%-115%

2014 80%-120%

2015 75%-125%

After 2015 70%-130%

If a 24-month rate is lower than the low end of the 25-year collar for the rate for a year, the rate at the low end of the collar applies, and if a 24-month rate is higher than the high end of the collar for the rate for a year, the rate at the high end of the collar applies. If a 24-month rate falls within the collar, it is not adjusted. The 25-year collar  gets wider from 2012 through 2016,  and the wider it gets, the more likely that the 24-month rates are to fall within it.

Knock-on effects.  The new methodology affects only calculation of minimum contributions and the plan actuary’s annual certification of the plan’s funded status (AFTAP Certification) used to determine whether there are restrictions for a year on lump sum distributions, annuity contract purchases, future benefit accruals and shutdown or other unpredictable contingent event benefits.

The new methodology does not apply to calculation of minimum and maximum lump sum benefits, maximum deductible contributions, calculation of the amount of excess pension assets that can be applied to purchase of retiree health and life insurance benefits, the plan sponsor’s financial reporting obligations or the plan’s PBGC reporting obligation under ERISA section 4010.  The new methodology does not apply to calculation of PBGC variable premiums, but it will affect the amount of PBGC variable premiums because lower current contributions result in higher unfunded liabilities and higher PBGC variable premiums, which will be made even higher by increase in the variable premium rate over the next few years under other provisions of MAP-21.

Required participant disclosures. Some underfunded plans will have to include information in their annual participant disclosures for plan years beginning in 2012, 2013 and 2014, comparing the funded status of the plan under the new rules and the prior rules, including a table showing the differences.

Effective dates. These changes are generally effective for plan years beginning in 2012 and later. Plan sponsors have some flexibility with respect to application of the new rules in the plan year beginning in 2012 and whether to apply the blended rate or the current rate.

IRS and DOL guidance required. Since the IRS has published the monthly rates only since 2001, it will have to develop those rates for the prior 13 years in order to calculate the 2012 25-year average.  It will also have to provide guidance on plan sponsor elections regarding use of the new method for 2012 and other transition issues.

The DOL is required by the statute to include language in its model annual disclosure notice addressing the new requirements that apply to underfunded plans.

Other MAP-21 changes that affect pension plans.  Other MAP-21 changes that affect single-employer defined benefit pension plans are extension of the ability to fund retiree health benefits from excess pension assets through 2021, addition of the ability to fund retiree group term life insurance benefits from excess pension assets, increase in PBGC premiums and PBGC governance reform, including appointment of an ombundsman. Multiemployer plans will be affected by their own PBGC rate increases and the PBGC governance changes.

Update 8/17: IRS Notice 2012-55 providing guidance on the above-described changes has been released and is available here.

Update 9/11/12: IRS Notice 2012-61 on pension funding stabilization has been released.  In addition, PBGC Technical Update 12-1 addresses the effect of MAP-21 on PBGC premiums and PBGC Technical Update 12-2 addresses the effect of MAP-21 on 4010 reporting for pension plans.

Disclaimer/IRS Circular 230 Notice