Resources

Thomson Reuters Tax & Accounting News

Featuring content from Checkpoint

Back to Thomson Reuters Tax & Accounting News

Subscribe below to the Checkpoint Daily Newsstand Email Newsletter

Congress-passed highway bill expands use of 25-year pension smoothing

Congress has passed, and President Obama is expected to sign, the Highway and Transportation Funding Act of 2014 (the Act). Included in the Act is a revenue-raising provision which expands the use of 25-year smoothing for pension plan funding purposes.

25-year smoothing.Background. In 2012, Congress enacted a transportation bill called the Moving Ahead for Progress in the 21st Century (MAP-21; P.L. 112-141). In addition to funding transportation items, MAP-21 also addressed concerns of plan sponsors regarding how low corporate bond interest rates were causing an increase in their plan funding obligations. To relieve this issue, MAP-21 provided for use of a 25-year interest rate corridor, over which the plan’s applicable interest rate could be determined. Under MAP-21, generally effective for plan years beginning on or after Jan. 1, 2012, the first, second, and third segment rates described in Code Sec. 430(h)(2)(C) are adjusted as necessary to fall within a specified range that is determined based on an average of the corresponding segment rates for the 25-year period ending on September 30 of the calendar year preceding the first day of that plan year.

Thus, if the adjusted first, second, or third segment rate described in Code Sec. 430(h)(2)(C)(i), Code Sec. 430(h)(2)(C)(ii), or Code Sec. 430(h)(2)(C)(iii) for any applicable month (determined without using the smoothing provision) is less than the “applicable minimum percentage” (see below), or more than the “applicable maximum percentage” (see below), of the average of the first, second, or third segment rates for years in the 25-year period ending on September 30 of the calendar year preceding the calendar year in which the plan year begins, then the segment rate for the applicable month is equal to the applicable minimum percentage or the applicable maximum percentage of the 25-year average average, whichever is closest.

The “applicable minimum percentage” and the “applicable maximum percentage” for a plan year beginning in a calendar year was determined in accordance with the following table: (Code Sec. 430(h)(2)(C)(iv)(II))

=============================================================================
                                 Applicable Percentages
 Calendar Year   Applicable Min. Percentage      Applicable Max. Percentage
=============================================================================
  2012                       90%                             110%
  2013                       85%                             115%
  2014                       80%                             120%
  2015                       75%                             125%
  After 2015                 70%                             130%
  -----------------------------------------------------------------------------

Similar changes were made to ERISA’s parallel funding provision, ERISA § 303(h)(2)(C)(iv).

New law. Sec. 2003(a) of the Act amends the table in Code Sec. 430(h)(2)(C)(iv)(II) to extend the use the 90% applicable minimum percentage and 110% applicable maximum percentage to calendar plan years 2012 through 2017, as opposed to just the 2012 calendar plan year. Further, the reduction in minimum percentages and increase in maximum percentages takes place over the years 2018 to 2021, as opposed to 2013 to 2016, as seen in the following table:

=============================================================================
                               Applicable Percentages
  Calendar Year   Applicable Min. Percentage      Applicable Max. Percentage
=============================================================================
  2012—2017                 90%                             110%
  2018                       85%                             115%
  2019                       80%                             120%
  2020                       75%                             125%
  After 2020                 70%                             130%
    -----------------------------------------------------------------------------

Similar changes are made to the table in ERISA § 303(h)(2)(C)(iv)(II). (ERISA § 303(h)(2)(C)(iv)(II), as amended by Act Sec. 2003(b)(1))

RIA observation: Thus, employers who might not otherwise be able to use the smoothing provision—for example, if their interest rate was 85% of the applicable minimum percentage for the 2014 plan year—can now use the smoothing provision.

Plan funding notices.Background. MAP-21 required plans to disclose the effect of the 25-year smoothing provision on plan funding. Thus, for a single-employer plan for an “applicable plan year” (see below), each plan funding notice required under ERISA § 101(f)(1) must include:

I. a statement that MAP-21 modified the method for determining the interest rates used to calculate the actuarial value of benefits earned under the plan, providing for a 25-year average of interest rates to be taken into account in addition to a 2-year average;
II. a statement that, as a result of MAP-21, the plan sponsor may contribute less money to the plan when interest rates are at historical lows; and
III. a table that shows the funding target attainment percentage (as defined in ERISA § 303(d)(2)), the funding shortfall (as defined in ERISA § 303(c)(4)), and the minimum required contribution (as determined under ERISA § 303ERISA § 303), for the applicable plan year and each of the two preceding plan years, determined both with and without regard to ERISA § 303(h)(2)(C)(iv). (ERISA § 101(f)(2)(D)(i))

New law. The Act amends ERISA § 101(f)(2)(D)(i)(I) and ERISA § 101(f)(2)(D)(i)(II) (items (I) and (II), above) by adding a reference to the Highway and Transportation Funding Act of 2014 after MAP-21. (ERISA § 101(f)(2)(D)(i), as amended by Act Sec. 2003(b)(2)(A)(i))

RIA observation: Thus, the notices to plan participants will have to state that (i) both MAP-21 and the Act have modified the method for determining the interest rates used to determine the actuarial value of benefits earned under the plan, and (ii) due to MAP-21 and the Act, the plan sponsor may contribute less to the plan than otherwise required when interest rates are at historical lows.

The Act also requires the Department of Labor (DOL) to modify the funding statements (items (I) and (II), above), to reflect the addition of the Act. (Act Sec. 2003(b)(2)(B))

RIA observation: The appendix to FAB 2013-01FAB 2013-01 provided a model supplement (the MAP-21 Supplement) to the single-employer defined benefit plan model annual funding notice. Presumably, the Employee Benefits Security Administration (EBSA) will update this model supplement to include references to the Act.

Applicable plan year.Background. For purposes of the MAP-21 changes to the plan funding notice requirements, an “applicable plan year” was defined as any plan year beginning after December 31, 2011, and before January 1, 2015, for which:

i. the ERISA § 303(d)(2) funding target is less than 95% of the funding target determined without regard to ERISA § 303(h)(2)(C)(iv);
ii. the plan has a funding shortfall (as defined in ERISA § 303(c)(4) and determined without regard to ERISA § 303(h)(2)(C)(iv) greater than $500,000; and
iii. the plan had 50 participants or more on any day during the preceding plan year. (ERISA § 101(f)(2)(D)(ii)

New law. The Act amends the definition of “applicable plan year” to mean any plan year beginning after December 31, 2011, and before January 1, 2020. (ERISA § 101(f)(2)(D)(ii), as modified by Act Sec. 2003(b)(2)(A)(ii))

RIA observation: Thus, the plan funding notice requirements, reflecting the effect of 25-year smoothing, are required for an additional five years.

Modification of funding target determination periods. Background. For purposes of determining a plan’s “funding target” and “target normal cost” for a plan year, the interest rate used in determining the present value of the plan’s benefits—for benefits that are reasonably determined to be payable during the 5-year period beginning on the first day of the plan year —is the first segment rate for the applicable month.

New law. The Act replaces “the first day of the plan year” with “the valuation date for the plan year.” (Code Sec. 430(h)(2)(B), as amended by Act. Sec. 2003(d)(1))

RIA observation: Thus, the first segment rate applies to benefits reasonably determined to be payable during the 5-year period beginning on the plan’svaluation date, instead of benefits reasonably determined to be payable during the 5-year period beginning on the first day of the plan year. Note that Reg. § 1.430(h)(2)-1(b)(2), which concerns the use of the first segment interest rate in determining plan liabilities, addresses only plans whose valuation date is the first day of the plan year.

A similar change is made to ERISA’s parallel provision. (ERISA § 303(h)(2)(B), as amended by Act Sec. 2003(d)(2)).

General effective dates. The amendments made by the Act, other than those regarding prohibited payments in bankruptcy (see below), apply to plan years beginning after Dec. 31, 2012. (Act Sec. 2003(e)(1))

A plan sponsor may elect not to have the amendments made by these provisions apply to any plan year beginning before Jan. 1, 2014, either (as specified in the election):

a. for all purposes for which the amendments apply, or
b. solely for purposes of determining the plan’s adjusted funding target attainment percentage (AFTAP) under Code Sec. 436 and ERISA § 206(g) for the plan year. (Act Sec. 2003(e)(2))

A plan won’t be treated as failing to meet the requirements of Code Sec. 436 and ERISA § 206(g) solely due to making this election. (Act Sec. 2003(e)(2))

Prohibited payments in bankruptcy.Background. The 2006 Pension Protection Act (P.L. 109-280) added special rules that limit a plan from making “prohibited payments,” such as lump-sum distributions, if (i) the plan’s AFTAP is below 60%, (ii) the plan sponsor is in bankruptcy, or (iii) the plan’s AFTAP is 60% or greater, but less than 80%. For plan sponsors in bankruptcy, the limit on making prohibited payments no longer applies once the plan’s actuary certifies that the plan’s AFTAP is at least 100%.

New law. The Act amends the prohibition on payments in bankruptcy by providing that the determination of a plan’s AFTAP must be made without using 25-year smoothing. (Code Sec. 436(d)(2), as modified by Act Sec. 2003(c)(1))

A similar amendment is made to ERISA’s parallel provision. (ERISA § 203(g)(3)(B), as modified by Act Sec. 2003(c)(2)(A)(ii)))

… Special effective dates for bankruptcy provision. For single-employer plans, the prohibition on the use of 25-year smoothing in determining a plan’s AFTAP when the plan sponsor in bankruptcy applies to plan years beginning after Dec. 31, 2014. (Act Sec. 2003(c)(3)(A))

For collectively bargained plans (plans maintained under one or more collective bargaining agreements), the prohibition on the use of 25-year smoothing in determining a plan’s AFTAP when the plan sponsor in bankruptcy applies to plan years beginning after Dec. 31, 2015. (Act Sec. 2003(c)(3)(B))

… Retroactive effect. If the effective date provision regarding the prohibition on the use of 25-year smoothing in determining a plan’s AFTAP when the plan sponsor in bankruptcy (see above), applies to any amendment to any plan or annuity contract, that plan or contract is treated as having been operated in accordance with the plan’s terms during the remedial amendment period described in Act Sec. 2003(c)(4)(B)(ii), below. (Act. Sec. 2003(c)(4)(A))

This period of retroactive effect applies to any amendment to any plan or annuity contract that is made (I) in accordance with the Act’s amendment to the rule governing prohibited payments in bankruptcy, or under any regulation issued by IRS or DOL under any provision that the Act amended, and (II) on or before the last day of the first plan year beginning on or after Jan. 1, 2016, or any later date as IRS may prescribe. (Act. Sec. 2003(c)(4)(B)(i))

RIA observation: Thus, plan sponsors have at least until Jan. 1, 2016 to amend their plans to reflect the Act’s change to the prohibitions on payments in bankruptcy.

The retroactive effect does not apply to any amendment unless, during the period that (I) begins on the date that the Act’s amendment to the rule governing prohibited payments in bankruptcy take effect, or the IRS or DOL regulations described above take effect (or for a plan or contract amendment that is not required by these amendments or IRS or DOL regulation, the effective date specified by the plan), and (II) ends on the last day of the first plan year beginning on or after Jan. 1, 2016, unless IRS prescribes a later date—or, if earlier, the date the plan or contract amendment is adopted, if the plan or contract operated as if the amendment were in effect, and the amendment applied retroactively for the period. (Act. Sec. 2003(c)(4)(B)(ii))

… Relief from the anti-cutback rules. The Act provides that a plan won’t be treated as violating the Code Sec. 411(d)(6) and ERISA § 204(g) anti-cutback rules solely due to amending the plan to provide for the changes to the prohibitions on payments in bankruptcy.