Defined benefit plans get some welcome relief
ARPA follows up on relief for single-employer DB plans provided by congressional actions in 2012 (the Moving Ahead for Progress in the 21st Century Act, or MAP-21), 2014 (Highway and Transportation Funding Act of 2014), and 2015 (Bipartisan Budget Act of 2015) by lowering the funding target liability and extending the amortization period. Here’s what sponsors of single-employer DB plans need to know.
The funding target liability was lowered
Since 2012, the interest rates used to determine a pension plan’s funding target have been limited to a 10% corridor of the 25-year average interest rates. Under the Bipartisan Budget Act of 2015, the corridor was set to increase to a 15% corridor in 2021, with additional expansion continuing to 30% through 2024. As the corridor expands, interest rates decline and the funding target liability increases. As a result, minimum required contributions were set to increase.
ARPA will effectively lower a plan’s funding target by increasing the interest rates used to determine the target. Under ARPA, the corridor for the 2020 plan year will shrink to 5% and there will be a floor on the 25-year average interest rates. Sponsors will have the option of deferring the interest-rate change until as late as 2022. This relief will begin to phase out in 2026 and be fully phased out by 2030.
The amortization period was extended to 15 years
The minimum required contribution for a plan year is equal to the funding target’s normal cost, plus a shortfall amortization charge. Prior to ARPA, a plan’s shortfall was amortized over seven years in each year that the funding percentage was less than 100%. The sum of those amortization payments is the shortfall amortization charge.
ARPA reduces any prior amortization payments and associated bases to zero, establishes a new amortization shortfall base for the first plan year, and extends the amortization shortfall period from 7 years to 15 years. This effectively gives sponsors a fresh start and longer runway with their amortization payments. The extension of the amortization period is automatically effective in 2022, but sponsors can elect to apply it to earlier plan years.
Still more to come on implementing the ARPA’s DB plan changes
Although ARPA has been signed into law, there are still many questions regarding how these changes will be implemented by the IRS, U.S. Department of Labor, and Pension Benefit Guaranty Corporation. For example, questions remain as to how a sponsor would make any of the above elections and how these changes would affect prior valuations and contributions. Pension plan sponsors and their business partners should continue to monitor the guidance coming out of Washington as they develop their plan strategies through the 2021 valuation process.
The content of this document is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made herein.
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