On July 6th, President Obama signed the “Moving Ahead for Progress in the 21st Century Act” (also known as the “Surface Transportation Extension Act of 2012” or the “2012 Highway Investment Act.”) into law. In addition to dealing with issues involving our country’s transportation system, the Act contains a number of provisions that impact the operation of tax-qualified defined benefit plans. The primary focus of the Act in the defined benefit plan area was to ease the funding requirement for these programs. Many of these plans have become underfunded due to investment performance and plan sponsors’ inability to make sufficient contributions. Let’s look at some of the significant changes in the Act, and how they will affect participants and their plans.
Easing funding requirements
The Act allows plan sponsors to use a technique known as ‘interest rate smoothing,’ to determine the earnings rate to use in actuarial calculations which determine the amount that a plan sponsor needs to contribute to the plan. Instead of having to use a rate which is the average of corporate bond rates over the last two years, the plans can now use a rate based upon a 25-year historic average of bond rates.
Interest rate smoothing should significantly ease funding requirements over the next several years for plan sponsors, as the 25-year historic average rates should be higher than the average rate over the last two years. A higher interest rate means that the funding requirement is reduced (the plan assets are presumed to earn more, and therefore a smaller amount of contribution is needed to meet the funding obligation). On the other hand, as a smaller employer contribution is made into the plan, participants should be concerned that the plan might not have enough funds to fully pay their benefits. Additionally, plan sponsors should realize that the funding benefit provided by the Act, will probably turn around in the future.
More help for the PBGC
The Pension Benefit Guaranty Corporation (PBGC) is responsible for providing benefits for participants of underfunded defined benefit plans, whose employers have stopped contributing to their plans. All (whether fully funded or underfunded) defined benefit plans pay an annual per-participant premium to the PBGC, and plans that are underfunded pay additional premiums. The Act increases the premiums for all plans by 20% in 2013, and by an additional 16.67% in 2014. The additional premiums for underfunded plans will increase by 44% in 2013, and an additional 38% in 2014. In years after 2014, increases will be tied to inflation. These significant increases will give already cash-strapped employers greater concern about maintaining these types of programs.
Impact on over funded plans
The Act also made some changes for over-funded plans. Over-funded plans can continue to provide retiree health benefits (a provision that would have expired in 2013 has been extended to 2021) and can begin to provide life insurance to participants.
We would be pleased to assist you with questions related to tax-qualified retirement programs. For more information on this topic, post a comment below or contact our Compensation & Benefits Advisory Services Group at 440-449-6800.