On August 16, 2012, IRS issued Notice 2012-55, providing new valuation interest rates for 2012, reflecting changes made by the “Moving Ahead for Progress in the 21st Century Act” (MAP-21).
We discuss MAP-21 in our article Pension Funding Relief / PBGC Premium Increases, and we refer you to that article for more detail on how the MAP-21 interest rate “floor” works.
Notice 2012-55 provides the “floor rates” for 2012.
2012 floor rates
The following chart summarizes what the rates would have been for 2012 (if MAP-21 relief had not passed) and what they are (i.e., with the MAP-21 floor).
Calendar year plans generally can use segment rates for any ending-month September 2011 – January 2012 to determine the 24-month average segment rates for 2012 plan funding. Looking at the rates for September 2011, MAP-21 increases the valuation interest rates by 3.48%, 1.60%, and 1.20% for the first, second, and third segments, respectively. For most plans, the second and third segment rates are the most important. The change in the first segment rate (0-5 years), while larger, will be less significant overall due to fewer years of compounding.
The effect of the new, higher rates on plan valuations will be fact-dependent. For plans with a typical duration (e.g., 12 years), the higher rates will generally reduce the value (for minimum funding) of plan liabilities by 15%-20%. That lower liability number will be used both for calculating the plan’s shortfall funding requirements (e.g., 7-year shortfall amortization) and for calculating the plan’s funded ratio (for purposes of the application, e.g., of funding-based benefit restrictions).
To come up with these numbers IRS estimated historical “segment rates” back to 1984, calculated 24-month averages based on these estimates, and then calculated a 25-year average of the 24-month averages. Rather than directly determining segment rates according to the methodology adopted under the Pension Protection Act, IRS estimated the applicable rates by starting with rates on Treasury securities and then using the spread between Treasury securities and corporate bonds for the period October 2003 through July 2011 to derive corporate rates back to 1984.
In the Notice IRS states:
The Treasury Department is considering replacing the methodology [described in the Notice] for determining the equivalent rates for months before October 2005, including possibly by applying the method — based on bond price data — that is currently used to determine the monthly corporate bond yield curve and the related spot segment rates. In no event would any such change in the methodology apply for purposes of plan years beginning in 2012.
So, it is possible that, for years 2013 and after, using a different methodology, IRS will produce different (and, conceivably, lower) rates for the last 25 years and thus a lower floor (and higher minimum funding requirements) than the rates in Notice 2012-55 would imply.
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We will continue to update you on this issue.