The combination of higher interest rates and a strong stock market have significantly improved pension funding. For some sponsors looking to exit the DB system, this improvement in funding may put them in a position to consider plan termination. In this article we briefly review some of the key issues the project of terminating a plan presents.
Recent IRS Notice 2021-48 details guidance on elections available to sponsors with consideration of changes made by the American Rescue Plan Act (ARP).
Bottom line: interest rates have stabilized since mid-Summer (near all-time lows) while asset performance has improved dramatically, leaving DB plans on-net slightly better off than they were at the beginning of the year. DC participants – who are generally (on average) younger than DB participants, with longer durations, and thus more affected by 2020 interest rate declines – did (on average) less well, notwithstanding strong asset returns.
Even for plans not at the VRP headcount cap, with respect to (relatively) smaller benefits, annuity settlement may be an efficient strategy. For almost all pension plans, there exists a threshold, greater than zero, below which these settlements make sense.
The IRS had in Notice 2020-61 (August 6, 2020) clarified that the extended CARES Act contribution deadline applied to both minimum and “excess” contributions – a critical issue in the calculation of PBGC variable-rate premiums. The extension did not, however, apply to the contribution due date for tax deductions or for filing Form 5500.
Defined benefit plan valuation interest rates have declined nearly 200 basis points since late 2018. Interest rate stabilization has significantly mitigated the effect of this decline on plan funding. GAAP accounting (e.g., balance sheet disclosure) is, however, indexed to current rates, and the steep declines in interest rates have presented a number of challenges and opportunities for defined benefit plan sponsors.
This election generally must be made (for a calendar plan) by October 15, 2020.
Defined benefit plan sponsors that (1) currently using the standard (spot-rate) method to determine unfunded vested benefits (UVBs) for purposes of calculating Pension Benefit Guaranty Corporation variable-rate premiums, and who (2) have the ability to elect to switch to the alternative (24-month average) method, may have an opportunity to reduce (in some cases significantly) 2020 variable-rate premiums by doing so.
For sponsors, PBGC’s new guidance is very good news, giving them extra time to make contributions that may reduce PBGC variable-rate premiums. We note that Notice 2020-61 generally requires an amendment to the Form 5500 for post-filing contributions that are counted as contributions for that plan year.
DB contribution timing is critical with respect to at least three issues – ERISA minimum funding, Internal Revenue Code tax deductions, and the calculation of unfunded vested benefits (UVBs) for purposes of determining Pension Benefit Guaranty Corporate variable-rate premiums.