On June 29, 2012, Congress passed a highway funding bill (H.R. 4348) which includes as a funding source, certain pension funding stabilization provisions. The impact of the pension changes would be to increase the segment rates used to calculate liability and normal costs for purposes of determining minimum required contributions and benefit restrictions for defined benefit pension plans. The effect of the change will be to increase most defined benefit plans’ funded status and decrease the minimum required contributions to these plans for the next couple of years. Current segment rates will still be used for determining the maximum deductible contributions and for financial statement reporting. The changes in the law apply to plan years beginning in 2012. Plan sponsors can elect to delay the effective date to 2013 for all or part of the purposes.
Certain additional disclosure requirements will apply if the Plan uses the higher segment rates. Under the Law, the PBGC premiums are increased by $7.00 per person as a measure to stabilize the depleted PBGC trust fund. There are greater increases for plans with significant unfunded liabilities.
The Conference Committee Report explains that the Legislation permits single employer plans to adjust the IRS published segment rate to the extent the rate for higher risk plans is outside the range of the average of the segment rates for the 25 year period ending September 30 of the preceding calendar year. Between 2012 and 2016, the range is increased from 10% off the 25 year average to 30% in 2016. The IRS is to calculate and publish the 25 year average segment rates each year. Current rules use a 24-month look-back for interest rate determination. If the segment rate is less than 90% of the average corporate bond yield for the preceding 25 years then under the new law that rate would be increased to be 90% of the average.
The IRS reports the June 2012 numbers as 1.84% for the first segment, 4.79% for the second segment and 5.9% for the third segment. The reported effect of the law change is to increase the long term rate from 5.3% to just under 7%.
Since passage of the new funding rules, commentators have noted that the impact is only short term and if interest rates spike upward, the 25 year smoothing would prevent plan sponsors from adjusting plan liabilities to take advantage of higher expected returns. After several years, the IRS segment rates and the 25 year average rates will likely align. If that occurs, then the impact will only be a short term reduction in minimum required pension contributions, which will increase taxable income and available cash flow for other business investments or job creation.