The American Rescue Plan Act of 2021 (ARPA), the most recent Covid-19 pandemic relief bill, which was signed into law by President Biden on March 11, provides two forms of general funding relief for single-employer pension plans: enhanced interest rate stabilization and extended amortization of funding shortfalls.
This will provide many employers with flexibility to smooth out funding obligations over longer time periods, which may help employers avoid disruptive cost-cutting measures and, for some, ensure the survival of both the employer and the pension plan.
Enhanced Interest Rate Stabilization
The minimum required contribution (MRC) for a plan year is based significantly on the interest rates used by the plan actuary to determine the present value of expected future benefit payments. Higher interest rates lead to lower present values and, in general, lower MRCs, and vice versa. The historically low interest rates prevailing in recent years have led to ever-increasing MRCs for many employers.
Prior versions of funding relief were designed to provide interest rate smoothing by “stabilizing” the historically low rates. Before and after these prior versions, the rules called for determining interest rates based on the average yields, over a recent 24-month period, of high-quality corporate bonds maturing during three “segments” (within five years, five to 20 years out, and 20+ years out).
These prior versions stabilized the 24-month segment rates by increasing or decreasing them to come within a “corridor” surrounding the 25-year averages of those same corporate bond yields. The corridor has been a 10% corridor since these rules went into effect in 2012, and was set to widen by 5% per year starting in 2021 until reaching 30% for the 2024 plan year and thereafter. In a low-interest-rate environment, the wider the corridor, the less the 24-month segment rates increase, i.e., stabilized rates are lower.
This structure led to significant funding challenges for many employers due to persistent historically low rates. With the 25-year averages continuing to decline each year as a new low-rate year replaces an old high-rate year, and with the corridor surrounding the declining 25-year averages set to widen, many employers were facing much higher contributions at the same time they were grappling with the economic consequences of the Covid-19 pandemic.
The ARPA enhances the interest rate stabilization structure already in effect in three ways.
- Initial Narrowing of Corridor: For the 2020 plan year, the 10% corridor is narrowed to 5%, thus increasing interest rates.
- Five-Year Deferral of Widening of Corridor: The corridor will not begin to widen until the 2026 plan year, at which time it will widen to 10% and thereafter increase by 5% per year until reaching 30% for the 2030 plan year and thereafter.
- Establishment of 5% Floor on 25-year Average Rates: Each of the 25-year average segment rates will be subject to a floor of 5%.
These provisions are generally effective starting with the 2020 plan year. However, a plan sponsor can elect to have these provisions not apply to any pre-2022 plan year, either for all purposes or solely for the purpose of determining the plan’s funding level under the rules governing benefit restrictions.
This flexibility can be helpful, for example, to a plan sponsor that wants the minimum funding relief for the 2020 plan year but does not want to try to reverse benefit restrictions previously imposed under pre-ARPA law to that plan year.
Extended Amortization of Funding Shortfalls
For most plans, and particularly for frozen plans, the lion’s share of the MRC for a plan year is the amount needed to amortize the plan’s funding shortfall. That amount is called the “shortfall amortization charge,” which in turn reflects what are called “shortfall amortization bases” and “shortfall amortization installments.”
- The shortfall amortization base for a plan year is, in effect, the funding shortfall in the plan that remains after accounting for the unamortized portion of prior shortfalls, i.e., the current year’s base is the total shortfall reduced by the present value of the outstanding amortization installments from prior plan years.
- The shortfall amortization installments are the annual installments needed to amortize the shortfall amortization base for a plan year over a period of years (seven plan years under pre-ARPA law), with each of those installments becoming part of the MRC for that plan year and (under pre-ARPA law) the following six plan years.
- The shortfall amortization charge for a plan year consists of the sum of all shortfall amortization installments that apply to that plan year.
The ARPA calls for significant changes to these rules. For the first plan year these ARPA provisions apply (see below), all pre-ARPA shortfall amortization bases are reduced to zero, eliminating all of the related shortfall amortization installments. A new “fresh start” full funding shortfall is then determined, and it is amortized over 15 years rather than just 7 years.
For all later plan years, the pre-ARPA rules continue to apply, except that a 15-year amortization schedule is used rather than the pre-ARPA seven-year amortization schedule, thus resulting in far less volatile (and lower) minimum funding requirements.
The ARPA changes to how funding shortfalls will be amortized go into effect starting with the 2022 plan year. However, a plan sponsor can elect to have these new rules start instead with the 2019, 2020, or 2021 plan year.
This flexibility may be helpful to plan sponsors in various circumstances, including where an election to start 15-year amortization for a pre-2022 plan year reduces MRCs for a current or prior plan year, or where the plan had no MRC with or without 15-year amortization for a prior plan year and leaving that plan year as is obviates the need to redo one or more old valuations.
A Bloomberg Law Practical Perspective with more information is available here.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Harold Ashner, partner at Keightley & Ashner LLP, represents clients on a wide variety of employee benefits matters, with an emphasis on PBGC issues. He previously served as assistant general counsel for legislation and regulations at PBGC, and currently serves in various leadership roles with the ABA.
Elliot Raff, senior counsel-compensation and benefits at Keightley & Ashner LLP, practices across all types of employee benefits and executive compensation matters. He previously served as senior corporate counsel for benefits at Bristol-Myers Squibb Co. and as assistant general counsel for executive compensation and benefits at Sears Holdings Corp.