This change in the interest rate calculation for pension funding affects a number of Internal Revenue Code and ERISA provisions. Significantly, the new interest rate calculation will likely have the effect over the next two or so years of:

• Reducing the employer’s minimum required contributions to the plan, as required under I.R.C. §430, including the target normal cost and funding target;
• Making it less likely that the plan will be required to impose restrictions on benefits due to underfunding as otherwise provided under I.R.C. §436;
• Reducing the present value of remaining shortfall and waiver amortization installments for purposes of determining any shortfall amortization base established in the current plan year, and the amortization installments with respect to a shortfall or waiver amortization; and
• Increasing in some instances the assumed rate of return when determining the average value of plan assets.

Just as significantly, the new interest rate structure does not:

• Lower the determination of the maximum deductible limit under I.R.C. §404(o);
• Reduce the calculation of the minimum present value requirement for lump sum distributions under 417(e)(3);
• Affect the determination of the excess assets that can be transferred to retiree health and group term life insurance accounts in the pension plan under I.R.C. §420;
• Decrease the calculation of PBGC variable-rate premiums; or
• Lessen the employer’s likelihood of having to report additional information to the PBGC required of contributing sponsors of certain underfunded plans.

The fact that the MAP-21 interest rate change does not apply to the rates used for calculating lump sum distributions is important for pension plan sponsors. In Notice 2012-61, the IRS clarified that, for purposes of calculating a pension plan’s funding target and target normal cost, the present value of a distribution subject to I.R.C. §417(e), encompassing lump sums, is to be based on certain assumptions, including the present value of the annuity used by the plan to determine the amount of the distribution (known as the “annuity substitution rule”). This rule is preserved by the Notice. Additionally, the new interest rate structure does not apply to the determination of minimum lump-sums or the maximum lump-sum that may be paid under the section 415 limit on benefits.

The pension stabilization provisions in MAP-21 also make reference to, but do not resolve, the “market rate of interest” definition issue for statutory hybrid plans, such as cash balance and pension equity plans. Under current rules, a statutory hybrid plan cannot provide for interest credits at an interest crediting rate that exceeds a market rate of return. See I.R.C. §411(b)(1)(H). While Treasury and the IRS are working on guidance for defining a market rate of interest is for this purpose, Q&A –H1 of Notice 2012-61 provides that for plans currently defining the interest rate using the segment rates under §430 of the Internal Revenue Code, the plan administrator may make a “reasonable interpretation” of the plan terms to determine whether MAP-21 applies, and also provides anti-cutback protection if the plan is timely amended to reflect that reasonable interpretation.

The Pension Benefit Guaranty Corporation issued Technical Update 12-2 to provide guidance on how MAP-21’s pension funding stabilization provisions apply to the notice of underfunding that plan sponsors are required to provide to the PBGC under ERISA §4010. According to the Technical Update, the new interest rate structure does not apply in determining the plan’s funding target or funding target attainment percentage (known as the “AFTAP”) for purposes of determining whether the additional information must be provided. The new interest rate structure does apply, however, to the other provisions of ERISA §4010, relating to the “4010 funding shortfall” and other items.

The effective date for the pension stabilization provisions are effective for plan years beginning after December 31, 2011. A plan sponsor may elect to defer the effective date to plan years beginning on or after January 1, 2013 either for all purposes or solely for the purposes of determining the funding percentage applying to benefit restrictions under section 436 of the Code. The transition rules also allow plan sponsors to revoke or change some elections to use the new rate structure. It should be noted however that there is a tight deadline of September 15, 2012, for plan sponsors trying to recharacterize minimum required contributions contributed in 2012 as satisfying the minimum required contribution for 2011. Notice 2012-61, Q&A-T2.

Lastly, the IRS simultaneously released Notice 2012-56 which provides guidance as to the corporate bond weighted average interest rate and permissible range of interest rates specified under the section 412(b)(5)(B)(ii)(II) of the Internal Revenue Code, reflecting the changes made by MAP-21.

Photo credit: Kirby Hamilton