On March 11, 2021, the American Rescue Plan Act of 2021 (ARPA) became law, and on November 15, 2021, the Infrastructure Investment and Jobs Act (IIJA) became law. Guidance on single-employer defined benefit (DB) pension plan funding rules pursuant to changes made by ARPA was published in IRS Notice 2021-48 on July 30, 2021. Notice 2021-48 provides plan sponsors the option to adopt some of the funding relief provisions as early as the 2019 plan year and the remaining relief provisions as early as the 2020 plan year, or to adopt all provisions as late as the 2022 plan year. The IRS has yet to publish any guidance on application of the IIJA.
Note to readers: This summary assumes that the reader has a substantive working knowledge of many of the technical provisions of Internal Revenue Code (IRC) §430 governing defined benefit pension plan funding requirements. “Funding relief” refers to a revised technical calculation that reduces the otherwise minimum dollar amount that would be required under the law prior to the change.
We note that valuation interest rates are based on a 25-year average of high-quality corporate bond rates in the years prior to the valuation year, as published by the IRS. The “stabilization corridor” set lower and upper limits for the 25-year averaged interest rate. The limitation range start at 95% to 105% and eventually widens to 70% to 130%. The “shortfall amortization base” is the value of the funding deficit assessed each year between the present value of accrued pension benefits and the plan assets. There are two main relief provisions for single-employer defined benefit pension plans that modify the provisions of Pension Protection Act of 2006 as follows:
- Segment rate stabilization change
- ARPA and IIJA set the 25-year average to be no lower than 5%, before application of the corridor lower limit referred to above
- The stabilization corridor is set as 95% to 105% in all years out to 2030 and incrementally achieves the widest range of 70% to 130% in 2035
- It is effective for plan years starting after December 31, 2019
- Plan sponsors may choose to defer to the 2021 or the 2022 plan year
- Amortization period
- Existing shortfall amortization bases are reset to zero
- The plan’s funding deficit is amortized over 15 years (increased from seven years under prior law)
- It is effective for plan years starting after December 31, 2021
- Plan sponsors may choose to recast their funding requirements for the 2019, 2020, or 2021 plan years, as clarified in IRS Notice 2021-48
The following is a summary of how one plan sponsor benefited from the funding relief provisions of ARPA and IIJA
Due to the COVID-19 pandemic, a plan sponsor in the entertainment industry was forced to close between March 2020 to September 2021. The pension plan’s high minimum required contributions would put a strain on the company’s cash flow because the company was experiencing reduced revenue.
When the Coronavirus Aid, Relief, and Economic Security (CARES) Act became law in March 2020, the plan sponsor was able to delay some of the cash contributions with due dates in 2020 and make them on December 30, 2020. The additional funding relief provisions in ARPA and IIJA give them significant relief for subsequent cash contributions in what they have concluded are difficult economic times. The plan sponsor benefited significantly when ARPA was passed and further benefited by the enactment of IIJA, as demonstrated in the table in Figure 1.
How does ARPA and IIJA help the plan sponsor?
The plan sponsor elected the “Amortization Period” relief for the 2019 plan year and the “Segment Rate Stabilization” relief for the 2020 plan year under ARPA. IIJA provided additional relief on “Segment Rate Stabilization.” The minimum required contribution (MRC) for the 2019 plan year decreases from $51 million to $33 million. This is due to the amortization period extension from seven years to 15 years. The MRC for the 2020 plan year decreases from $59 million to $26 million. This is due to both the amortization period extension and the continued application of segment rate stabilization. The plan sponsor can reduce the cash contributions by a total of $51 million in 2019 and 2020. Based on a 10-year funding projection, the total reduction in MRC is $164 million from the 2019 plan year to the 2028 plan year. This is an ongoing plan and the active population is assumed to be level during the projection period. Below is a summary of MRC (in millions) prior to IIJA and after IIJA.
FIGURE 1: SUMMARY OF MRC PRIOR TO IIJA AND AFTER IIJA (IN MILLIONS)
|MRC Prior to IIJA||$51||$59||$71||$77||$66||$63||$53||$42||$32||$0||$514|
|MRC After IIJA||$33||$26||$33||$34||$35||$35||$35||$34||$34||$33||$332|
|Difference in $||($18)||($33)||($38)||($43)||($31)||($28)||($18)||($8)||$2||$33||($182)|
What other issues does the plan sponsor need to consider?
Reduction in future cash contribution requirements
Note that lower employer contributions reduce the plan’s funded status. If the plan sponsor’s contribution policy is to meet the MRC, the funded percentage of the plan decreases from 102% to 90% in the 2028 plan year after IIJA. Due to the extension of the amortization period to 15 years under ARPA, the plan is projected to be 100% funded by the 2033 plan year. In addition, the contributions begin to increase in comparison starting with the 2027 plan year.
Exposure to IRS Section 436 benefit restrictions and PBGC variable rate premiums
The plan may be subject to benefit restrictions or at-risk classification in some plan years due to lower funded percentages. A plan is subject to IRS Section 436 benefit restrictions in a given year if the funding target attainment percentage (FTAP) is less than 80%. FTAP is the actuarial value of assets less credit balances over the funding target. A plan is at-risk in a given year if the FTAP based on standard assumption is less than 80% and the FTAP based on at-risk assumption is less than 70% for the prior plan year. For this plan, it was at benefit restrictions and at-risk in the 2020 plan year only. A plan that is less than 80% funded—based on the Pension Benefit Guaranty Corporation (PBGC) Section 4010 filing test—and has a Section 4010 funding shortfall in excess of $15 million is subject to PBGC 4010 filing. This plan has been subject to PBGC 4010 filings for several years. Most defined benefit plans are subject to PBGC premium. For plans with an unfunded PBGC liability, when the market value of assets is less than the PBGC liability they are also subject to a PBGC variable rate premium (VRP). VRP equals the VRP rate times the unfunded PBGC liability but is limited to a cap, which is the per participant cap rate times the number of participants. For this plan, the VRP is already at the cap. For other plans, the plan sponsor should consider the advantages and disadvantages of adopting ARPA in a specific plan year and decide whether additional contributions should be made to the plan to avoid benefit restrictions, at-risk status, PBGC variable rate premiums, and/or a PBGC 4010 filing.
Corresponding effect on DB plan accounting costs
ARPA funding relief does not have any direct impact on plan accounting requirements under Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 960 ("Plan Accounting – Defined Benefit Pension Plans"), or employer accounting under FASB ASC Subtopic 715 ("Compensation – Retirement Benefits – Defined Benefit Plans – General"). However, it should be noted that decreasing cash contributions to the plan will comparatively result in a higher net periodic pension cost in the future because there would be a corresponding lower expected asset return on a lower asset base. Similar to the funded status for ERISA funding purposes, the plan’s funded status under FASB ASC Subtopic 715 decreases due to a lower asset value.
Defined benefit plan pensions are one of the main sources of retirement income to current and future retirees. Any law that can help maintain the affordability and funding flexibility of defined benefit plans is essential to both the employers and the employees. ARPA and IIJA provide maximum flexibility for a prudent contribution policy by lowering the contribution requirements for several years and minimizing the fluctuations in future contribution requirements. This helps plan sponsors with short-term cash restraints and budgeting and allows them to pursue full funding of their plans in a less risky manner over time. For well-funded defined benefit plans, ARPA provides flexibility when adopting the funding relief provisions. This is a win-win situation.