The Pension Benefit Guaranty Corporation (PBGC) issued a proposed rule to modernize the actuarial assumptions used to calculate the lump sum present value of certain guaranteed benefits in the defined benefit (DB) plans that undergo distress or PBGC-initiated, involuntary terminations.
Upon plan termination, PBGC becomes the appointed statutory trustee and is responsible for paying guaranteed benefits. The present value of each participant’s guaranteed benefit using these proscribed interest rates is then calculated. If the resulting present value is $5,000 or less, it is deemed to be “de minimis” and can be paid to the participant as a lump sum in lieu of an annuity.
PBGC believes that most DB plans no longer use these legacy interest rates. Since 2000, DB plans have been amended to use Internal Revenue Code Section 417(e)(3) variable interest rates to convert an annuity to an accelerated form of payment, such as a lump sum. This proposed rule would only affect those plans that continue to use PBGC legacy interest rates.
Use of lump sum assumptions by PBGC
Before 1994, plans under Section 417(e)(3) were required to use these legacy interest rates to determine the minimum permissible lump sum equivalent of an annuity benefit. This was changed by the Retirement Protection Act of 1994 (RPA 94), which amended Section 417(e)(3) to no longer require the use of PBGC lump sum interest rates for distributions in plan years beginning on or after January 1, 2000.
Since 2000, PBGC began publishing two separate tables of lump sum interest rates so as not to affect private sector plans that chose to continue to use PBGC’s legacy interest rates. They are known as Appendix B with PBGC’s interest rates for lump sums, and Appendix C providing the legacy interest rates for use by the private sector. To date, the tables have always been identical.
Proposed regulatory changes
Under the new proposed rule, PBGC would adopt the interest and mortality assumptions from Section 417(e)(3) of the Code and discontinue publication of PBGC’s legacy interest rates. The interest rate assumption in Section 417(e)(3) is defined as the minimum present value spot segments rates and is published monthly by the Internal Revenue Service (IRS).
For the few private-sector plans that elect to continue to use PBGC’s lump sum interest rates, the proposed rule would require the publishing of a final set of interest rates. These final rates would be equal to the average immediate and deferred rates for the 120-month period ending in July 2019, rounded to the nearest quarter-percent, to be used for valuation dates on or after the final rule’s effective date. The proposed rule would provide an immediate rate of 1.5% for discounting benefits for the period between the annuity starting date and each future payment date and a deferred rate of 4% for discounting benefits during the period leading up to the annuity starting date.
Request for comments
Because PBGC has incomplete information on private-sector plan use of its legacy interest rates, it is soliciting comments on which private sector plans use these rates and for what purpose, and whether setting the legacy interest rates at a 120-month average would cause any undue burden. (It is anticipated, but has not yet been confirmed, that this change in actuarial assumptions will not constitute a “cut back” in accrued benefits under IRC Section 411(d)(6). It is expected that IRS will issue a comment to this effect.) Comments must be submitted on or before November 29, 2019, to be assured of consideration.
Employers that are still using PBGC’s legacy interest rates should review their plan documents and carefully analyze how this proposed change would affect their plans going forward. We suggest that plan sponsors also review any non-qualified plans that may reference these legacy rates and assess the impact. Those that find using the final set of interest rates PBGC is proposing would have an undue burden on their plans should consider commenting on the proposed rule before the November 29 deadline.
Please contact your Milliman consultant for further information.