Expiring smoothing provisions may require cash calls to fund pensions beginning in 2021

The Bipartisan Budget Act of 2015, enacted on November 2, 2015, extended the pension smoothing provisions provided in the Moving Ahead for Progress in the 21st Century (MAP-21) Act to the 2020 plan year. Absent another law to further extend the pension smoothing provisions, we expect plan funding targets to increase at greater speed than the levels experienced in recent years beginning in the 2021 plan year. This projected increase in funding target liability, absent an offsetting increase in plan assets, is likely to deteriorate a plan’s funded status. As a result, we expect corresponding increases in otherwise required minimum funding contributions. Even plans that have experienced funding holidays for the last several years could see a cash contribution required in the 2021 plan year.

There are several ways to plan now to mitigate large increases in cash contribution requirements beginning in 2021. The first way is to start making level funding contributions prospective from the 2018 plan year. Ideally, if a plan can fund the expected funding shortfall before the 2024 plan year, the year when the segment rate relief corridor fully expires, then minimum required contributions for future years would just be the plan’s target normal cost (assuming future expected asset returns are achieved). However, there is a risk of funding more than necessary. If overall actual asset performance is better than expected and corporate bond rates rise higher than expected, a plan that is well funded now is more likely to become fully funded before the 2024 plan year and may find itself having already made more contributions than necessary. However, the funding ratio will still be better than simply funding the minimum required contribution.

Another way to avoid minimum required contributions is to voluntarily reduce funding balances to eliminate funding shortfalls. Another consideration would be to decrease liability exposure by purchasing annuities or having lump-sum window offerings.

If no action is taken until 2021, plan sponsors should expect hefty increases in minimum funding requirements.