The Treasury Department and the IRS announced at the end of last week that final regulations will provide automatic approval for defined benefit plans to make a new choice of interest rates for the first plan year beginning in 2010, regardless of what choices were made for earlier plan years. This is important because many pension plans are faced with having to choose the interest rate to use for 2009 by September 30, 2009. Plan sponsors should contact their actuarial advisors to determine the impact of the announcement on employer plans.
The choice of interest rate is necessary for the plan’s actuary to certify the plan’s “adjusted funding target attainment percentage” (AFTAP). If a plan does not have an AFTAP certification before October 1, 2009, the plan is deemed to be less than 60 percent funded. That funding status would trigger significant restrictions on the plan, including a prohibition on lump sum distributions and a freeze on benefit accruals. Such funding status can also impact frozen pension plans.
The announcement was made in an unusual manner through an Employee Plans newsletter, released on September 25, 2009. The newsletter indicates that the final regulations are close to issuance but will not be released before the September 30 deadline.
Many defined benefit plans might find it favorable to use the spot yield curve for 2009 purposes. The IRS had previously announced in another Employee Plan newsletter that determining liabilities using interest rates under the corporate bond yield curve (determined without regard to 24-month averaging) for any applicable month represents a reasonable interpretation of the new funding rules. A calendar year plan with a January 1, 2009 valuation date could use the monthly yield curve for January 2009, or any one of the four months immediately preceding January 2009. Interest rates in September, October or November of 2008 are often more favorable for these calculations.
The new announcement confirms that a plan could use this approach for 2009 and change to the smoothed rate of valuation (the segment rate over a 24-month average) for 2010 and later without having to receive IRS approval. As a general rule, the smoothed rate is favorably viewed as providing more predictability in plan funding. If a plan stays with the spot rate for 2010, the only month that could be used will probably be the month before the month of the plan’s valuation date.
Final regulations under Code Sections 430 and 436 on defined benefit funding and benefit restrictions due to funding levels are expected in the new future. Various legislative efforts to mitigate the funding requirements in current law also continue to be considered by Congress but are not close to passage at this time.
Please contact the authors or any member of the McGuireWoods Employee Benefits or Labor & Employment teams for additional information.