American Rescue Plan Act: Implications for Defined Benefit Plans

April 2021

The American Rescue Plan Act of 2021, a $1.9 trillion stimulus package passed as part of the federal government’s response to address the economic effects of the COVID-19 pandemic, was signed into law on March 11, 2021. The Act includes several provisions that will impact single-employer defined benefit plans. The provisions will reduce the minimum required contributions for most pension plan sponsors, and include options for early or retroactive application of some of the rules to plan years as far back as 2019. Plan sponsors now have decisions to make, since early or retroactive adoption of the various provisions may not be to their advantage.

Changes to Interest Rates used in the Valuation

The interest rate smoothing technique already in place under current funding relief laws dates back to 2012. The law extended the averaging period used to generate the segment interest rates for purposes of calculating a plan’s minimum required contributions and funding percentages, and applied a collar to the resulting averaged segment rates. This had the combined effect of increasing the effective rates –thereby decreasing the liabilities, normal costs, and the resulting required contributions to the plan –while increasing the plan’s funding percentages.  

The current funding relief was set to expire in 2024, but is now extended to 2030 under the American Rescue Plan Act, with the rate collar narrowed in each affected year. The combined effects of these and other changes provided by the Act will further reduce the liabilities, normal costs, and required contributions, and result in additional increases in funding percentages beyond the effects of the current relief laws. The adjustments to the interest collars are illustrated in the following charts.

The interest rate changes under the Act apply for plan years beginning in 2020. There is an option to defer use of the new rates to as late as 2022 for purposes of calculating both minimum required contributions and funding percentages, or only for the purpose of calculating funding percentages, which are used to determine whether statutory benefit restrictions apply.

As noted, the changes to interest rate smoothing will increase the segment rates used for calculating the plan’s primary liability measures: the funding target and target normal cost. This means those items will be lower (potentially 5–10% lower) under these new rules, provided the plan uses segment rates to calculate its funding target. If a plan uses the full yield-curve in the determination, this provision of the Act will have no effect on the plan.

Changes to Shortfall Amortization Mechanisms

Generally, the minimum required contribution under a pension plan includes a seven-year amortization of the funding shortfall. Under the Act, it was increased to 15 years. In addition, existing shortfall amortization bases will be eliminated, and a new, single shortfall amortization amount will be established at the time of implementation of the Act.  Coupled with the change in interest rates, the changes to the shortfall amortization processes will generally serve to lower the plan’s minimum funding requirement even further, potentially by a significant amount.

Changes to the amortization process are effective for the 2022 plan year, and plan sponsors are being given an option to elect to apply the new amortization rules as early as the 2019 plan year.

What It All Means: Considerations for Plan Sponsors

For cash-strapped employers already following a policy of making only the minimum contribution, the Act provides meaningful additional relief, especially if it is applied retroactively. However, retroactive application of the relief will likely result in the need for revised funding valuations and government forms filings, which in turn will likely cause additional consulting fees. Also, as of this writing, there are some unanswered questions regarding the mechanics of applying these changes retroactively – with respect to how the contribution requirements and other valuation outcomes already determined in earlier years would be modified by the overlay of revised values. For example:

  • If a plan sponsor applies one or both of the interest rate relief and shortfall amortization relief back to an earlier plan year when they had already met their original (higher) minimum contribution requirement for the year, will they now be able to characterize the prior contributions as excess contributions? If so, can they be used to create additional prefunding balance or to restore any balances that were previously applied to satisfy the original minimum?
  • How will lower retroactive obligations impact the funded percentages? These percentages reflect the ratios of assets to liabilities and, if below certain thresholds, have effects on operational issues like the required timing of plan contributions and restrictions on benefit payments. Will plan sponsors be able to retroactively avoid benefit restrictions and pay benefits that were previously limited?

While the funding relief might be attractive, it can also be said that relaxing statutory funding requirements neither improves the long-term health of poorly-funded plans, nor promotes funding levels required for those plans that are seeking to terminate operations and make full settlement of all benefits that are due. Employers are best advised to fund at a higher level appropriately tailored to the specific circumstances of their plan, and avoid the temptation to deposit at the newly diminished minimum threshold.

For those plan sponsors already funding more than the minimum legal requirement, this legislation may have no significant usefulness. They might choose to continue funding in excess of the new lower minimum, create even larger prefunding balances, lower premiums on government insurance that protects against plan insolvency (PBGC premiums), and/or achieve termination sufficiency sooner. Also, sponsors with overfunded plans or plans that had no minimum contribution due might not be impacted at all.  

In Summary

There are many facets to the relief offered under the Act that may or may not benefit a particular plan sponsor, given their plan and their company’s current situation. Plan sponsors should consult with the plan’s actuary for assistance both in deciding whether to take advantage of the lower funding requirements versus following a policy of making larger contributions, and in determining the best timeframe to implement the relief provisions for their plan.

Learn more

To learn more about the American Rescue Plan Act and how it may impact defined benefit plans, please contact:

Dan Berry

Senior Vice President

McGriff Retirement Consulting

336-291-1143
Dan.Berry@McGriff.com

Sources:

https://www.thezdi.com/blog/2021/3/9/the-march-2021-security-update-review 

https://www.microsoft.com/security/blog/2021/03/02/hafnium-targeting-exchange-servers/

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