The U.S. Senate Finance Committee released the text of its bipartisan proposed changes in retirement benefits laws known as the Enhancing American Retirement Now (EARN) Act. This follows the Senate Health, Education, Labor, and Pensions (HELP) Committee’s release of the Retirement Improvement and Savings Enhancement to Supplement Healthy Investments for the Nest Egg Act (RISE & SHINE) Act.
Proposed defined benefit (DB) plan legislation typically has a policy goal of providing additional security for the participants’ accrued pension benefits. It is difficult to see where that policy goal is achieved with these proposed changes as you will see below.
We note to affected plan sponsors that these changes are proposed to be retroactively effective, so you may have a statutory requirement to restate your DB plan valuations after December 31, 2021, that you thought were already completed and certified by your enrolled actuary. The reason for the “do-over” is perhaps to facilitate a refund of an overpayment of Pension Benefit Guaranty Corporation (PBGC) variable rate premiums, which is described below.
Background
The purpose of this article is to attempt a simplified review of the technical changes under the proposed legislative changes that are part of the EARN Act and the RISE & SHINE Act on single-employer defined benefit plans. The proposed bills’ statutory text is the source of our modeling.
The IRS and PBGC are not required to provide any authoritative guidance on legislative proposals, so we have made our best guess of the technical interpretations of the bills’ text. Mandatory guidance will only be issued when the Senate and the House pass the package of proposed changes to employee benefit laws and the president signs them.
Proposed changes (and the specific bill where the text can be found) for single-employer defined benefit plans are as follows:
- Cash balance (“hybrid”) plans interest crediting rate cap: Statutory hybrid plans, of which cash balance plans are one of the models, can set the interest crediting rate at a maximum of 6% for the determination of the plan’s contributions (RISE & SHINE Act).
- This proposed change may also impact the plan’s annual nondiscrimination testing for cash balance plans.
- Statutory mortality improvement rates: Assumed increases in the statutory mortality improvement rates (Internal Revenue Code (IRC) §430, the “applicable mortality table”) would be capped at 0.78% for any age at which the rate is greater than 0.78% (EARN Act).
- PBGC variable rate premium percentage freeze: The PBGC variable rate premium annual increases (based on the consumer price index) calculation will be frozen at $48 per $1,000 of unfunded vested benefits (UVBs), i.e., 4.8%, as is mandatory in 2022 and all plan years thereafter (RISE & SHINE Act).
Description of plans used in the estimates
For the estimate of changes of the cash balance pay credits and mortality improvement rates, these three plan designs were modified to test the impacts of the proposed changes:
- Plan A is a traditional final average pay (FAP) plan that was recently closed to new entrants. The population is approximately 60% male.
- Plan B is a cash balance plan with a legacy final average pay component. The plan is still open to new entrants who are only eligible for the cash balance portion of the plan. The population is approximately 60% female.
- Plan C is a pure cash balance plan that has no in-pay status participants.
For the estimate of changes for the PBGC variable rate premium percentage freeze, the plan has 10,000 participants and a PBGC unfunded vested benefit liability of $100 million in year 1.
Other
We “forced” the following:
- All plans have a funding deficit under the IRC §430 or the PBGC unfunded vested benefits rules.
- Plans B and C offer a statutory hybrid plan’s 8.0% interest crediting rate set against the proposed maximum interest crediting of 6.0%.
- The PGBC premium was below the amount needed to be limited by the PBGC’s 2022 dollar cap of $598 per participant.
These estimates are the changes only for the valuation year. We have not attempted any stochastic forecasting, which of course is much more complex. We did a simplified deterministic forecast for the PBGC variable rate cap calculations.
We believe that our modeling is directionally reasonable, while the effect on any specific defined benefit plans is impossible to assess.
Summary of estimated changes
Cash balance interest crediting rate capped at 6.0% for Plans B and C only
| Plan B | Plan C | |
| Actuarially Determined Liabilities | Decrease 3.0% to 3.7% | Decrease 16.0% to 19.0% |
| Minimum Required Contribution | Decrease 19.0% to 20.0% | Decrease 30.0% to 33.0% |
| PBGC Premium | Decrease 8.0% to 8.5% | Decrease 48.0% to 52.0% |
The impact of limiting the interest crediting rate to 6.0% was most impactful for Plan C as it is a pure cash balance plan. Plan B estimates are a modest reduction in liabilities and PBGC premiums compared to Plan C. Plan B also estimates a large decrease in the minimum required contribution because the normal cost for this plan consists of only cash balance benefits.
Limiting the interest crediting rate to 6.0% for cash balance plans may have an impact on the plan’s nondiscrimination testing under IRC §401(a) as follows:
- Minimum benefits: A cash balance plan must provide meaningful benefits under IRC §401(a)(26). Cash balance pay credits may increase if the interest crediting rate is lower.
- The “Gateway” test: Higher cash balance pay credits may be needed for non-highly compensated employees (HCEs) to pass the minimum allocation gateway.
- Corrective action could be necessary: It may be more expensive (higher cash balance pay credits) to fix a nondiscrimination failure.
Mortality improvement rates capped at 0.78%
| Plan A | Plan B | |
| Actuarially Determined Liabilities | Decrease 1.0% to 1.5% | Decrease 0.5% to 1.2% |
| Minimum Required Contribution | Decrease 2.5% to 3.0% | Decrease 2.5% to 3.0% |
| PBGC Premium | Decrease 2.5% to 3.0% | Decrease 2.5% to 3.0% |
Both plans saw a modest reduction in liabilities, although the impact was less for Plan B because of the cash balance portion of the liability, which is less sensitive to changes in mortality rates. Note that Plan C was not impacted by this provision due to being a pure cash balance plan with no in-pay status participants.
PBGC unfunded vested benefits percentage freeze
In order to estimate this change, a simplified plan that has 10,000 participants and a PBGC unfunded vested benefit liability of $100 million is the pricing model. There is an assumption that the population and unfunded vested benefits liability would remain level over 10 years. The variable rate premiums (VRPs) are calculated over the 10-year period using a 3% indexing rate under the first scenario and then with no indexing under the second scenario. The present value of the premiums was calculated using a 5% interest rate.
| VRP rate increases at 3% per year after year 1 | Freeze VRP rate at 4.8% | Estimated reduction in VRP | Percent change | |
| Present Value of Variable Rate Premiums | $42.1M | $37.1 | $5.0 | -12% |
Neither simple forecast resulted in the plan meeting or exceeding variable rate premium per participant cap ($598 in 2022).
Takeaway
The EARN Act and the RISE & SHINE Act, as currently drafted, will likely impact most DB plan sponsors to varying degrees. The changes are proposed to be retroactive to the 2022 plan year, which offers the potential for PBGC premium refunds or the clawback of credit balances that were used to satisfy minimum required contributions. Congress may need to act on these laws before the end of 2022, leaving plan sponsors a short period of time to amend 2022 results.
Acknowledgment: The 2023 PBGC variable rate premium is $52 per $1,000 of UVBs, i.e., 5.2%. The total 2023 VRP is capped at $652 per participant.
If the effective date is unchanged, we anticipate that safe harbor compliance guidelines will be issued by the federal agencies to relieve the burden to plan sponsors.
Please talk to your Milliman consultant to continue to be informed.