American Rescue Plan Act: Implications for Defined Benefit Plans

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.

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.

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.  

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.