Congress sends pension ‘smoothing’ provision to the president

Congress agreed on a highway funding bill on July 31 that will raise $6.4 billion by easing short-term pension funding obligations. The president is expected to quickly sign the bill into law to avoid any lapse in federal payments for transportation projects.

The legislation will adjust the interest rates used to calculate pension liabilities. Funding obligations are calculated under normal rules using a two-year average of interest rates. The lower the interest rate, the higher the funding obligations — so plan sponsors have faced increased funding obligations with the historically low interest rates over the last several years.
Congress responded in 2012 with legislation that adjusts the interest rate up or down if it falls outside of a specified percentage range of the 25-year average rate. The change had the effect of raising the interest rate used to calculate liabilities.

The Highway and Transportation Funding Act of 2014 now further narrows the specified range to the following percentages of the 25-year average:

  • 90% to 110% for 2012–2017
  • 85% to 115% for 2018
  • 80% to 120% for 2019
  • 75% to 125% for 2020
  • 70% to 130% for 2021 or later
The range for plan years beginning in 2014 had been 80% to 120% and was set to expand to 70% to 130% by 2016. In the current rate environment, this change will raise the interest rate used to calculate pension liabilities and should lead to lower required contributions in the short term, followed by higher contributions in future years. Because contributions are deductible, taxable income should increase in the short term, and the bill is estimated to raise revenue in the 10-year budget window.

Next steps
The IRS is expected to quickly offer guidance that will provide the segment rates under the new specified ranges, but companies with defined benefit pensions should begin examining their plans to see how the legislation will affect their funding obligations.

Eddie Adkins

Jeffrey Martin

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