Pension & Benefits News PBGC final regs modify assumptions PBGC uses to determine de minimis lump-sum benefits
Monday, October 5, 2020

PBGC final regs modify assumptions PBGC uses to determine de minimis lump-sum benefits

By Pension and Benefits Editorial Staff

The Pension Benefit Guaranty Corporation (PBGC) has issued final regulations that modify the assumptions it uses to determine de minimis lump-sum benefits in PBGC-trusteed terminated single-employer defined benefit plans. The PBGC states that the changes are intended to modernize the methodology used to determine de minimis lump-sums in terminated underfunded single-employer plans.

Specifically, under the final regulations, the PBGC adopts the interest and mortality assumptions from Code Sec. 417(e)(3) (and ERISA Sec. 205(g)(3)) for this purpose and discontinues monthly calculation and publication of the PBGC’s lump-sum interest rate assumption.

Use of lump-sum assumptions. For PBGC-trusteed terminated single-employer plans, the PBGC calculates the present value of each participant’s benefit to determine whether it is de minimis (present value of $5,000 or less) and therefore may be paid as a lump sum. The PBGC issues monthly interest assumptions in two separate tables (one for PBGC-paid lump-sums and one for legacy interest rates used by the private sector) that consists of an “immediate” rate for discounting benefits for the period between the annuity starting date and each future payment date, and up to three “deferred” rates for discounting benefits during specified parts of the period leading up to the annuity starting date. The mortality assumption is the 1984 Unisex Pensioners Mortality Table.

According to the PBGC, it is aware that a relatively small number of plans use the PBGC’s interest rates as computed using its historical methodology (legacy interest rates) to determine the lump-sum equivalents of annuity benefits. The PBGC understands that these plans do so because, before 1994, under Code Sec. 417(e)(3), plans were required to use the PBGC’s legacy interest rates to determine the minimum permissible lump-sum equivalent of an annuity benefit. Since 1994, private-sector plans have not been required to use the PBGC’s lump-sum interest rates to determine the minimum lump-sum equivalents of annuity benefits. The PBGC states that anecdotal evidence suggests many, if not most, plans were amended to discontinue use of the PBGC’s legacy interest rates for calculating lump-sum equivalents of annuity benefits in favor of using the new interest assumption under Code Sec. 417(e)(3).

Final changes. The PBGC received seven comments on the proposed regulations. Although commenters generally supported the PBGC’s proposal, they expressed concern about the proposed interest assumptions for use by private-sector plans and the proposed effective date, both of which have been addressed with modifications in the final regulations.

The final regulations, like the proposed regulations, amend the PBGC’s benefit payments regulation to provide that it will use the “applicable interest rate” and “applicable mortality table” specified in Code Sec. 417(e)(3).

Although most of the commenters reported that they were aware of “few, if any” plans that explicitly refer to Appendix C (or the rates the PBGC publishes for private sector use), these same commenters expressed concern with permanently “locking in” legacy interest rates for plans that do refer to appendix C. The proposed regulations had provided a final interest rate set for private-sector plans to use for valuation dates on or after the effective date of the final rule. These commenters had no objection to the PBGC ceasing publication of the legacy interest rates but requested that the PBGC adopt an alternative basis for Appendix C rates that is responsive to market conditions. The PBGC has decided not to adopt that part of the proposed regulations. Instead, the final rule provides, in Appendix C, legacy interest rate information determined in accordance with the PBGC’s long-standing methodology, with two “minor” modifications.

In the first modification, the final regulations provide a table for plans to use to determine interest assumptions in accordance with the PBGC’s historical methodology. Specifically, the table in Appendix C replicates the PBGC’s methodology by associating any given applicable external bond rate with the set of immediate-and-deferred rates the methodology would have yielded. This allows practitioners to determine which set of legacy interest rates applies for any month indefinitely, according to the PBGC. Instead of having to wait for the PBGC to publish the legacy rates each month, practitioners will be able to look up the rates themselves as soon as the applicable external bond rate is published.

The second modification is a change to the applicable external bond rate. The Moody’s indices that the PBGC uses for this purpose are available only for a fee. To avoid increasing burden on plans that use the PBGC’s legacy interest rates, the final regulations substitute the publicly available 12-year rate for the second preceding month from the corporate bond yield curve (without regard to 24-month averaging) published by the Secretary of the Treasury and described in Code Sec. 430(h)(2)(D)(ii), which is closely correlated with the “mean 5-day rates” the PBGC has been using. Although the PBGC believes that this substitution will result in exactly the same immediate-and-deferred rates the majority of the time, the PBGC notes that, in some cases, the resulting rates may differ by a small amount.

Anti-cutback requirements. For plans that use the PBGC’s legacy rates but do not explicitly reference appendix C (i.e., plans that include a more general reference to PBGC’s lump-sum interest rates) in their plan documents, the preamble to the proposed regulations stated that “once the appendix C rates are no longer identical to the rates used by the PBGC, the plan terms [for such a plan] may have an ambiguity that should be resolved.” One commenter questioned the use of the word “ambiguity.” The commenter stated that there would be no ambiguity as to how the proposed regulations would affect those plans because if the PBGC started using the applicable interest rates under Code Sec. 417(e)(3) to determine lump sums, absent a plan amendment, the plans would do the same. Further, the commenter asserted that IRS Rev. Rul. 81-12 makes clear that, absent a plan amendment, the anti-cutback requirements in Code Sec. 411(d)(6) would not apply to the plans.

The PBGC realizes that this sentence in the preamble to the proposed rule might have unintentionally caused some confusion. The word “ambiguity” in the PBGC’s preamble was not intended to suggest whether any particular plan provision might be ambiguous, or how a plan administrator should interpret any particular plan provision. As to the anti-cutback requirements, the PBGC consulted with the IRS on the application of Code Sec. 411(d)(6). The IRS informed the PBGC that, in the case of a plan provision under which the amount of a lump-sum distribution is determined using the PBGC’s lump-sum interest rate, the anti-cutback rules are not violated merely because the application of these final regulations result in a change in the underlying interest rate(s) used to determine the amount of a lump-sum distribution.

Effective date and applicability. The PBGC received several comments concerning the timing of the final regulations. The commenters requested delaying the effective date for the changes because affected plans may need time to communicate the changes to participants, to update administrative systems, and to determine whether to (or how to) mitigate any undesired effects (e.g., a rush to retire among participants concerned about an upcoming decrease in lump-sum amounts).

The PBGC thinks that participants in plans that use the PBGC’s legacy interest rates in Appendix C will not see significant changes in lump-sum amounts, and that there will be no incentive for participants to retire sooner than planned. So, the PBGC believes there is no need for a delayed effective date for these reasons. However, for plans that use the PBGC’s legacy interest rates without specific reference to Appendix C or the rates for private-sector use, which commenters report represent the vast majority of the relatively few plans that use the legacy interest rates, the PBGC agrees that a delayed effective date could be helpful for communicating and implementing the change.

The PBGC is providing a delayed effective date of January 1, 2021. The amendments to the regulations that affect the PBGC’s calculation and payment of lump-sum benefits apply to trusteed plans with termination dates on or after January 1, 2021. Thus, this means that the PBGC will continue to publish monthly legacy interest rates for both appendix B and appendix C through December 2020.

Source: 85 FR 55587.

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