October 23, 2017
Benefits Law Alert
Benefits Law Alert
Author(s): Claire P. Rowland
Despite many voiced concerns, the IRS took the final step in updating mortality tables that directly impact the funding costs for most single-employer defined benefit plans. Defined benefit plans must use these mortality tables to calculate the actuarial liabilities for minimum funding requirements and the amount of lump sum distributions.
The updated mortality tables reflect improvements in mortality since the last issuance of the tables in 2008 and, thus, may increase minimum funding obligations for sponsors of defined benefit plans. Increased longevity built into the updated tables would also boost lump sum payouts for most defined benefits plans, causing larger cash outflows from the plans.
The final rule is generally applicable for plan years beginning on or after January 1, 2018. However, in certain circumstances the final rule provides a limited one-year transition period until January 1, 2019. Plans sponsors and their actuaries may need to carefully consider whether the plans can take advantage of the transition period.
Plan sponsors of defined benefit plans are required to use IRS-approved mortality tables to determine the minimum funding level, adjusted funding target attainment percentage and PBGC variable rate premiums for their plans, as well as the minimum lump-sum distribution amounts and maximum benefits for participants. In order to reflect the projected trends and actual mortality experience of defined benefit plan participants, the IRS should review and update the mortality tables at least every ten years.
Between 2014 and 2016, the Society of Actuaries issued several reports demonstrating its study of mortality improvements for private pension plan participants. Following these reports, the IRS announced in December 2016 its proposed rule updating the 2008 mortality tables and technical rules for developing substitute mortality tables. During a public hearing on the proposed rule, its critics voiced serious concerns about the sufficiency of the economic impact analysis conducted by the IRS. The rule’s opponents pointed out the expected significant increase in plan funding costs, the timing required to adopt the updated tables and the requirements of Executive Order 13771, which calls for two existing regulations to be cut before new regulations are issued.
The IRS dismissed the cost and timing concerns, and asserted that the final rule is not subject to the requirements of Executive Order 13771 because it merely transfers payments rather than increasing costs. The final regulations left plan sponsors in no doubt that they need to gear up (and quickly) for the use of the updated tables.
The updated mortality tables reflect the fact that people are living longer—by about two to three years. The expanded longevity tends to both increase a plan’s liabilities and make lump-sum distributions more expensive.
Many plan sponsors already use the updated mortality tables to calculate their plan’s funded status. For those plans that do not yet do so, however, beginning in 2018, minimum funding levels for defined benefit pension plans and the calculation of variable-rate premiums for PBGC will be affected—potentially significantly—by the use of the updated mortality tables. Estimates of the likely funding increase vary depending upon a particular plan’s benefit design and participant demographics.
Note that cash balances plans likely will not be significantly impacted. These plans pay a lump sum equal to a participant’s current account balance without regard to mortality assumptions. In fact, for cash balance plans that use the updated mortality tables to convert account balances to annuity forms the impact of the regulations may be favorable. The periodic annuity payments may be smaller with the use of the updated mortality tables. Depending on a plan’s actual mortality experience, the total annuity payout over time may be larger or smaller. Meanwhile, additional cash would be available in the plan for investments.
Although the updated tables must be used to determine minimum lump sum distributions in plan years beginning in 2018, a limited transition period is available under the final rule for minimum funding calculations.
If a plan sponsor concludes that the use of the updated mortality tables prescribed under the final rule would be administratively impracticable or would result in an adverse impact that is more than de minimis, the plan sponsor may use the previously applicable mortality tables determined in accordance with former regulations provided a plan-specific mortality table is not used for plan funding purposes. The plan sponsor must inform the plan actuary of its intent to use the previously applicable mortality tables.
The IRS guidance does not explain what constitutes a “de minimis” adverse business impact for purposes of the transition relief. Additional guidance would be welcome. Meanwhile, plan sponsors —especially those with small- and mid-sized plans—may want to start a dialog with their actuaries and legal counsel regarding the feasibility of delaying until the 2019 plan year the use of the updated mortality tables for minimum funding purposes.
In addition to the regulations, IRS issued two pieces of companion guidance.
First, and most relevant from plan sponsors, is Notice 2017-60 that contains the mortality table for use in determining the minimum present value of certain optional annuity forms of payment. The mortality table is a modified, unisex version of the mortality tables the Internal Revenue Code prescribes for plan funding purposes. The new mortality table will apply to annuity starting dates occurring during stability periods beginning in the 2018. The Notice also contains static (rather than generational) mortality tables used in limited instances (for plan years that begin in 2017 with valuation dates occurring in 2018, and for plan sponsors that, as described above, can demonstrate impracticability or adverse business impact of the tables’ use in 2018).
The 2017 regulations also updated guidance on the use of plan-specific substitute mortality tables for purposes of the minimum funding and present value determination. In the simultaneously issued Revenue Procedure 2017-55, the IRS modified and simplified the procedure for requesting approval of the substitute tables. Plan sponsors first requesting approval for a substitute table for the plan year beginning in 2018 may, instead of submitting the application seven months in advance, file it by February 28, 2018, so long as they request a 90-day extension of the IRS 180-day review period.
Plan sponsors should meet with their plan actuary in order to understand the impact the updated tables will have on their plan’s liability, and should verify with the actuary that their minimum funding contributions and lump-sum distribution amounts are correctly calculated under the applicable mortality tables. Plan sponsors should then decide upon their desired approach—within the available options—to accommodate any expected increases in the amount and duration of their plan’s liabilities.
Participant communications also should be reviewed to ensure accuracy before annuity and lump-sum distribution amounts are communicated to participants.
Most plans incorporate the IRS-mandated mortality tables by a reference to Section 430 or 417 of the Internal Revenue Code. For those plans, no amendment is required to reflect the updated tables. For a plan that expressly provided for the use of the prior tables, an amendment would be required. However, the IRS regulations and companion guidance do not address any plan amendment deadlines. Plan sponsors should consult their legal counsel for any necessary amendments to their plans.
In addition, employers with small- and mid-sized plans should evaluate whether they should take advantage of the transition relief for the 2018 plan year. Employers with large plans may wish to reevaluate whether they would benefit from generating their own mortality assumptions.
The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.