The Internal Revenue Service’s (IRS) delay until 2018 of implementation of updated mortality tables for pensions gives defined benefit (DB) plan sponsors some extra time to prepare for significant changes tied to increased participant longevity. But the delay also may affect pension liability valuation in up to three ways, according to investment consulting firm Cambridge Associates.
The three areas of pension liability that may be touched by the delay are minimum required contributions, variable-rate Pension Benefit Guaranty Corporation (PBGC) premiums, and lump-sum distributions to terminated vested participants (see Consider These Steps When Administering DB Plan Lump-Sum Windows.)
In an April client brief about the implementation delay for the 2014 mortality assumptions known as RP-2014, Cambridge Associates said: “Practically speaking, this means that for the remainder of 2017, the liability valuation of these three purposes is temporarily lower (and funded status therefore temporarily higher), than it would be once the new tables are adopted.”
History of New Tables
The Society of Actuaries on Oct. 27, 2014, released the final RP-2014 mortality tables and the MP-2014 mortality improvement scale for determining participant longevity in pension benefit calculations, updating tables from the year 2000.
The IRS and U.S. Treasury Department usually evaluate options for updating the mortality tables as mandated by federal law, and they generally issue proposed regulations to make the changes available for comment before they are enacted. Pension plans then set their own mortality, or “generational,” tables based on these underlying lifespan assumptions.
One important lesson all DB plan sponsors can benefit from now is that the rules for valuing pension liabilities—and funded status—can be “dramatically” different for different purposes, the Cambridge Associates client brief said.
The brief points out several issues that plan sponsors may have to address soon:
- Contributions to the plan may have to rise. Because funded status determines the level of minimum required contributions, a drop in funded status means higher required contributions must make up the deficit.
- Premiums due to the PBGC may jump dramatically for certain plans because a lower funded status also means higher PBGC premiums.
- Lump-sum distributions may gain attention. Paying out benefits while the plan is underfunded results in a lower funded status in percentage terms, the brief said. Depleting funds means it will be harder to compensate for shortfalls with investment returns.
Sponsors should expect to see their IRS funded status decline in 2018 to roughly the same amount as they saw their accounting funded status decline when RP-2014 was first used on their financial statements, Cambridge Associates said. Generally, a plan’s IRS funded status under recent federal rules is significantly higher than for accounting or economic purposes due to the use of a higher liability discount rate.
As for PBGC premiums, which already are on the rise from controversial hikes brought about by the federal laws mentioned above, plan sponsors can expect a “double whammy” in 2018 as a result of variable-rate PBGC premiums. They will face both higher rates per $1,000 of underfunding from the previous legislation and new, greater levels of underfunding due to the IRS adopting the new mortality tables, the investment consulting firm wrote.
At the same time, the reality of increased longevity and longer-term retirements may lead some employees to work beyond a pension plan’s “normal retirement age,” offsetting somewhat the increased liabilities brought about by the latest mortality assumptions.
Uses for Mortality Tables
Among other things, mortality tables are used to figure a DB plan’s minimum funding requirements, or targets, as required by federal regulations. The Pension Protection Act of 2006 (PPA) established a minimum funding ratio of 80% (pension assets divided by liabilities) in most cases. The tables also let plan sponsors establish present value requirements each year. The net present value of individuals’ pensions calculates their value in current dollars. Net present value accounts for the fact that the payments will be spread out over several years and could be invested and paying a return in that time period.
The regulations that govern the use of the new mortality tables by DB plans allow plan sponsors to apply the projection of mortality improvement in one of two ways: through use of static tables like the ones released July 31, 2015, or through use of generational tables, the IRS said.
“Sponsors should ensure that they are equipped with a comprehensive pension strategy that encompasses both funding and investment policies” as well as potential “derisking” options ahead of 2018 IRS implementation of the altered mortality tables, Cambridge Associates recommended.
|Jane Meacham is the editor of BLR’s retirement plan compliance publications. She has nearly 30 years’ experience as a writer/editor of financial services news.|
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Author: Jane Meacham