The SECURE 2.0 Act of 2022 was signed into law on December 29, 2022. While most of the attention has been on the changes that apply to defined contribution (DC) plans, there are some that apply to defined benefit (DB) plans. We will review three provisions that impact single employer DB plans.
- The cap on the mortality improvement rates will lower liability amounts, resulting in reduced minimum required contributions and Pension Benefit Guaranty Corporation (PBGC) premiums for underfunded plans.
- In addition to the change in mortality, the termination of the indexing on the PBGC variable rate premium will further reduce costs for certain underfunded plans.
- The benefit accrual rules for cash balance plans using a variable interest crediting rate are changing, providing potential opportunity for plans sponsors to modify their plan designs to provide higher accruals for older, longer-service employees.
Lower liabilities due to the cap on mortality improvement rates
The Internal Revenue Service (IRS) annually prescribes the mortality tables that single employer DB plans use to value benefit obligations for purposes of ERISA minimum funding requirements.1
- This change will also lower the liability associated with vested benefits as of the valuation date used to determine the PBGC variable rate premium (VRP) for underfunded plans.
- It is unclear whether the cap on the mortality improvement will impact the mortality table used to determine minimum present values (i.e., lump sums) under Internal Revenue Code Section 417(e) starting in 2024.
Figure 1 shows the mortality improvement rates in excess of 0.78% for males at every age for select payment years based on the MP-2021 improvement scale, the latest scale published by the Society of Actuaries.2 The excess rates for females follow a similar pattern to the male rates shown below.
Figure 1: MP-2021 mortality improvement rates in excess of 0.78% (male)
Excess improvement rates occur at only some ages in the payment years before 2030 but appear for nearly all ages after 2030. Limiting mortality improvements will shorten projected life expectancies and lower plan liabilities. The impact of this change will depend on the demographics of the plan.
Example: Figure 2 illustrates how the actuarial liability and minimum required contribution change for two hypothetical plans. Plan A is a traditional final average pay (FAP) plan that was recently closed to new entrants. The population is approximately 60% male. Plan B is a cash balance plan with a legacy final average pay component. The plan is still open to new entrants who are only eligible for the cash balance portion of the plan. The population is approximately 60% female.
Figure 2: Change due to cap on mortality improvement rates
| Plan A | Plan B | |
|---|---|---|
| Actuarial Liability | Decrease 1.0% to 1.5% | Decrease 0.5% to 1.2% |
| Minimum Required Contribution | Decrease 2.5% to 3.0% | Decrease 2.5% to 3.0% |
| PBGC Variable Rate Premiums | Decrease 2.5% to 3.0% | Decrease 2.5% to 3.0% |
Indexing of the PBGC variable rate premium rate is terminated
Single employer DB plans pay premiums to the PBGC, the federal agency that insures pension benefits. Plans pay a flat rate premium based on the number of participants in the plan, plus a variable rate premium (VRP) if the plan is underfunded. The VRP is limited by a per participant premium cap. Prior to SECURE 2.0 all premium rates were indexed based on the change in the national average wage index.
For the 2023 year, the flat rate is $96 per participant and the VRP is 5.2% ($52 per $1,000) of the plan’s unfunded vested benefit (UVB) liability up to a cap of $652 per participant.
- If a plan does not have UVB, they will not pay a VRP and are not impacted by this change.
- If a plan has UVB and the VRP each year is capped by the per participant VRP cap, they are also not impacted by this change. Their premiums will increase since the VRP cap continues to be indexed.
- If a plan has UVB but their VRP is not capped, they may see some savings due to this change. The amount of savings will depend on the rate the VRP would have increased each year (absent the law change) and the plan’s level of UVB.
Example: Figure 3 illustrates how much a hypothetical plan may save on PBGC premiums. For this simplified example, the plan’s 10,000 participants and UVB of $100 million remain level over the next 10 years and, absent SECURE 2.0, the VRP increases 3.0% per year. In this case, the plan would save about $6.3 million in PBGC premiums over the 10-year period.
Figure 3: Premium savings over 10 years (millions)
| VRP rate increases 3% per year |
Freeze VRP rate at 5.2% |
Estimated savings in premium |
Percent change |
|
|---|---|---|---|---|
| Present Value* of Flat Rate Premium | $8.4 | $8.4 | $0.0 | 0.0% |
| Present Value* of Variable Rate Premium | $46.5 | $40.2 | $6.3 | -13.5% |
| Total Premium | $54.9 | $48.6 | $6.3 | -11.5% |
* Present value calculated using on a 5.0% discount rate
Benefit accrual rules for cash balance plans
All DB pension plans must demonstrate that the benefit formula provided by the plan is not impermissibly backloaded, i.e., providing accruals for older or longer-service employees that are higher than what the law allows. The Internal Revenue Code (IRC) specifies three ways plans can test compliance with these rules. Most cash balance plans use the 133-1/3% rule, which provides that the annual rate of benefit accrual payable at normal retirement age cannot exceed 133-1/3% of the annual rate of benefit accrual earned in any earlier plan year.
Cash balance plans can be set up with a fixed interest credit rate (e.g., 5.0%), or a variable interest crediting rate (e.g., the return on a portfolio of assets). For testing purposes, plans with a variable interest crediting rate must choose a fixed rate for the current year and all future years when projecting pay credits to normal retirement (generally age 65). Prior to SECURE 2.0, plans were required to perform the test using the lowest possible interest crediting rate, and the IRS limited negative rates to 0%. This resulted in many cash balance plans implementing a minimum interest credit to satisfy the accrual rules.
When testing, each pay credit is projected with interest to normal retirement and then annuitized to determine whether the resulting benefit accrual exceeds 133-1/3% of any accrual earned in a prior year.
Allowing a reasonable interest crediting rate not to exceed 6% for testing purposes, rather than testing using the lowest rate will:
- Provide some plan sponsors the opportunity to provide higher benefit accruals to older, longer-service employees.
- Allow plan sponsors that currently have a minimum interest crediting rate to eliminate this provision in their plans.
Plan sponsors should consider the funding and accounting impacts for any plan design changes, as well as understand any other limitations that may be more likely to apply with the new design, such as the maximum benefit limitations under IRC Section 415.
Example: Figure 4 illustrates the hypothetical pay credits for participants of different ages in a cash balance plan that satisfies the 133-1/3% rule. For this example, we have assumed a salary of $100,000 and that the 133-1/3% rule is tested using either a 0% rate or a 6% rate.
Figure 4: Permissible pay credits at various ages
| Testing Rate | Project pay credit at 0% | Project pay credit at 6% | ||||
|---|---|---|---|---|---|---|
| Age of Accrual | Pay Credit | Accrual at 65* | Percent | Pay Credit | Accrual at 65* | Percent |
| 25 | $3,000 | $300 | $3,000 | $3,086 | ||
| 40 | $4,000 | $400 | 133 1/3% | $9,500 | $4,077 | 132% |
| 50 | $4,000 | $400 | 133 1/3% | $17,000 | $4,074 | 132% |
| 65 | $4,000 | $400 | 133 1/3% | $41,000 | $4,100 | 133% |
* Projecting the pay credit with interest to normal retirement (age 65) and annuitizing the amount using an annuity factor of 10.
- Using a 0% interest crediting rate for testing purposes, a pay credit of $3,000 at age 25 would provide a projected accrual of $300 at age 65. A pay credit earned at any later age cannot provide a benefit accrual that is greater than 133-1/3% of $300 and is therefore limited to $4,000.
- If a 6% interest crediting rate is used for testing purposes, the $3,000 pay credit at age 25 would provide a projected accrual of $3,086 at age 65. Including higher projected interest credits allows the plan to provide higher pay credits to older individuals.
Please contact your Milliman consultant for how these provisions may impact your plan.
1 Plans can request approval from the IRS to use mortality tables based on their own experience rather than using the published tables.
2 The mortality table and mortality improvement scale are periodically updated by the Society of Actuaries.