Critical Point Episode 32: Understanding IRS guidance Notice 2021-48 under the American Rescue Plan

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Charles Clark: Hello. And welcome to Milliman’s Critical Point Podcast. I’m Charlie Clark. I'm a principal and the director of Milliman’s Employee Benefits Research Group. We are here today to talk about the IRS’s notice 2021-48, which was released at the end of July. And it provides guidance on changes to single-employer defined benefit pension plan cash contribution rules under the American Rescue Plan Act to which we’ll refer to as ARPA. Plan sponsors and advisors have been eagerly awaiting this technical guidance. And it provides a road map to the implementation of ARPA. During this Critical Point podcast today we’ll be discussing the ways in which this guidance impacts plan sponsors and the participants of single-employer pension plans. I’m happy to be joined today by my colleague Casey Baldwin. Casey is a principal and actuary who specializes in the single-employer pension plan. And he’s from our Portland, Oregon, office. Glad you could join me today, Casey.

Casey Baldwin: Good morning Charlie, it’s good to be with you.

Understanding IRS 2021-48: Answers to technical questions on ARP

Charles Clark: Yeah. You know, Casey, the IRS finally got around to providing this important guidance assisting the plan sponsors. We’ve been waiting for it for a while. And it reflects the assistance relief that Congress authorized due to the pandemic emergency. So just what did we learn for defined benefit plans?

Casey Baldwin: Well, Charlie, we finally got some clarification. We’ve been waiting for that quite a while. And we got some answers to some of our technical questions. Overall, I would say there really weren’t any major surprises in the guidance. Prior to this guidance many of us have been kind of trying to push forward the good faith and interpret the laws that have been written. But there were some details that we just didn’t have answers to. Now, we have concrete answers and we can move forward. Outside of those provisions the guidance seemed to place quite a bit of emphasis on memorializing elections. So plan sponsors are going to need to provide written notification to the actuary after making any elections under ARPA.

Charles Clark: Let’s get a little bit more into of what you refer to as a clarification. What was clarified in this guidance?

Casey Baldwin: Yeah. I think one of the big items was on the interest-rate relief provisions provided by ARPA. And when I talk about the interest-rate provisions that’s what are used to calculate the pension obligations. And by default, this provision on the interest-rate relief was to go into effect for the 2020 plan year. Plan sponsors had the option of deferring all the way to 2022. In the original language the way it was written there was some ambiguity and many of the practitioners thought that it was only allowed to apply in 2020 or 2022; 2021 was not an option. So finally we got an answer there and clearly they put that to bed and we can, with an election, go ahead and reflect that interest-rate relief for the first time in 2021.

Charles Clark: Good. That’s great news I assume for all plan sponsors. But is there anything else we should talk about here?

The impact on interest rate relief

Casey Baldwin: Yeah. Well, interest-rate relief is not new to actuaries or plan sponsors. We’ve been dealing with it for the last 15 years. Since the Pension Protection Act of 2006 went into effect we’ve generally been in a very low interest-rate environment. When we have low interest rates that results in larger liabilities and larger cash contributions for the plan sponsors. So periodically we’ve had lawmakers providing us with interest-rate, and I will say that that’s temporary interest-rate relief, really to insulate plan sponsors from dealing with the effects of low interest rates. The interest-rate relief prior to ARPA was set to start phasing out in 2021. So that was a concern many actuaries and plan sponsors had.

Casey Baldwin: So the interest-rate relief in effect prior to ARPA was set to start phasing out in 2021. Now, ARPA resets that interest-rate relief and it pushes that phase-out period to 2026. However, we’re aware of the current infrastructure bill being debated right now in the Senate and that defers the beginning of the phase-out commencement all the way to 2031. So that’s something we’re definitely keeping our eye on. It’s important to remember with this interest-rate relief that it does not apply to all liability measurements. For example, each year a pension plan will play a premium to the Pension Benefit Guarantee Corporation or PBGC. And part of this PBGC premium they pay each year has what’s called a very variable premium. And that variable premium is determined on the unfunded liability that the plan has. That unfunded liability is not going to be changed by ARPA.

Casey Baldwin: So while the ARPA guidance sets a clear path that prior IRS funding calculations may be changed retroactively, plan sponsors have cautioned that these PBGC variable-rate premium calculations are likely to change. So we, of course, would change our view if PBGC issued specific guidance in one of their periodic technical updates.

Charles Clark: But I thought I read something in there that the interest-rate relief not only changes minimum funding cash contributions but also statutory hybrid plans. What’s that? And why do we care about it?

Casey Baldwin: Yeah. So the guidance clearly indicated that certain hybrid plans could be affected by the ARPA interest-rate relief. So hybrid plans or cash balance plans, as they’re sometimes referred to, they provide participants with an account balance that’s credited with interest periodically. Now, many of these hybrid plans tie their interest credits to the funding segment rates. And if they did that those interest crediting rates will be affected by ARPA. So I think there’s a couple of takeaways from that provision there. That is that ARPA will produce higher segment rates for funding and that’s going to result in higher interest crediting rates for these plans of credit cash balance. So that could offset some of the savings that comes from this interest-rate relief. And I think one of the takeaways there for plan sponsors is, if they do have a plan with interest crediting rates that are tied to the segments rates, it may be advantageous for them to wait and defer, to reflect that interest-rate relief to 2022. And then also depending on when the interest-rate relief goes into effect the plan may be required to adjust past interest credits. That may be something that they had to do retroactively.

Impact on plan amortization rate

Charles Clark: Thanks, Casey. What I understand and what I’ve read is there’s another component to implementing ARPA. And the other major provision in there is to pay off what I’ve been referring to as an IRS funding deficit over a longer period of time than under the pension plan law being replaced. Can you discuss that, please?

Casey Baldwin: Yeah. So single-employer DB plans have generally amortized their shortfalls or deficits over a seven-year period. Now, with ARPA that permanently bumps that amortization rate up to 15 years. That’s pretty much what we expected to see in the guidance. The law was written that way. So we didn’t really see any curveballs on this. The default there is that the 2022 plan year will be the year in which that extended amortization goes into effect. But plans do have the option to adopt as early as 2019. And so the extended amortization period—what that’s going to do is it’s going to lead to lower contribution requirements. So we expect many of our plans to make that election and implement early.

Impact to prefunding balances and other items

Charles Clark: One of the more technical provisions has to do with this idea of a prefunding balance. And what a prefunding balance is, is in the past, if a plan sponsor has made higher contributions than was necessary to meet the minimum funding requirements, they get a credit. So can you talk to us a little bit about what changes, if any, have been made for what’s called the prefunding balances, Casey?

Casey Baldwin: Yeah. The IRS threw us a bone here—generally in the past we’ve always considered written elections to reduce prefunding balance as irrevocable. However, the guidance clearly gives plans an option to revoke those prior elections to the extent that their prefunding balance that was used now exceeds the minimum after reflecting ARPA. In other words, if they use too much balance to satisfy requirements prior to ARPA, this will give them the opportunity to go back and recoup some of that prefunding balance. And then also we know that some plan sponsors may have made excess cash contributions after ARPA’s reflected. And so they’ll have the opportunity to go and reflect those excess contributions and add them to their prefunding balance. Once again, all these corrections will require written elections and those elections are generally due by the end of 2021. Overall, we’re really quite pleased with the flexibility that the IRS gave us.

Charles Clark: That’s a remarkable comment as normally we may not feel like that. And thank you for pointing out the written elections again. Do you want to add anything more to that?

Casey Baldwin: Yeah. One surprise that we saw in all this in those written elections is that the plan sponsor's address is listed as one of the essential items on the written election form. Some of us consultants have been pushing forward and issuing election forms prior to any guidance. And most of those forms did not include the address.

Charles Clark: Now, is there any further comment you have on what can be done for the plan sponsors that already signed these election forms and may have missed this—what some might see as a silly detail.

Casey Baldwin: So Charlie we’re taking the position that if a plan already signed an election form that it was done out of good faith. And we don’t anticipate trying to go back and make corrections to those forms. Obviously, as we go forward we’re going to put the address, the plan sponsor’s address, on all the forms and that will be taken care of going forward.

Charles Clark: Let’s start wrapping this up, Casey. Are there any pitfalls to be aware of or other items to consider before we thank our audience for being with us today, please?

Casey Baldwin: Sure, Charlie. I can share a few thoughts on that. I think there’s a couple of things to be aware of. First, I would say be aware of the ramifications. So with ARPA we had the opportunity to go as far back as 2019 to redo some of our evaluations and a lot of the calculations. So with that we need to be real careful that everything we do is in sync including our 5500 filings, our PBGC filings. You will have the opportunity to reassign receivable contributions. We don’t think that will impact the PBGC premium but that could come about. So that’s something that’s worth considering.

Casey Baldwin: So the second thing I would say is don’t be fooled. The relief that we’re getting is temporary and it’s artificial in many ways. For example, if a plan pays lump sums, the lump sums that it’s going to pay for participants doesn’t change. So even though we’re getting interest-rate relief, that only impacts what we put on paper. The actual cost of the plan is what we pay to participants or ultimately what we pay to an insurance company to offload that liability. So don’t be fooled by that. Also, if a plan goes ahead and takes advantage of some of the lower contributions that come through ARPA it could have impact on your PBGC variable premium. It could also delay the timing to get fully funded on a plan termination basis. So plan sponsors are going to want to reevaluate some of their long-term objectives. And then also on Notice 2021-48 we want to make sure that those are—or make it known that those are for IRS calculations only. The plan sponsors need to weigh the consequences on their accounting liabilities. If they’re putting in less cash it could have an impact on their P&L and their balance sheet obligations. And then finally I would say to plan sponsors reassess your risks. The landscape has changed with ARPA. So if prior to ARPA your primary driver of making decisions was cash avoidance, and I have plans that were in that boat, you now have more cushion and things have changed. So you may have some more flexibility on your investments. You may have more flexibility to de-risk. We’ve had this 80% threshold that’s out there. Any time your plan’s funding percentage falls below 80% you can be subject to benefit restrictions. That measurement is going to be affected by ARPA. So plans should have more cushion and be able to stay above that 80% threshold a little easier. That may give them some room to operate and do some more de-risking activity that they weren’t able to do prior to ARPA. And then last I would just say revisit your objectives and risk tolerance. Maybe it’s a good chance to talk to your actuary and revisit those things and make sure you’re on the path that you want to be and not just defaulting to the minimum required contributions that result through ARPA.

Charles Clark: Thanks, Casey. That’s really helpful. I’ll just wrap up folks and close here. So we know the IRS delivered to the plan sponsors and the pension actuaries this concise technical guidance to implement the IRS funding calculations under ARPA. In general, and as we wrote to our readers in our Benefits Alert released on August 3, there was a lot of flexibility to consider. Casey’s comments just before this, my closing statement, is a good road map to follow and alert that unintended adverse financial results could occur if this isn’t carefully evaluated, particularly the impact on the balance sheet. Thanks, Casey.

Casey Baldwin: Thanks, Charlie. It’s been good to be with you.

Charles Clark: Thank you. And everyone, thanks. You’ve been listening to Critical Point podcast presented by Milliman. To listen to other episodes of our podcast visit us at Milliman.com. And you can also find us at iTunes, Google Play, Spotify, and Stitcher. See you next time.