The SECURE 2.0 Act of 2022 (SECURE 2.0) significantly changes the legal and administrative compliance landscape for U.S. retirement plans. Foley & Lardner LLP is authoring a series of articles that take a “deep dive” into key SECURE 2.0 provisions that will affect how employers structure and administer their 401(k) plans, pension plans, and other types of employer-sponsored retirement plans.
In this article, we explore several changes that SECURE 2.0 made to the rules affecting defined benefit pension plans.
Cash Balance Plan Compliance with Back-Loading Requirements
The rate at which a participant accrues benefits under a defined benefit pension plan must satisfy certain rules designed to ensure that the participant has meaningful accruals through-out his or her career. These rules are generally referred to as the back-loading rules. The rules prevent plan designs and accrual patterns under which a participant’s benefit accrual rate for any plan year (when expressed as an annuity payable at normal retirement age) exceeds the participant’s benefit accrual rate for any prior plan year by more than a prescribed amount.
Compliance with the back-loading rules is potentially difficult for cash balance plans that determine interest credits based upon a variable rate, such as plans that credits interest based on the actual rate of return on plan assets. The Internal Revenue Service has historically required that the back-loading test be performed by assuming that the most recent interest crediting rate remains in effect for future years.
Many cash balance plans grant annual contribution credits under an age-weighted formula that provides larger contribution credits (as a percentage of current compensation) for older employees. For any such plan that credits interest pursuant to a variable rate, these plans may struggle to pass the back-loading test for years in which the interest crediting rate is low. These plans generally pass the back-loading test for years with a higher interest crediting rate, because even though the younger employee might receive a smaller employer contribution credit, the credit has more years to accumulate, at the higher interest crediting rate, until participant’s normal retirement age.
SECURE 2.0 eliminates the requirement that a cash balance plan with a variable interest crediting rate use the most recent interest crediting rate as the projected rate for purposes of testing compliance with the back-loading rules. Instead, the plan is now permitted to specify a projected interest rate that is a reasonable estimate of the projected crediting rate, not to exceed six percent. The practical effect of the change is that plans that provide for employer contribution credits on an age-weighted basis will be more likely to pass the back-loading requirements, even though older or more senior employees receives a larger annual contribution credit.
The change is effective for plan years beginning after December 29, 2022.
Limitation on Mortality Improvement Rates
A pension plan sponsor’s required minimum contribution is actuarially determined on the basis of several factors. One such factor is a mortality table that defines the period over which plan benefits are expected to be paid. The mortality table required to be used for minimum funding purposes is periodically updated to reflect mortality improvement rates. SECURE 2.0 directs the Secretary of the Treasury to apply a cap on mortality improvement rates. For purposes of the minimum funding requirements, the future mortality improvements that are assumed for years beyond the valuation date cannot be greater than 0.78% (or such other percentage determined by the Secretary of the Treasury to reflect overall mortality changes as projected by the Social Security Administration).
Elimination of PBGC Variable Rate Premium Indexing
Defined benefit pension plans pay an annual premium to the Pension Benefit Guaranty Corporation (PBGC). The premium consists of both (1) a flat-rate premium that applies on a per participant basis, regardless of the plan’s funded status, and (2) a variable rate amount that is paid by plans with unfunded vested benefits, based on the degree of plan underfunding.
Prior to SECURE 2.0, the variable rate premium was indexed, meaning that the variable rate premium (per $1,000 of underfunding) increased every year. Starting with the 2024 plan year, the PBGC variable rate premium will change from an indexed amount to a flat $52 per $1,000 of unfunded vested benefits (which is the same as the indexed amount for the 2023 plan year). Thus, there will no longer be automatic increases in the PBGC variable premium rate.
Transfer of Surplus Pension Assets to Pay Retiree Health and Life Obligations
Under current law, an employer may “repurpose” surplus assets in an overfunded pension plan to pay certain retiree health and life insurance benefits. These rules were scheduled to expire at the end of 2025. SECURE 2.0 extends the expiration date to the end of 2032. To be eligible, the transfer must be no more than 1.75% of plan assets and the plan must be at least 110% funded.
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