IRS Notice 2022-50 for Pension Plan Funding
Examine how IRS Notice 2022-50 provides the interest rates that drive key financial calculations for single-employer defined benefit pension plans.
The Internal Revenue Service issues formal guidance with data for financial and actuarial calculations, including the monthly publication of interest rates for certain retirement plans. These updated figures are used for compliance with various sections of the Internal Revenue Code.
Parties Affected by the Notice
The information in notices concerning pension funding rates is directed at sponsors of single-employer defined benefit pension plans. A plan sponsor is the employer that has established the retirement plan for its employees and is financially responsible for it. These employers must follow specific funding rules, and the IRS interest rates are a direct input into their compliance calculations.
The data is also used by the professionals who administer these plans. Pension actuaries and plan administrators use this information to perform calculations that determine a plan’s liabilities, required contributions, and participant benefits.
Key Interest Rates Provided in the Notice
The IRS notices on this topic provide several sets of interest rates derived from high-quality corporate bond yields. The foundational data is the corporate bond yield curve, which shows interest rates across a spectrum of maturities and reflects the yields on investment-grade corporate bonds.
From this yield curve, the IRS provides spot segment rates. These are broken down into three segments based on when benefit payments are expected to be made. The first segment rate applies to payments expected in the first five years, the second to payments expected between five and 20 years, and the third to payments expected beyond 20 years. These rates directly reflect current market conditions for different time horizons.
The guidance also includes 24-month average segment rates. These are rolling averages of the spot segment rates over the preceding two-year period. This smoothing mechanism helps to reduce the volatility that can arise from short-term fluctuations in the bond market. The use of these smoothed rates is permitted for certain calculations to provide more stability for plan funding.
Use in Pension Plan Administration
The segment rates are used to determine the minimum funding requirements for single-employer defined benefit plans. Actuaries use these rates to calculate the present value of all future benefits the plan is projected to pay out. However, recent legislation, including the American Rescue Plan Act of 2021 and the Infrastructure Investment and Jobs Act, has significantly altered how these rates are applied for funding calculations. These laws implemented an “interest rate stabilization” rule by narrowing the corridor around a 25-year average of interest rates. This has had the effect of raising the interest rates used for funding calculations, which in turn lowers the present value of liabilities and reduces the minimum contribution an employer must make.
These interest rates are also used to determine the amount of a lump-sum distribution paid to a retiring employee. When a plan participant elects to receive their pension benefit as a single payment rather than a series of monthly payments, the plan must calculate the present value of that future annuity stream. The segment rates are used for this calculation, with the first segment rate applied to the first five years of expected payments, the second rate to the next 15 years, and the third rate thereafter, making the calculation sensitive to the published figures.
The funding level of a pension plan also has a direct impact on the insurance premiums paid to the Pension Benefit Guaranty Corporation (PBGC). Plans are required to pay both a flat-rate premium and a variable-rate premium, with the latter being dependent on the plan’s unfunded vested benefits. While segment rates are used to calculate these unfunded benefits, the interest rate stabilization rules that apply for minimum funding purposes do not apply to PBGC premium calculations. For PBGC purposes, plans must use either the spot segment rates or the 24-month average rates without the legislative adjustments. This can result in a plan’s liability being calculated as higher for premium purposes than for funding purposes.