Published
March 12, 2021
Last March, the Federal Reserve slashed interest rates to near-zero to support the economy as the world faced the COVID-19 pandemic. No one doubted the Fed’s decision, but only a few realized the dire consequences this would have on private companies that sponsor defined benefit pension plans. Unfortunately, because of the time value of money, the lower the interest rate used to determine future payments, the higher the current contributions – even if the promised benefit does not change. Alas, the effort to save the economy was about to wreak havoc on those very companies that voluntarily still maintained pensions for their employees.
To understand this, we need to rewind to 2006 when Congress decided to tie pension funding to near-term interest rates instead of smoothed rates such as the old 30-year treasury bond. There is debate over whether long-term obligations paid out over decades need to be tied to current interest rates or funded at 100%. (For example, we don’t require you to have enough money in the bank to pay off a 30-year mortgage when you get it).
However, in 2006 when this change was made, it didn’t seem such a big deal when interest rates were at 6%. However, as time went on and interest rates went down, Congress realized that it might not have been such a good idea. Starting in 2012, Congress allowed plans to use 90% of the 25-year average instead of the 24-month average. This was again extended in 2015, but it was set to start dropping by 5% in 2021.
If interest rates were still 6%, this wouldn’t be a problem. But they aren’t, and they aren’t going back to 6% anytime soon.
However, the American Rescue Plan (ARP) found a solution that helps employers help themselves. That’s right, it didn’t cost the government any money – in fact, it raised money. ARP solves this problem by smoothing interest rates over 25 years and allowing losses to be recognized for 15 rather than seven years. The rate percentage will gradually decrease, but hopefully, by then, the economy will have recovered.
In the meantime, these simple, but meaningful changes help employers help themselves by giving them the flexibility to decide how to deploy hundreds of millions of dollars to the immediate needs of their workforce, business, and community rather than tying it up in their otherwise well-funded pensions. (A February 2021 Milliman report found that the top 100 pensions were at 89.9% funded). They also have the option to fund up their plans, if that is what works for them.
Contrary to some assertions, employers are not walking away from these plans, putting benefits at risk, or bankrupting the system. The U.S. Chamber would argue that any employer that is dedicated enough to maintain a pension plan in this day and age is dedicated to ensuring those promises are met. In fact, they are legally obligated to do so. However, it is difficult to fulfill that promise if government action has made your contributions so artificially high you may face bankruptcy instead.
Sometimes, the best solution is to give businesses the tools they need to help themselves.
About the authors
Chantel Sheaks
Chantel Sheaks develops, promotes, and publicizes the Chamber’s policy on retirement plans, nonqualified deferred compensation, and Social Security.
