DB Q&A: Defined Benefit Plan Mortality Assumptions

Last October, the Internal Revenue Service (IRS) issued final regulations and other guidance on the mortality tables that apply to defined benefit (DB) pension plans for the purposes of minimum funding. These directives affect the calculation of Pension Benefit Guaranty Corporation (PBGC) variable premiums, as well as lump-sum and other accelerated distribution options.

Q. Was there a reason that the IRS issued final regulations updating mortality tables at this time?

A. Yes. The Pension Protection Act of 2006 (PPA) requires the Treasury Department to update these mortality tables at least every 10 years, to reflect pension plan experience and projected trends in experience. The last update was effective as of 2008.

Q. When will the new mortality tables become effective?

A. The new mortality rules will generally become effective this year, although, as discussed below, if certain conditions are satisfied, plan sponsors may delay the application of the new rules for one year, but only for funding purposes.

Q. Will it be necessary to amend plans to reflect the new mortality assumptions?

A. In most instances, it will not be necessary to amend your plan. Many plans contain language that incorporate, by reference, changes in mortality assumptions.

Q. Will financial accounting for defined benefit pension plans be similarly affected?

A. In general, the financial accounting for the plan will already have reflected the lower mortality rate.

Q. Do the new mortality assumptions apply to all benefit calculations under the defined benefit plan?

A. The answer is plan-specific. Some plans call for the use of the statutory mortality table, even when not required under the Internal Revenue Code (IRC), for example, converting a single life annuity, into a joint and survivor benefit or a 10-year period certain. If your plan so provides, it will be necessary to discuss with the plan’s actuary the effect of the change in mortality assumption.

Q. What effect will the change in mortality assumptions have upon the cost of a plan?

A. While it will be necessary to discuss this issue with the plan’s actuary, estimates indicate that there will be between a 3% and 5% increase in the cost of providing lump sums. It is for this reason that plan sponsors using the de-risking technique of offering a single-sum benefit as an option to terminated vested participants who are not in pay status may have been advised to have benefits paid under this option.

Q. If the plan utilizes a different mortality assumption for those circumstances in which the IRC’s mortality assumptions are required to be used, will it be necessary to update those mortality tables as well?

A. While the technical answer to this question is no, the changing of the statutory table would be an appropriate time to revisit the other mortality assumptions. While there is a wide range of acceptable mortality tables, certain tables may relate back to the 1970s, and their updating should be discussed with the plan’s actuary.

Q. Is it possible to delay the application of the new mortality rates?

A. Yes. In a change from the proposed regulations, the final regulations provide for a one-year delay—limited to the use of the new mortality table for funding purposes, and not for lump-sum benefit purposes—if the plan sponsor concludes that using the new table this year would either be “administratively impractical” or would result in an “adverse business impact that is greater than de minimis.” However, the IRS guidance does not define either “administratively impractical” or “de minimis,” so this is a tactic that should be used with caution and only on the advice of ERISA [Employee Retirement Income Security Act] counsel.

Q. Is it possible to have a plan-specific substitute mortality table?

A. Yes. However, while the final regulations expanded the circumstances under which plan sponsors could consider use of a plan-specific mortality table, the availability of this option is restricted to large plans, because the plan must have a credible mortality experience. The plan’s actuary must be notified of this action, and the IRS must approve it in advance. In general, a request for approval must be submitted at least seven months before the first day of the first plan year for which the substitute mortality tables are to apply. Under a transition rule, plan sponsors were allowed to apply by this February 28 to use substitute mortality tables for plan years beginning in 2018.

Marcia Wagner is a specialist in pension and employee benefits law and is the principal and founder of The Wagner Law Group P.C., one of the nation’s largest boutique law firms specializing in the Employee Retirement Income Security Act (ERISA), employee benefits and executive compensation. A summa cum laude and Phi Beta Kappa graduate of Cornell University and a graduate of Harvard Law School, she has practiced law for 30 years, 21 with her own firm. She is recognized as an expert in a variety of employee matters, including qualified and nonqualified retirement plans, fiduciary issues, all forms of deferred compensation, and welfare benefit arrangements.