PBGC Premiums Getting in the Way of Its Mission

Letting the agency set its own premiums and basing them more on risk would encourage the offering and maintenance of pension plan, the Academy of Actuaries says.

The Pension Benefit Guaranty Corporation (PBGC) was created by the Employee Retirement Income Security Act (ERISA) to encourage the continuation and maintenance of private-sector defined benefit (DB) pension plans, provide timely and uninterrupted payment of pension benefits and keep pension insurance premiums at a minimum.

An Issue Brief from the American Academy of Actuaries argues that the way PBGC premiums are set is leading many plan sponsors to decide to discontinue their plan, reduce the size of their plan or not to adopt a plan—running counter to the mission to encourage the continuation and maintenance of private-sector DB plans.

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The per-participant flat rate premium for plan years beginning in 2020 is $83, up from a 2012 rate of $35. The 2020 variable-rate premium (VRP) is 4.5% of the value of unfunded vested benefits (UVB), up from a 2012 rate of 0.9%. The VRP is subject to a per-participant cap, which is $561 per participant in 2020. The initial cap in 2013 was $400 per participant.

As the Academy’s Issue Brief notes, from 2012 to 2020, the flat rate premium has more than doubled and the VRP has increased by a factor of 5, though the cap has limited this increase for the most poorly funded plans. One issue, according to the Academy, is that Congress, not the PBGC, sets premiums.

In 1980, Section 406 of the Multiemployer Pension Plan Amendments Act (MPPAA) allowed PBGC premiums to be calculated as general fund revenue for budget scoring, even though the premiums themselves are not used to pay for unrelated programs. Basically, PBGC premiums are categorized as an increase in general revenue and Congress increases them to offset the costs associated with other government expenditures in order to achieve budget neutrality.

The Academy argues that letting the PBGC set its own premiums would not only take them “off budget,” but would allow the agency “to review the premium structure and adjust it to be more timely when needed, to more appropriately reflect its risks, to reduce moral hazards and anti-selection and to discourage termination of plans and lump sums.”

Linda K. Stone, senior pension fellow with the American Academy of Actuaries, says it would be helpful for the PBGC to set its own rates because there is a disconnect between the level of premiums and the risk the agency bears for carrying out its mission. “Congress is independently setting rates, and it has an incentive to raise them to use them as a budget balancer,” she notes.

She says the outcome may be that high-risk pensions pay more in premiums, but “something is wrong with the system if plan sponsors with healthy pensions are exiting the system because of high premiums.” Stone notes that a recent PBGC report about risk transfer activity (RTA) shows as many healthy plan sponsors are exiting the DB system or reducing participant count as are unhealthy plan sponsors.

The PBGC’s VRP is based on how much a plan is underfunded. Stone points out that there is nothing in the calculation that considers the health of the plan sponsor. “Two plans could have the same amount of underfunding, but one is in distress and the other healthy,” she says. “And it’s the one in distress that is more likely to end up taken over by the PBGC.” Stone points out that the agency has the ability to use sophisticated models for assessing risk and setting premiums.

“We don’t know how much the premiums set by the PBGC would be compared to what is being paid now,” she says. “However, the single-employer program is in surplus by $8.7 billion and it’s projected that in 10 years it will have a surplus of $46 billion. So, it seems like everyone is overpaying. There needs to be modeling to restructure premiums for what healthy companies should be paying versus those companies whose plan is more likely to end up with the PBGC.”

DB plan sponsors might have different reasons for offloading some or all their pension obligations, but Stone says she think premium levels are a bigger driver of plan sponsors’ actions than other things. “For example, many sponsors are looking at retirees who are only getting a small benefit and cutting them from their plans,” she says. “They are paying a premium of $600 per participant to keep them in the plan when the liability for these participants isn’t that high. That’s why plan sponsors are sending small benefit annuitants to insurance companies.”

Stone says she checked with the PBGC about how to get premiums off budget. She was told that since only Congress can change premiums, the agency believes only Congress can get them off budget. “That would take a lawmaker understanding the ramifications to the system,” she says.

A bill intended to prohibit the use of premiums as an offset for other federal spending was introduced in 2016 and reintroduced in 2017, but Stone says she doesn’t know of anyone who is working on the issue now. The Academy wrote a letter to Senate leaders in 2017 about the effect of pension-related revenue offsets.

“We know how important DB plans are to retirement security. An annuity paid for a lifetime makes such a difference in dealing with longevity risk and making money last. The DB system has been very beneficial,” Stone says. “But seeing a large number of plan sponsors exiting the system doesn’t support trying to have a robust DB system to enable a secure retirement.”

Maximum Benefit and Contribution Limits Table 2021

Maximum Benefit/Contribution Limits for 2016 through 2021, with a downloadable PDF of limits from 2011 to 2021.

Maximum Benefit/Contribution Limits for 2016-2021
As Published by the Internal Revenue Service


PDF of Maximum Benefit/Contribution Limits for 2011-2021 available here.

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2021 2020 2019 2018 2017 2016
Elective Deferrals (401k
& 403b plans)
$19,500 $19,500 $19,000 $18,500 $18,000 $18,000
Annual Benefit Limit $230,000 $230,000 $225,000 $220,000 $215,000 $210,000
Annual Contribution Limit $58,000 $57,000 $56,000 $55,000 $54,000 $53,000
Annual Compensation Limit $290,000 $285,000 $280,000 $275,000 $270,000 $265,000
457(b) Deferral Limit $19,500 $19,500 $19,000 $18,500 $18,000 $18,000
Highly Compensated Threshold $130,000 $130,000 $125,000 $120,000 $120,000 $120,000
SIMPLE Contribution Limit $13,500 $13,500 $13,000 $12,500 $12,500 $12,500
SEP Coverage Limit $650 $600 $600 $600 $600 $600
SEP Compensation Limit $290,000 $285,000 $280,000 $275,000 $270,000 $265,000
Income
Subject to
Social Security
$142,800 $137,700 $132,900 $128,400 $127,200 $118,500
Top-Heavy Plan Key Employee Comp $185,000 $185,000 $180,000 $175,000 $175,000 $170,000
Catch-Up Contributions

$6,500

$6,500

$6,000

$6,000 $6,000 $6,000
SIMPLE Catch-Up Contributions $3,000 $3,000 $3,000 $3,000 $3,000 $3,000

The Elective Deferral Limit is the maximum contribution that can be made on a pre-tax basis to a 401(k) or 403(b) plan (Internal Revenue Code section 402(g)(1)). Some still refer to this as the $7,000 limit (its original setting in 1987).

The Annual Benefit Limit is the maximum annual benefit that can be paid to a participant (IRC section 415). The limit applied is actually the lessor of the dollar limit above or 100% of the participant’s average compensation (generally the high three consecutive years of service). The participant compensation level is also subjected to the Annual Compensation Limit noted below.

The Annual Contribution Limit is the maximum annual contribution amount that can be made to a participant’s account (IRC section 415). This limit is actually expressed as the lessor of the dollar limit or 100% of the participant’s compensation, applied to the combination of employee contributions, employer contributions and forfeitures allocated to a participant’s account.

In calculating contribution allocations, a plan cannot consider any employee compensation in excess of the Annual Compensation Limit (401(a)(17)). This limit is also imposed in determining the Annual Benefit Limit (above). In calculating certain nondiscrimination tests (such as the Actual Deferral Percentage), all participant compensation is limited to this amount, for purposes of the calculation.

The 457 Deferral Limit is a similar restriction, applied to certain government plans (457 plans).

The Highly Compensated Threshold (section 414(q)(1)(B)) is the minimum compensation level established to determine highly compensated employees for purposes of nondiscrimination testing.

The SIMPLE Contribution Limit is the maximum annual contribution that can be made to a SIMPLE (Savings Incentive Match Plan for Employees) plan. SIMPLE plans are simplified retirement plans for small businesses that allow employees to make elective contributions, while requiring employers to make matching or nonelective contributions.

SEP Coverage Limit is the minimum earnings level for a self-employed individual to qualify for coverage by a Simplified Employee Pension plan (a special individual retirement account to which the employer makes direct tax-deductible contributions.

The SEP Compensation Limit is applied in determining the maximum contributions made to the plan.

EGTRRA also added the Top-heavy plan key employee compensation limit.

Catch up Contributions, SIMPLE “Catch up” deferral: Under the Economic Growth and Tax Relief Act of 2001 (EGTRRA), certain individuals aged 50 or over can now make so-called ‘catch up’ contributions, in addition to the above limits.

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