In recent months there have been many news stories about the financial burden that pension plans have placed upon old-line companies in the automobile, steel, and airline industries. At a time when companies in these industries face stiff competition from newer companies, the old-line companies need to make large contributions to their pension plans, as a result of their deterioration in funded status. This article summarizes the events of the past few years that have led to that deterioration and the interim relief that Congress has provided.

With the downturn in the stock market in recent years, many pension plans of large companies experienced significant asset losses that led them from the overfunded status that had existed for a large part of the 1990s into underfunded status. Because these plans are subject to the minimum funding requirements of the pension laws, the asset losses must be paid for through increased minimum funding requirements. While almost all pension plans required additional contributions, pension plans of large companies were especially impacted because of the additional funding rules that apply to these plans.
 
For large pension plans, one part of the minimum funding requirement is based upon the difference between the plan's current liability and the value of the plan's assets. The current liability is a measure of the value of the benefits earned to date and is generally calculated using an interest rate based upon the interest rates on 30-year Treasury securities as specified by the Commissioner.[1] The contribution based upon this difference is called the deficit reduction contribution (because it makes up the deficit between the current liability and the value of the plan's assets). The deficit reduction contribution (DRC) resulted in relatively large increases in contributions for employers with large underfunded plans, many of whom had no funding requirements for the past few years.
 
The increased contribution requirements come at a time when many companies and industries are still recovering from the economic downturn that occurred at the same time the markets declined. Employers have found that the DRC has increased markedly for two reasons. The first is the asset losses described above, which widened (or created) the deficit between current liability and assets. The second is that the interest rate used to calculate the current liability has been depressed in comparison to other interest rates in the market place. Accordingly, employers have argued that interest rates more reflective of the market should be used to calculate current liability. In response, Congress adjusted the interest rate used for plan years beginning in 2002 and 2003 to allow interest rates as high as 120% of the 30-year Treasury rate, rather than 105%.
 
The airline and steel industries have been particularly hard hit by the funding requirements for their pension plans. Some companies have taken the step of terminating their underfunded plans, which adds to the liability of the Pension Benefit Guaranty Corporation. To provide interim relief, in April, Congress passed the Pension Funding Equity Act of 2004 (PFEA).  PFEA provided relief for the 2004 and 2005 plan years by:

• Replacing the interest rate based upon the 30-year Treasury securities with an interest rate based upon long-term investment grade corporate bonds; and
• Allowing for the election of an alternate DRC calculation for certain plans of employers in the airline and steel industries.

The interest rate based on long-term investment grade corporate bonds is significantly higher than the interest rate based on the 30-year Treasury securities. The use of a higher interest rate reduces the calculated current liability and thus has the effect of reducing the DRC for an underfunded plan. In cases with only some underfunding, the use of the rate based on corporate bond rates will eliminate the need to make a DRC altogether.  This relief applied to all defined benefit plans, not to plans in specific industries.

The alternate DRC calculation allows an employer in the airline and steel industries to elect to determine the DRC as 20% of the otherwise applicable amount (i.e., an 80% reduction). In order to do an election, it must be filed with the IRS, followed by notification of the PBGC, and notification of plan participants of the election.  Also, restrictions are placed upon the ability to increase benefits under a plan for which the alternate DRC election has been made. The following lists the announcements and notices that have been issued with respect to PFEA:

• Notice 2004-34 provides guidance as to how the interest rate based upon long-term investment grade corporate bonds is determined.[2]
• Announcement 2004-38 sets forth how the employer may make the alternate DRC election for eligible plans.
• Announcement 2004-43 (corrected by Announcement 2004-51) sets forth the requirements for notifying the PBGC and plan participants of the alternate DRC election and sets forth the deadline for making the election.

Multiemployer plans are not subject to the DRC calculation; however, they also needed to increase the funding requirements because of the asset losses. Under PFEA, multiemployer plans can elect to defer the amortization of certain investment losses.  Guidance has not yet been issued with respect to this election.
 
Lastly, for 2004 and 2005, PFEA changed the interest rate used for non-annuity benefits under section 415(b) of the Code by replacing the 30-year Treasury rate with a flat rate of 5.5 percent. Guidance is in process for transition rules that were provided with respect to this change.

[1] Each month a Notice is published in the Internal Revenue Bulletin specifying the 30-year Treasury rate for the prior month as well as related rates.


[2] Subsequent notices set forth the corporate bond rates and related interest rates as well as for the 30-year Treasury rate.