Plan Sponsors Should Prepare Now for 2012 Pension Interest Rates

The IRS recently released the October interest rates for pension plans. What do they hold in store for plan sponsors? This post summarizes some of the important rates along with our observations.

Funding Segment Rates

The interest rates used to determine pension plan liabilities for IRS funding purposes are composed of three segment rates (unless a full yield curve is elected). Below is a comparison of how the rates have changed over the past year.

There’s been a significant drop in the first two segment rates. This will likely increase the liabilities for retirees significantly. The third segment rate didn’t drop quite as much, but it will still increase pension liabilities.

Combined with the volatile stock market and poor asset returns, the funded status of many pension plans is likely to decrease in 2012 and their IRS minimum required contributions will increase. In hindsight, liability-driven investing (LDI) is probably looking like a great idea to many at this point.

417(e) Minimum Lump Sum Rates

The September interest rates (published in October) used to determine minimum lump sum payouts were also released. The changes here are much more subtle.

The first two segment rates decreased slightly while the third segment rate increased a bit. It’s tough to say what the impact will be on lump sum payments given the opposing interest rate movement, but it will likely be relatively minor.

The important take-away is that many plan sponsors were hoping that minimum lump sum interest rates would increase substantially in 2012 since it is the last year of the phase-in from 30-year Treasury rates to PPA corporate bond rates. However, even corporate rates are still relatively low, so sponsors will have to wait until these rates increase before there is a material impact on their lump sum payouts.

Even if a plan doesn’t use an October lookback, the year-over-year change in funding and lump sum rates will likely follow a similar pattern. We’ll provide updated posts and analysis each month as we get closer to the end of 2011. With luck, maybe pension interest rates will have a bit of an uptick before 2012 arrives.

For a complete listing of the segment rates, click here  and for a complete listing of the 417(e) minimum lump sum rates, click here. We’ve also included graphs of the PPA segment and spot rates below to give a general picture of how rates have been moving over the past couple of years.