Compliance December 17, 2015

SCOTUS Decision Could Impact Retirement Plans

The Supreme Court same-sex marriage decision is applied to retirement plans in IRS guidance.
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A notice from the Internal Revenue Service (IRS) gives guidance to plan sponsors, applying the Supreme Court’s same-sex marriage case to retirement plans, as well as other benefits. The landmark case, Obergefell v. Hodges, decided in June 2015, held that under the 14th Amendment states cannot deny same-gender couples the right to marry and must recognize same-gender marriages performed in other states.  

The Treasury and the IRS said they understand that some plan sponsors may alter aspects of their employee benefit plans, or how their plans are administered, in response to the decision, and some plan sponsors have already asked for clarification of how it might apply to some employee benefit plans, such as a discretionary expansion of benefits not required under the federal tax rules.

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IRS Notice 2015-86 provides a Q-and-A to address issues, such as the ones below, that plan sponsors might be grappling with. 

For federal tax law purposes, does Obergefell require that a sponsor of a qualified retirement plan change the terms or operation of its plan?

The short answer is “no.” A qualified retirement plan is not required to make additional changes as a result of the decision. An earlier IRS notice from 2014 did require qualified retirement plans to be amended to reflect the Windsor decision. However, a plan sponsor may decide to amend its plan following Obergefell to make certain optional changes or clarifications.

NEXT: Amending a qualified retirement plan

May a qualified retirement plan be amended to provide new rights or benefits with respect to participants with same-sex spouses?

In response to Windsor, some plan sponsors may have amended their qualified retirement plans to provide new rights or benefits with respect to participants with same-sex spouses in order to make up for benefits or benefit options that had not previously been available to those participants.

For example, such an amendment may have provided participants who commenced a single life annuity distribution before June 26, 2013 (the date of the Windsor decision) with an opportunity to elect a qualified joint and survivor annuity form of distribution as of a new annuity starting date.

Following Obergefell, some plan sponsors might similarly decide to make discretionary plan amendments to provide new rights or benefits with respect to participants with same-sex spouses. Plan sponsors are permitted to make such amendments, which must comply with the applicable qualification requirements (such as the nondiscrimination requirements of section 401(a)(4)).

Is an amendment to a single-employer defined benefit plan that is intended to respond to Obergefell or this notice (for example, by extending certain rights and benefits to a same-sex spouse) subject to the requirements of section 436(c)?

In general, a discretionary amendment to a single-employer defined benefit plan that increases the liabilities of the plan cannot take effect unless the plan’s adjusted funding target attainment percentage is sufficient or the plan sponsor makes the additional contribution specified under section 436(c)(2). Because an amendment that extends rights and benefits to a same-sex spouse in response to Obergefell or this notice is a discretionary expansion of coverage, the amendment is subject to the requirements of section 436(c).

More information and other questions are on the IRS website.

Client Service December 17, 2015

What to Discuss with DB Clients in 2016

Mercer has outlined key investment issues it says DB plan sponsors should focus on in the new year.
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“Meager investment returns and low interest rates made 2015 a challenging year for many defined benefit plans, with funded status rising only modestly,” says Matt McDaniel, U.S. head of defined benefit risk at Mercer Retirement. “Changing regulations and market volatility have meant that sponsors who have been proactive in managing their obligations and developing their strategy have been rewarded.”

According to McDaniel, looking ahead, Mercer believes “the path to improvement will be through taking actions when opportunities present themselves, and not waiting for a slow melt up in markets and rates.”

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Discussions with DB plan clients suggested by Mercer include:

Prepare for opportunities 

2015 was a year of massive pension risk transfers amid daily changes in insurance pricing. Pricing volatility was caused by both market movements and firm-specific factors. As this pricing volatility is expected to continue into 2016, sponsors have potential to materially improve their outcomes if they are able to take advantage of attractive terms when they appear. To transact quickly, sponsors should consider frontloading much of the preparation work and ensure that participant data are clean.

Evaluate funding 

Plan sponsors should determine if “borrowing to fund” would have economic value. The cost to maintain an underfunded pension plan has risen due to increases in the Pension Benefit Guaranty Corporation (PBGC) variable rate premium (VRP) due to the passage of the Bipartisan Budget Act of 2015. By 2019, the VRP is anticipated to be 4.4% of the unfunded liability. In today’s low interest rate environment, accelerating the funding of pension debt (along with reducing or eliminating the VRP) may increase overall economic value.

Develop a glidepath 

DB plan sponsors, especially those with closed or frozen plans, should consider taking steps to coordinate their investment strategy with the plan’s liabilities. Long maturity bonds are the best liability match and lowest-risk investment for most DB plans, so there can be a natural progression of increasing a plan’s allocation to long bonds as funded status improves.

Increase growth allocations 

The prevailing outlook for bond returns is below average due to low interest rates. Whether or not interest rates rise, long bonds are unlikely to earn much more than their current yield, which is quite low. Low yields and more conservative mortality assumptions are core causes of low funded status for many plans. As such, DB sponsors should consider increasing growth asset allocation to improve long-term asset growth. This action may present short-term risks because of the higher level of funded status volatility, which can present larger balance sheet swings, more material declines in funded status, and potentially higher cash funding requirements. However, with the extension of funding relief in the Bipartisan Budget Act of 2015, the impact of short-term volatility on cash funding may be muted, allowing time for investment risk to earn positive results.

Isolate interest rate risk 

DB sponsors looking to reduce interest rate risk but not decrease allocations to equity and growth assets can separate a plan’s interest rate exposure from its fixed-income allocation. Using Treasury separate trading of registered interest and principal securities (STRIPS) instead of traditional bonds or employing interest rate futures, a plan can increase or maintain its effective duration without dedicating more assets to the fixed income. Sponsors have the opportunity to reduce funded status volatility by reducing interest rate risk—via increasing fixed income duration—without simultaneously transferring assets from growth investments with better prospects to low-return fixed income.

Plan for liquidity 

Investing in private assets with a higher potential return, such as private equity, real estate, debt, or infrastructure is another way DB sponsors may improve asset growth in 2016. These kinds of assets can be used in a plan with an appropriate time horizon, usually at least 15 years. Sponsors considering these kinds of assets need to understand their liquidity constraints.

Design the investment end state 

DB plan sponsors that have already frozen their plans should consider developing an “end-state” strategy. Whether a plan sponsor chooses to terminate the plan and transfer all payments to an insurance company and participants, or “run out” the plan, a strategy to reach the needed funding level, typically a combination of investment, contributions and liability management, should be developed.

 

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