Volume 30 | Issue 65 | October 11, 2007
IRS Issues Pension Yield Curve
On October 9, the IRS issued Notice 2007-81, which describes the methodology that will be used to determine
the pension yield curve prescribed by PPA. This guidance is necessary to determine minimum funding
contributions and lump sum payments beginning with 2008 plan years. However, additional guidance is still
needed regarding calculation of minimum lump sum distributions.
Background
Under current law, the interest rate used to determine current liability for calculating minimum required
contributions must lie between 90% and 100% of the weighted average of corporate composite bond rates as
published by the IRS for the month before the valuation date. Minimum lump sum amounts are required to be
calculated using a recent 30-year Treasury rate published by the IRS.
PPA requires, generally beginning with the 2008 plan year, minimum required contributions and minimum lump
sum payments to be determined using three “segment rates” derived from a corporate bond yield curve which is
to be developed by Treasury. For minimum funding purposes, the segment rates are averaged over 24 months.
PPA provides transitions from the former rates to the new PPA-required rates – a 3-year transition for minimum
funding, and a 5-year transition for minimum lump sum calculations. For minimum funding purposes, sponsors
may elect to use the actual yield curve, without 24-month averaging, in lieu of the segment rates, and may also
elect to ignore the 3-year transition provision. However, once the elections are made, IRS approval is required to
revoke them. (Note there is no option to elect to ignore the 5-year transition for minimum lump sum rates.)
For funding purposes, the interest rates are determined as of the “applicable month” – i.e., the month of the
valuation, or if elected, any of the four preceding months. Once elected, IRS approval will be required to change
the election.
Notice 2007-81
Notice 2007-81 provides an explanation of the methodology used to determine the PPA corporate bond yield
curve, and includes the full yield curve and various segment rates for August 2007, as well as historical segment
rates going back to September 2005. The notice also contains a link to a white paper providing more detail on the
methodology.
Volume 30 | Issue 65 | October 11, 2007
Yield Curve Construction
In general, yield curves will be developed by Treasury for each business day of a month, expressed as rates at
half-year intervals covering 100 years. The monthly curves are then determined by taking an arithmetic average
of the points from the daily yield curves. The three segment rates are determined as an arithmetic average of the
monthly rates for the appropriate time period (i.e., 0.5 to 5.0 years, 5.5 to 20.0 years, and 20.5 to 60.0 years).
The first, second and third segment rates for August 2007 are 5.40%, 6.20%, and 6.66% respectively.
The yield curve is developed using only bonds in the highest 3 quality ratings (i.e., AAA, AA, A) with maturities of
30 years or less. The curve will be permitted to monotonically increase or decrease after 30 years – i.e., it will not
be held constant.
Minimum Funding
The 24-month average is calculated by averaging the points on the monthly curves (which are the arithmetic
average of the points on the daily curve).
The 24-month average segment rates through August 2007 are 5.26% (first segment), 5.82% (second segment),
and 6.38% (third segment). The corresponding transitional first, second and third segment rates (using the 2008
transition) are 5.66%, 5.85%, and 6.03% respectively. This compares to the pre-PPA range of permissible
corporate composite bond rates of 5.27% to 5.86%.
Lump Sum Calculations
The three August 2007 transitional segment rates for minimum lump sum calculations (using the 2008 transition)
are 5.02% (first segment), 5.18% (second segment), and 5.28% (third segment). These compare to the August
2007 pre-PPA minimum lump sum rate (the 30-year Treasury rate) of 4.93%.
BUCK COMMENT. It is not clear if the IRS will continue to permit rates to be redetermined less frequently
than monthly and be based on rates (or the average of rates) up to five months before the applicable
“stability” period.
Under PPA, the mortality tables used for minimum lump sum calculations are to be based on the same table used
for minimum funding purposes, subject to modifications issued in guidance. Proposed guidance has been issued
regarding the PPA-required mortality tables for minimum funding purposes. That guidance asked for comments
regarding the applicability of that mortality basis to lump sum calculations, but no further guidance has been
issued regarding the modifications, if any, to these tables for minimum lump sum calculations under PPA.
BUCK COMMENT. We are not sure when guidance on any modifications to the funding mortality basis for
lump sum calculation purposes will be issued. Therefore, it is not certain at this time the exact impact PPA
will have on lump sum distributions from plans. In addition, lump sum benefit calculations must be reflected
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Volume 30 | Issue 65 | October 11, 2007
in distribution notices which are to be provided 30 to 180 days prior to commencement of payment(s).
Therefore, notices will have to be sent before December 2007 for benefits with January 1, 2008 annuity
starting dates.
Absent additional guidance, sponsors will have no choice but to assume that lump sum benefit calculations
should be based on the funding mortality basis.
Publication of Curves and Rates
The IRS will continue to publish each month the pre-PPA corporate composite bond rates and the 30-year
Treasury bond rates, which will be used to determine transitional segment rates. Along with these rates, they will
publish the new monthly corporate bond yield curves, the 24-month average funding segment rates, the funding
transitional segment rates, and the minimum lump sum transitional segment rates.
Conclusion
Since the segment rates (or full corporate bond yield curve) are applied to the projected cash flows of individual
plans, the effect of transitioning to the use of the yield curve on minimum required contributions will be unique to
each plan. Similarly, for lump sum calculations, the segment rates are applied to each participant’s projected
benefit payouts, so the effect on lump sum payments will vary by participant.
Buck’s consultants are ready to discuss the Treasury yield curve in more detail with you and analyze the potential
effect on your funding requirements and level of lump sum payments.
This FYI is intended to provide general information. It does not offer legal advice or purport to treat all the issues surrounding
any one topic.
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