Low interest rates and the sunsetting of favorable funding rules will create significant increases in contribution requirements in the next few years. Congressional action early this decade protected plan sponsors from feeling the full effect of the current low-interest-rate environment, but that protection is set to phase out starting in 2021. It is critical that defined benefit sponsors understand future expected cash contributions so they can make plans now and avoid unpleasant surprises later.
Single-employer private-sector pension plans are required to determine minimum funding liabilities using yields on high-quality (A or better) corporate bonds. These rates are published by the IRS in a few different forms, but most plan sponsors use the three-segment yield-curve option that averages these corporate bond yields over a two-year time horizon.
The market collapse in 2008, combined with the plummeting of corporate bond yields starting in 2011, created significant contribution pressure for plan sponsors. Congress reacted by enacting a number of funding relief measures. One of these measures was so-called "interest rate stabilization." Sponsors using the two-year average yield curve would now additionally reflect the average of the last 25 years of corporate bond yields when valuing their minimum funding liabilities.
The practical implication of the relief was to limit interest rates to be close to their 25-year averages initially, with this limitation set to phase out over a few years. The first year the law was in effect — 2012 — a 10% corridor around the long-term average was used and was set to widen by 5% each year thereafter until it reached 30% in 2016. However, Congress extended the initial 10% corridor twice — first to 2017 and then again to 2020. The impact of this action has been "temporary" relief that has lasted seven years already and will only begin to phase out in 2021 (unless future legislation pushes it out even further).