In Notice 2016-50, the IRS describes the mortality assumptions to be used to develop minimum funding requirements under Section 430 and present value calculations under Section 417(e) for qualified defined benefit pension plans for the 2017 plan year. The IRS is expected to release sometime during 2017 mortality tables to be used for the same purposes for the 2018 plan year and beyond. The updated tables for 2017 do not reflect a significant change from the 2016 tables, but more significant changes may be on the horizon for years beginning with 2018.

The Society of Actuaries released the MP-2016 mortality projection scale, updating the MP-2015 scale, shortly after the IRS published Notice 2016-50. The updated scale includes three additional years of US population mortality data, as well as changes to two parameter inputs intended to improve the model's stability year over year. Mortality has not been improving as rapidly as predicted by scale MP-2015, but is still projected to improve more rapidly than what is reflected in the 2017 IRS tables.

Minimum funding requirements

Section 430(h)(3) prescribes the mortality assumption to be used for the development of minimum funding requirements. Section 430(h)(3)(B) requires the Secretary to revise mortality tables to be used in developing minimum funding requirements under Section 430 at least every 10 years to reflect more recent actual experience of pension plans.

IRS final regulations (TD 9419, 73 FR 44632) under Section 430(h)(3), published in 2006, provided mortality tables based on the tables contained in the Society of Actuaries RP-2000 Mortality Tables Report, adjusted for mortality improvement using projection "Scale AA" as recommended in that report. IRS Notice 2016-50 represents an extension of one additional year of projected mortality improvements from the basic tables and projection scales that have been in use since 2008. Next year (2017) will mark the tenth year that the basic tables and projection scale will have been in use.

Due to the periodic revision requirements of Section 430(h)(3)(B), it is anticipated that the IRS will publish new mortality tables that would become effective beginning with the 2018 plan year and would reflect more recent actuarial studies of pension plan mortality experience. In October 2014, the Society of Actuaries released an updated base mortality table, RP-2014, along with an accompanying projection scale, MP-2014. MP-2014 was updated to MP-2015 in October 2015 (see Tax Alert 2015-2016 {}) and to MP-2016 in October 2016. Even though MP-2016 represents a decline in mortality improvement from MP-2014 and MP-2015, it still identifies that people are living longer than predicted in the RP-2000 mortality table and projection Scale AA. Thus, if the IRS adopts mortality assumptions based on the RP-2014 mortality table and MP-2016 mortality improvement scale, there will be an increase in minimum funding requirements under Section 430 and the underlying plan obligations that determine applicability of benefit restrictions under Section 436.

Lump-sum distributions

Section 417(e) identifies the minimum basis for calculating actuarially equivalent values for benefit distributions paid out more rapidly than life annuities and is most commonly applied to develop the present value, or lump sum, of an annuity otherwise payable for a pension plan. Adopting new mortality tables similar to RP-2014 and MP-2016 will increase the value of a lump sum, in comparison to the current mortality assumptions. Many plans offer a lump-sum option as part of ongoing operations. The increased lump-sum value may require additional funding to the plan to meet benefit payment obligations or to avoid benefit restrictions. Other plan sponsors have been allowing participants a one-time opportunity (a window) to elect a lump-sum distribution to help reduce the size of their pension plans.

Implications

Under Section 430(h)(3)(C), plan sponsors may apply to the Secretary to approve the use of substitute mortality tables that meet the applicable requirements, rather than using the standard mortality tables provided under Section 430(h)(3)(A). Plan sponsors, particularly those that have already performed experience studies for financial reporting purposes, may wish to consider whether they would benefit from the use of a substitute mortality table when the new IRS tables are effective in 2017. Approved tables could be used to develop minimum funding requirements under Section 430 and funding levels under Section 436, but could not be used to calculate lump-sum amounts under Section 417(e). Therefore, plan sponsors may want to consider offering lump sums to plan participants before the potential increase in lump-sum values in 2018.

All plan sponsors should assess, for their budgets in 2018 and beyond, the potential effect a new mortality table will have on future minimum funding requirements and funding levels under Section 436. Additionally, plan sponsors may wish to begin increasing funding levels sooner than 2018 to help smooth out cash flow needs.

———————————————