Interest Rates and Pension Term Paper

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Interest Rates and Pension Plans

The strength of private retirement plans must be maintained in the upcoming years due to the increasing number of Baby Boomers who will be retiring in the United States. Many retired Americans rely on private pensions and employer-sponsored retirement savings as a secondary source of income in addition to Social Security (Brinner 131). In addition, because the human life expectancy has increased dramatically over recent years, it is very important that policymakers encourage the growth of employer-sponsored retirement plans (Hungerford et al. 13).

Defined benefit plans are employer-provided retirement plans that provide a guaranteed retirement income (Blomquist and Wijkander 32). The employer typically assumes all of the investment risk and the benefits are guaranteed by the Pension Benefit Guaranty Corporation. In the United States alone, there are approximately 50,000 defined benefit plans that cover about 23 million workers (Hungerford et al. 16)

History of Discount Rates

Over the years, Congress has adjusted the appropriate discount rate in order to address specific problems as they arose. From 1987 to 2002, the law required that defined benefit pension plans use a weighted 4-year average of the returns of the 30-year U.S. Treasury bond rate as their discount rate for determining funding adequacy. Under the 1987 law, plans were allowed to use any number between 90-110% of that rate. The spread between 90-110% was intended to allow the pension plan a slight amount of flexibility in its calculations.

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In 1994, Congress narrowed this range to 90-105% of that weighted average. This discount rate is also used to determine lump-sum benefits for workers who want a one-time payment instead of a monthly check (Hungerford et al. 20).

On April 9, 2004 Congress passed the Pension Funding Equity Act of 2004, and the President signed it into law on April 10, 2004. This Act replaces the 30-year Treasury bond interest rate assumption with a composite of long-term corporate bond rates for the years 2004 and 2005. The replacement of the 30-year Treasury rate for the determination of pension liabilities and other calculations is an issue of great importance for sponsors of defined benefit plans. On October 31, 2001, following a three-year program of buying back 30-year bonds, the Treasury Department announced that it would stop issuing the bonds. Shortly after, the Job Creation and Worker Assistance Act of 2002 increased the range of permissible interest rates for determining contributions and premiums for under-funded pension plans to 120% of the current 30-year Treasury rate. However, the Job Creation and Worker Assistance Act expired on December 31, 2003.

The U.S. Chamber of Commerce assumes that a composite corporate bond rate is the appropriate replacement for the 30-year Treasury rate because it is a realistic interest rate assumption that reflects both the long-term rates actually earned by pension plans and the annuity rates charged to terminating pension plans. The Chamber.....

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