Section 412 of the Internal Revenue Code provides minimum funding requirements with respect to certain defined benefit pension plans.^[7] Section 412(l) provides additional funding requirements for certain of these plans, based in part on a plan’s unfunded current liability, as defined in section 412(l)(8).

Pursuant to section 412(c)(6), if the otherwise applicable minimum funding requirement exceeds the plan’s full funding limitation (defined in section 412(c)(7) as the excess of a specified measure of plan liability over the plan assets), then the minimum funding for the year is reduced by that excess. Under section 412(c)(7)(E), the full funding limitation cannot be less than the excess of 90% of the plan’s current liability (including the expected increase in current liability due to benefits accruing during the plan year) over the value of the plan’s assets. For this purpose, the term current liability generally has the same meaning given that term under section 412(l)(7).

Section 412(l)(7)(C)(ii) provides that, for purposes of determining current liability in plan years beginning on or after January 1, 1995, the mortality table used is the table prescribed by the Secretary. Under section 412(l)(7)(C)(ii)(I), the initial mortality table used in determining current liability under section 412(l)(7) must be based on the prevailing commissioners’ standard table (described in section 807(d)(5)(A)) used to determine reserves for group annuity contracts issued on January 1, 1993. For purposes of section 807(d)(5), Rev. Rul. 92-19, 1992-1 C.B. 227, specifies the prevailing commissioners’ standard table used to determine reserves for group annuity contracts issued on January 1, 1993, as the 1983 Group Annuity Mortality Table (1983 GAM). Accordingly, Rev. Rul. 95-28, 1995-1 C.B. 74, sets forth two gender-specific mortality tables — based on 1983 GAM — for purposes of determining current liability for participants who are not entitled to disability benefits.^[8]

Section 412(l)(7)(C)(iii)(I) specifies that the Secretary is to establish different mortality tables to be used to determine current liability for individuals who are entitled to benefits under the plan on account of disability. One such set of tables is to apply to individuals whose disabilities occur in plan years beginning before January 1, 1995, and a second set of tables for individuals whose disabilities occur in plan years beginning on or after such date. Under section 412(l)(7)(C)(iii)(II), the separate tables for disabilities that occur in plan years beginning after December 31, 1994, apply only with respect to individuals who are disabled within the meaning of title II of the Social Security Act and the regulations thereunder. Rev. Rul. 96-7, 1996-1 C.B. 59, sets forth the mortality tables established under section 412(l)(7)(C)(iii).

Under section 412(l)(7)(C)(ii)(III), the Secretary of the Treasury is required to periodically (at least every 5 years) review any tables in effect under that subsection and, to the extent necessary, by regulation update the tables to reflect the actual experience of pension plans and projected trends in such experience. Section 412(l)(7)(C)(ii)(II) provides that the updated tables are to take into account the results of available independent studies of mortality of individuals covered by pension plans. Pursuant to section 412(l)(7)(C)(ii)(II), any new mortality tables prescribed by regulation can be effective no earlier than the first plan year beginning after December 31, 1999. Under section 412(l)(10), increases in current liability arising from the adoption of such a new mortality table generally are required to be amortized over a 10-year period.

In order to facilitate the review of the applicable mortality tables pursuant to section 412(l)(7)(C)(ii)(III), Rev. Rul. 95-28 requested comments concerning the mortality table to be used for determining current liability for plan years beginning after December 31, 1999, and information on existing or upcoming independent studies of mortality of individuals covered by pension plans. In Announcement 2000-7, 2000-1 C.B. 586, the IRS and the Treasury Department also requested comments regarding mortality tables to be used for determining current liability for plan years beginning after December 31, 1999, but indicated that it was anticipated that in no event would there be any change in the mortality tables for plan years beginning before January 1, 2001.

Notice 2003-62, 2003-2 C.B. 576, was issued as part of the periodic review by the IRS and the Treasury Department of the mortality tables used in determining current liability under section 412(l)(7). At the time the Notice 2003-62 was issued, the IRS and the Treasury Department were aware of two reviews of mortality experience for retirement plan participants undertaken by the Retirement Plans Experience Committee of the Society of Actuaries (the UP-94 Study and the RP-2000 Mortality Tables Report),^[9] and commentators were invited to submit any other independent studies of pension plan mortality experience. Notice 2003-62 also requested the submission of studies regarding projected trends in mortality experience. With respect to projecting mortality improvements, the IRS and the Treasury Department requested comments regarding the advantages and disadvantages of reflecting these trends on an ongoing basis through the use of generational, modified generational, or sequentially static mortality tables.

In addition, Notice 2003-62 requested comments on whether certain risk factors should be taken into account in predicting an individual’s mortality. Comments were requested as to the extent that separate mortality tables should be prescribed that take into account these factors, with particular attention paid to the administrative issues in applying such distinctions. In this regard, comments were specifically requested as to how it would be determined which category an individual fits into, the extent to which an individual, once categorized, remains in that same category, the classification of individuals for whom adequate information is unavailable, whether distinctions are applicable to beneficiaries, and the extent to which distinctions may overlap or work at cross purposes. Some examples of factors that were listed in Notice 2003-62 are the following: gender, tobacco use, job classification, annuity size, and income. Comments were also requested as to whether classification systems, if permitted, should be mandatory or optional. A number of comments were submitted regarding the issues identified in Notice 2003-62.

The IRS and the Treasury Department have reviewed the mortality tables that are used for purposes of determining current liability for participants and beneficiaries (other than disabled participants). The existing mortality table for determining current liability (1983 GAM) was compared to independent studies of mortality of individuals covered by pension plans, after reflecting projected trends for mortality improvement through 2007. The comparison indicates that the 1983 GAM is no longer appropriate for determining current liability. For example, comparing the RP-2000 Combined Healthy Mortality Table for males projected to 2007 (when this proposed regulation would take effect) with the 1983 GAM shows that a current mortality table reflects a 52% decrease in the number of expected deaths at age 50, a 26% decrease at 65, and a 19% decrease at age 80. Comparing annuity values derived under these updated mortality rates with annuity values determined under the 1983 GAM shows an increase in present value of 12% for a 35-year-old male with a deferred annuity payable at age 65, a 5% increase for a 55-year-old male with an immediate annuity, and a 7% increase for a 75-year-old male with an immediate annuity (all calculated at a 6% interest rate). Female mortality rates also changed, although with a different pattern. For females, the number of expected deaths decreased by 10% at age 50, but increased by 33% at age 65 and increased by 2% at age 80.^[10] Comparing annuity values derived under these updated mortality rates with annuity values determined under the 1983 GAM shows a decrease in present value of 3% for a 35-year-old female with a deferred annuity payable at age 65, a 2% decrease for a 55-year-old female with an immediate annuity, and a 2% decrease for a 75-year-old female with an immediate annuity (all calculated at a 6% interest rate).

Based on this review of the 1983 GAM compared to more recent mortality experience, the IRS and Treasury Department have determined that updated mortality tables should be used to determine current liability for participants and beneficiaries (other than disabled participants).^[11]

The proposed regulations would set forth the methodology the IRS and Treasury would use to establish mortality tables to be used under section 412(l)(7)(C)(ii) to determine current liability for participants and beneficiaries (other than disabled participants). The mortality tables that would apply for the 2007 plan year are set forth in the proposed regulations. The mortality tables that would be used for subsequent plan years would be published in the Internal Revenue Bulletin. Comments are requested regarding whether it would be desirable to publish a series of tables for each of a number of years (such as five years) along with final regulations, with tables for subsequent years to be published in the Internal Revenue Bulletin.

These new mortality tables would be based on the tables contained in the RP-2000 Mortality Tables Report. Commentators generally recommended that the RP-2000 mortality tables be the basis for the mortality tables used under section 412(l)(7)(C)(ii) (although one commentator urged that large employers be permitted to use mortality tables tailored to their actual mortality experience). The IRS and the Treasury Department have reviewed the RP-2000 mortality tables and the accompanying report published by the Society of Actuaries, and have determined that the RP-2000 mortality tables form the best available basis for predicting mortality of pension plan participants and beneficiaries (other than disabled participants) based on pension plan experience and expected trends. Accordingly, the proposed regulations would change the mortality tables used to determine current liability from tables based on 1983 GAM to updated tables based on the RP-2000 mortality tables. As under the currently applicable mortality tables, the mortality tables set forth in these proposed regulations are gender-distinct because of significant differences between expected male mortality and expected female mortality.

The proposed regulations would provide for separate sets of tables for annuitants and nonannuitants. This distinction has been made because the RP-2000 Mortality Tables Report indicates that these two groups have significantly different mortality experience. This is particularly true at typical ages for early retirees, where the number of health-induced early retirements results in a population that has higher mortality rates than the population of currently employed individuals. Under the proposed regulations, the annuitant mortality table would be applied to determine the present value of benefits for each annuitant. The annuitant mortality table is also used for each nonannuitant (i.e., an active employee or a terminated vested participant) for the period after which the nonannuitant is projected to commence receiving benefits, while the nonannuitant mortality table is applied for the period before the nonannuitant is projected to commence receiving benefits. Thus, for example, with respect to a 45-year-old active participant who is projected to commence receiving an annuity at age 55, current liability would be determined using the nonannuitant mortality table for the period before the participant attains age 55 (i.e., so that the probability of an active male participant living from age 45 to the age of 55 using the mortality table that would apply in 2007 is 98.59%) and the annuitant mortality table after the participant attains age 55. Similarly, if a 45-year-old terminated vested participant is projected to commence an annuity at age 65, current liability would be determined using the nonannuitant mortality table for the period before the participant attains age 65 and the annuitant mortality table for ages 65 and above.

The mortality tables that would be established pursuant to this regulation would be based on mortality improvements through the year of the actuarial valuation and would reflect the impact of further expected improvements in mortality. Commentators generally stated that the projection of mortality improvement is desirable because it reflects expected mortality more accurately than using mortality tables that do not reflect such projection. The IRS and Treasury agree with these comments, and believe that failing to project mortality improvement in determining current liability would tend to leave plans underfunded. The regulations would specify the projection factors that are to be used to calculate expected mortality improvement. These projection factors are from Mortality Projection Scale AA, which was also recommended for use in the UP-94 Study and RP-2000 Mortality Tables Report. The mortality tables for annuitants are generally based on a future projection period of 7 years, and the mortality tables for nonannuitants are generally based on a future projection period of 15 years. These projection periods were selected as the expected average duration of liabilities and are consistent with projection periods suggested by commentators.

The RP-2000 Mortality Tables Report did not develop mortality rates for annuitants younger than 50 years of age or for nonannuitants older than 70 years of age. The mortality tables for annuitants use the values that apply for the nonannuitant mortality tables at younger ages, with a smoothed transition to the annuitant mortality tables by age 50. Similarly, the mortality tables for both male and female nonannuitants use the values that apply for the annuitant mortality tables at older ages (i.e., ages above 70), with a smoothed transition to the nonannuitant mortality tables by age 70.

The mortality tables for annuitants applicable for the 2007 plan year would use the values that apply for the nonannuitant mortality tables at ages 40 and younger for males and at ages 44 and younger for females with a smoothed transition to the annuitant mortality tables between the ages of 41 and 49 for males and between 45 and 49 for females. Similarly, the mortality tables for both male and female nonannuitants applicable for the 2007 plan year use the values that apply for the annuitant mortality tables at ages 80 and older, with a smoothed transition to the nonannuitant mortality tables between the ages of 71 and 79.

The proposed regulations would provide an option for smaller plans (i.e., plans where the total of active and inactive participants is less than 500) to use a single blended table for all healthy participants — in lieu of the separate tables for annuitants and nonannuitants — in order to simplify the actuarial valuation for these plans. This blended table would be constructed from the separate nonannuitant and annuitant tables using the nonannuitant/annuitant weighting factors published in the RP-2000 Mortality Tables Report. However, because the RP-2000 Mortality Tables Report does not provide weighting factors before age 50 or after age 70, the IRS and the Treasury Department would extend the table of weighting factors for ages 41 through 50 (ages 45-50 for females) and for ages 70 through 79 in order to develop the blended table.

The proposed regulations do not provide for the use of generational mortality tables to compute a plan’s current liability. Although commentators generally stated that the use of generational mortality tables provides a more accurate prediction of participant mortality, they urged against requiring the use of generational mortality tables, arguing that many actuarial valuation systems are not currently capable of using a generational approach to mortality improvement. However, several commentators requested that the use of generational mortality tables be permitted on an optional basis. The IRS and the Treasury Department agree that the use of generational mortality tables would be preferable, but believe that the approach taken in the proposed regulations (i.e., projecting liabilities for annuitants and nonannuitants to average expected duration) is appropriate because it reasonably approximates the use of generational tables without being overly complex to apply. In light of several comments requesting that the use of generational tables be optional, the IRS and the Treasury Department are considering adopting such a rule and request comments regarding any issues that might arise in implementing an optional use of a generational table. In addition, comments are requested regarding how much lead time would be appropriate if generational mortality tables were to be required in the future.

The RP-2000 mortality tables and the accompanying report analyze differences in expected mortality based on a number of factors, including job classification, annuity size, employment status (i.e., active or retired), and industry. The IRS and the Treasury Department have considered whether separate mortality tables should be provided based on any of these distinctions, or on other distinctions cited in Notice 2003-62, such as tobacco use or income level. The IRS and the Treasury Department have concluded that it is inappropriate to apply distinctions other than the annuitant and nonannuitant distinction described above. In general, these other distinctions were not made because of the complexity involved in the process. For example, no distinction was made for tobacco use because of the difficulty in obtaining, maintaining, and documenting accurate data on the extent of tobacco use.

Although several commentators recommended that separate mortality tables apply to plans that are determined to be “white collar” or “blue collar” in nature, the IRS and Treasury have not adopted this recommendation because of serious administrability concerns. Commentators recognized that it may be difficult to identify whether a specific individual falls into the category of blue collar or white collar (especially if an individual has shifted job classifications during his or her career), and suggested that the classification be based on whether the plan is primarily composed of blue collar employees or white collar employees or whether a plan covers a mixed population of blue collar and white collar employees. While the plan-wide classification may avoid the difficulties of categorizing those individuals who are hard to classify as either blue collar or white collar, it would create additional problems if a plan shifted between these categories.

More importantly, the RP-2000 Mortality Tables Report indicates that plans that are primarily blue collar in nature, but that provide large annuities, tend to have significantly better mortality experience than the average mortality for individuals in the RP-2000 Mortality Tables Report. As a result, classifying such a plan as blue collar and allowing the plan to use a weaker mortality table will lead to systematic underfunding of the plan.^[12] Other concerns weighing against the use of separate tables for blue collar and white collar plans include the risk of anti-selection by plans in the absence of mandatory adjustments and the lack of research showing the extent to which any mortality differences attributable to blue collar or white collar status extend to beneficiaries of the plan.

As noted above, the mortality experience is significantly different for annuitants and nonannuitants. While the use of separate mortality rates for these groups of individuals will likely entail changes in programming of actuarial software, the IRS and Treasury believe that the improvement in accuracy resulting from the use of separate mortality tables for annuitants and nonannuitants more than offsets the added complexity. Furthermore, the annuitant/nonannuitant distinction does not have the same difficult administrative issues as separate tables based on collar type, annuity size, or tobacco. This is because it is usually a straightforward process to categorize an individual as an annuitant or a nonannuitant, and once an indvidual is categorized as an annuitant, the individual’s status usually does not change again.

These regulations are proposed to apply to plan years beginning on or after January 1, 2007.

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It is hereby certified that these regulations will not have a significant economic impact on a substantial number of small entities. This certification is based upon the fact that these regulations provide for special rules to simplify the application of these regulations by actuaries who provide services for small entities. Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Before these proposed regulations are adopted as final regulations, consideration will be given to any written (a signed original and eight (8) copies) or electronic comments that are submitted timely to the IRS. The IRS and Treasury Department specifically request comments on the clarity of the proposed regulations and how they may be made easier to understand. All comments will be available for public inspection and copying.

A public hearing has been scheduled for April 19, 2006, at 10 a.m. in the auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC. Due to building security procedures, visitors must use the main building entrance on Constitution Avenue. In addition, all visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 30 minutes before the hearing starts. For more information about having your name placed on the list to attend the hearing, see the “FOR FURTHER INFORMATION CONTACT” section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to present oral comments at the hearing must submit written (signed original and eight (8) copies) or electronic comments and an outline of the topics to be discussed and the time to be devoted to each topic by March 29, 2006. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

Paragraph 1. The authority citation for part 1 continues to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.412(l)(7)-1 is added to read as follows: