Sec. 1.430(h)(2)-1 Interest rates used to determine present value.
(a) In general.
(1) Overview. This section provides rules relating to the interest rates to be applied for a plan year under section 430(h)(2). Section 430(h)(2) and this section apply to single employer defined benefit plans (including multiple employer plans as defined in section 413(c)) that are subject to section 412 but do not apply to multiemployer plans (as defined in section 414(f)). Paragraph (b) of this section describes how the segment interest rates are used for a plan year. Paragraph (c) of this section describes those segment rates. Paragraph (d) of this section describes the monthly corporate bond yield curve that is used to develop the segment rates. Paragraph (e) of this section describes certain elections that are permitted to be made under this section. Paragraph (f) of this section describes other rules related to interest rates. Paragraph (g) of this section contains examples. Paragraph (h) of this section contains effective/applicability dates.
(2) Special rules for multiple employer plans. In the case of a multiple employer plan to which section 413(c)(4)(A) applies, the rules of section 430 and this section are applied separately for each employer under the plan as if each employer maintained a separate plan. Thus, each employer under such a multiple employer plan may make elections with respect to the interest rate rules under this section that are independent of the elections of other employers under the plan. In the case of a multiple employer plan to which section 413(c)(4)(A) does not apply (that is, a plan described in section 413(c)(4)(B) that has not made the election for section 413(c)(4)(A) to apply), the rules of section 430 and this section are applied as if all participants in the plan were employed by a single employer.
(b) Interest rates for determining plan liabilities.
(1) In general. The interest rates used in determining the present value of the benefits that are included in the target normal cost and the funding target for the plan for a plan year are determined as set forth in this paragraph (b).
(2) Benefits payable within 5 years. In the case of benefits expected to be payable during the 5-year period beginning on the valuation date for the plan year, the interest rate used in determining the present value of the benefits that are included in the target normal cost and the funding target for the plan is the first segment rate with respect to the applicable month, as described in paragraph (c)(2)(i) of this section.
(3) Benefits payable after 5 years and within 20 years. In the case of benefits expected to be payable during the 15-year period beginning after the end of the period described in paragraph (b)(2) of this section, the interest rate used in determining the present value of the benefits that are included in the target normal cost and the funding target for the plan is the second segment rate with respect to the applicable month, as described in paragraph (c)(2)(ii) of this section.
(4) Benefits payable after 20 years. In the case of benefits expected to be payable after the period described in paragraph (b)(3) of this section, the interest rate used in determining the present value of the benefits that are included in the target normal cost and the funding target for the plan is the third segment rate with respect to the applicable month, as described in paragraph (c)(2)(iii) of this section.
(5) Applicable month. Except as otherwise provided in paragraph (e) of this section, the term applicable month for purposes of this paragraph (b) means the month that includes the valuation date of the plan for the plan year.
(6) Special rule for certain airlines.
(i) In general. Pursuant to section 6615 of the U.S. Troop Readiness, Veterans' Care, Katrina Recovery, and Iraq Accountability Appropriations Act, 2007, Public Law 110-28 (121 Stat. 112), for a plan sponsor that makes the election described in section 402(a)(2) of the Pension Protection Act of 2006 (PPA '06), Public Law 109-280 (120 Stat. 780), the interest rate required to be used to determine the plan's funding target for each of the 10 years under that election is 8.25 percent (rather than the segment rates otherwise described in this paragraph (b) or the full yield curve as permitted under paragraph (e)(4) of this section).
(ii) Special interest rate not applicable for other purposes. The special interest rate described in paragraph (b)(6)(i) of this section does not apply for other purposes such as the determination of the plan's target normal cost.
(c) Segment rates.
(1) Overview. This paragraph (c) sets forth rules for determining the first, second, and third segment rates for purposes of paragraph (b) of this section. The first, second, and third segment rates are set forth in revenue rulings, notices, or other guidance published in the Internal Revenue Bulletin. See § 601.601(d)(2) relating to objectives and standards for publishing regulations, revenue rulings and revenue procedures in the Internal Revenue Bulletin.
(2) Definition of segment rates.
(i) First segment rate. For purposes of this section, except as otherwise provided under the interest rate stabilization rules in section 430(h)(2)(C)(iv), the first segment rate is, with respect to any month, the single rate of interest determined by the Commissioner on the basis of the average of the monthly corporate bond yield curves (described in paragraph (d) of this section) for the 24-month period ending with the month preceding that month, taking into account only the first 5 years of each of those yield curves.
(ii) Second segment rate. For purposes of this section, except as otherwise provided under the interest rate stabilization rules in section 430(h)(2)(C)(iv), the second segment rate is, with respect to any month, the single rate of interest determined by the Commissioner on the basis of the average of the monthly corporate bond yield curves (described in paragraph (d) of this section) for the 24-month period ending with the month preceding that month, taking into account only the portion of each of those yield curves corresponding to the 15-year period that follows the end of the 5-year period described in paragraph (c)(2)(i) of this section.
(iii) Third segment rate. For purposes of this section, except as otherwise provided under the interest rate stabilization rules in section 430(h)(2)(C)(iv), the third segment rate is, with respect to any month, the single rate of interest determined by the Commissioner on the basis of the average of the monthly corporate bond yield curves (described in paragraph (d) of this section) for the 24-month period ending with the month preceding that month, taking into account only the portion of each of those yield curves corresponding to the 40-year period that follows the end of the 15-year period described in paragraph (c)(2)(ii) of this section.
(d) Monthly corporate bond yield curve.
(1) In general—
(i) Construction of monthly corporate bond yield curve. For purposes of this section, the monthly corporate bond yield curve for a month is defined as the set of spot rates at specified durations. The specified durations are at 6-month intervals ranging from 6 months through 100 years and the spot rate at a duration is the yield (when compounded semiannually) for a bond that matures at that duration with a single payment at maturity. The monthly corporate bond yield curve is constructed as the average of the spot rates from the set of daily corporate bond yield curves as specified in paragraph (d)(1)(ii) of this section. Each daily corporate bond yield curve is constructed using the methodology set forth in paragraph (d)(2) of this section based on the data described in paragraph (d)(3) of this section. The yield curve for each month will be published in the Internal Revenue Bulletin. See § 601.601(d) of this chapter.
(ii) Monthly corporate bond yield curve constructed through averaging. Each spot rate at a specified duration on the monthly corporate bond yield curve for a month is equal to the arithmetic average, for each business day of that month, of the spot rates at that duration on the daily corporate bond yield curves.
(2) Construction of the daily corporate bond yield curve—
(i) In general—
(A) Calculation of spot rates. The spot rate at duration of ½ year on the daily corporate bond yield curve is set equal to the yield at maturity of ½ year from the daily par yield curve described in paragraph (d)(2)(i)(B) of this section. The spot rate for any later duration on the daily corporate bond yield curve is determined by applying an iterative process based on the spot rates at earlier durations and the daily par yield curve.
(B) Calculation of par yield curve. The daily par yield curve (that is, the curve in which the rate at maturity t on the curve is equal to the yield for a bond with maturity of t for which the price is the same as the principal amount) is calculated from the discount function described in paragraph (d)(2)(i)(C) of this section and the hump adjustment variable described in paragraph (d)(2)(iii)(D) of this section.
(C) Derivation of discount function. The discount function for a day at duration t (denoted d(t)) is derived from the forward interest rate function as described in paragraph (d)(2)(ii) of this section (denoted f(z)) using the following equation:
Equation 1 to Paragraph (d)(2)(i)(C)
(ii) Determination of forward interest rates—
(A) In general. The forward interest rate function used to derive the discount function is determined as a series of cubic polynomials (referred to as a cubic spline) that have a smooth junction at specified knot points (maturities of 0, 1.5, 3, 7, 15, and 30 years). The requirement that the polynomials have a smooth junction at a knot point is satisfied if the two polynomials that are meeting at the knot have the same value, the same derivative, and the same second derivative at that knot point.
(B) Constraints on the forward interest function. The following three constraints are placed on the forward interest rate function--
(1) The second derivative of the function is set to 0 at maturity 0.
(2) The value of the forward interest rate function at and after 30 years is constrained to equal its average value from 15 to 30 years.
(3) The derivative of the forward interest rate function is set to 0 at maturity 30 years.
(iii) Parameters for daily bond price model—
(A) B-spline coefficients. The assumed cubic spline for the forward interest rate function can be described as a linear combination of B-splines, with five parameters, which are determined taking into account the two coefficients for the bond-quality adjustment variables described in paragraphs (d)(2)(iii)(B) and (C) of this section and the coefficient for the hump adjustment variable described in paragraph (d)(2)(iii)(D) of this section. The five parameters and three coefficients are determined using the bond data weighted as described in paragraph (d)(2)(iv) of this section. After this weighting of the bond data, the five parameters and three coefficients are chosen to minimize the sum of the squared differences between the bid price for each of the bonds (or ask price for commercial paper) and the price estimated for each of those bonds determined using the specified parameters and coefficients, and taking into account the bond’s coupon rate, number of years until maturity, and rating.
(B) Adjustment factor for share of bonds that are AA-rated. The first adjustment variable is based on the proportion of bonds that are rated AA within the universe of bonds in the data set that are rated AA or AAA, weighted by par value. In the case of an AAA-rated bond the adjustment variable described in this paragraph (d)(2)(iii)(B) is equal to the product of the proportion described in the preceding sentence and the number of years until maturity for the bond. In the case of an AA-rated bond the adjustment variable described in this paragraph (d)(2)(iii)(B) is equal to the product of (1- that proportion) and the number of years until maturity for the bond. In the case of an A-rated bond, the adjustment variable described in this paragraph (d)(2)(iii)(B) is 0.
(C) Adjustment factor for share of bonds that are A-rated. The second adjustment variable is based on the proportion of bonds rated A within the universe of bonds in the data set, weighted by par value. In the case of an AAA-rated bond or an AA-rated bond, the adjustment variable described in this paragraph (d)(2)(iii)(C) is equal to the product of the proportion described in the preceding sentence and the number of years until maturity for the bond. In the case of an A-rated bond, the adjustment variable described in this paragraph (d)(2)(iii)(C) is equal to the product of (1- that proportion) and the number of years until maturity for the bond.
(D) Hump adjustment variable. The hump adjustment variable is a mathematical function that is a cubic spline in the interval from 10 years maturity through 30 years maturity made up of two polynomials with a smooth junction (as described in paragraph (d)(2)(ii)(A) of this section) at 20 years maturity. The spline rises from 0 at 10 years maturity to 1.0 at 20 years maturity, then falls back down to 0 at 30 years maturity. The hump adjustment variable is 0 for maturities less than 10 years and maturities greater than 30 years.
(iv) Weighting of bond data. The bond data are weighted in three steps. In the first step, equal weights are assigned to the commercial paper rates at the short end of the curve, and the par amounts outstanding of all the bonds are rescaled so that their sum equals the sum of the weights for commercial paper. In the second step, the squared price difference for each commercial paper rate is multiplied by the commercial paper weight, and the squared price difference for each bond is multiplied by the bond’s rescaled par amount outstanding. In the third step, applicable for bonds with duration greater than 1, the weighted squared price difference for each bond from the second step is divided by the bond’s duration.
(3) Data used—
(i) In general. Except as otherwise provided in this paragraph (d)(3), the bonds that are used to construct the daily corporate bond yield curve for a business day are bonds with maturities longer than ½ year, with at least two payment dates, and that:
(A) Are designated as corporate;
(B) Have high quality ratings (AAA, AA, or A) as of that business day from the nationally recognized statistical rating organizations;
(C) Have at least $250 million in par amount outstanding on at least one day during the month;
(D) Pay fixed nominal semiannual coupons and the principal amount at maturity; and
(E) Mature not later than 30 years after that business day.
(ii) Excluded bonds. The following types of bonds are not used to construct the daily corporate bond yield curve for a date:
(A) Bonds not denominated in U.S. dollars;
(B) Bonds not issued by U.S. corporations;
(C) Bonds that are capital securities (sometimes referred to as hybrid preferred stock);
(D) Bonds with variable coupon rates;
(E) Convertible bonds;
(F) Bonds issued by a government-sponsored enterprise (such as the Federal National Mortgage Association);
(G) Asset-backed bonds;
(H) Callable bonds, unless the call feature is make-whole or the call feature is exercisable only during the last year before maturity;
(I) Putable bonds;
(J) Bonds with sinking funds; and
(K) Bonds with an outstanding par amount below $250 million for the day for which the daily yield curve is constructed.
(iii) Durations equal to or below ½ year. The data for durations equal to or below ½ year that is used to construct the daily corporate bond yield curve consists of AA financial and AA nonfinancial commercial paper rates, as reported by the Federal Reserve Board.
(e) Elections.
(1) In general. This paragraph (e) describes elections for a plan year that a plan sponsor can make to use alternative interest rates under this section. Any election under this paragraph (e) must be made by providing written notification of the election to the plan's enrolled actuary. Any election in this paragraph (e) may be adopted for a plan year without obtaining the consent of the Commissioner, but, once adopted, that election will apply for that plan year and all future plan years and may be changed only with the consent of the Commissioner.
(2) Election for alternative applicable month. As an alternative to defining the applicable month as the month that includes the valuation date for the plan year, a plan sponsor that is using segment rates as provided under paragraph (b) of this section may elect to use one of the 4 months preceding that month as the applicable month.
(3) Election to use full yield curve.
(i) In general. For purposes of determining the plan's funding target and target normal cost, and for all other purposes under section 430 (including the determination of shortfall amortization installments, waiver installments, and the present values of those installments as described in paragraph (f)(2) of this section), the plan sponsor may elect to use interest rates under the monthly corporate bond yield curve described in paragraph (d) of this section for the month preceding the month that includes the valuation date in lieu of the segment rates determined under paragraph (c) of this section. In order to address the timing of benefit payments during a year, reasonable approximations are permitted to be used to value benefit payments that are expected to be made during a plan year.
(ii) Reasonable techniques permitted. In the case of a plan sponsor using the monthly corporate bond yield curve under this paragraph (e)(3), if with respect to a decrement the benefit is only expected to be paid for one-half of a year (because the decrement was assumed to occur in the middle of the year), the interest rate for that year can be determined as if the benefit were being paid for the entire year. See § 1.430(d)-1(f)(7) for additional reasonable techniques that can be used in determining present value.
(4) Plan sponsor. For purposes of the elections described in this section, any reference to the plan sponsor generally means the employer or employers responsible for making contributions to or under the plan. In the case of plans that are multiple employer plans to which section 413(c)(4)(A) does not apply, any reference to the plan sponsor means the plan administrator within the meaning of section 414(g).
(f) Interest rates used for other purposes.
(1) Effective interest rate.
(i) In general. Except as otherwise provided in paragraph (f)(2) of this section, the effective interest rate determined under section 430(h)(2)(A) for the plan year is the single interest rate that, if used to determine the present value of the benefits that are taken into account in determining the plan's funding target for the plan year, would result in an amount equal to the plan's funding target determined for the plan year under section 430(d) as described in § 1.430(d)-1(b)(2) (without regard to calculations for plans in at-risk status under section 430(i)).
(ii) Zero funding target. If, for the plan year, the plan's funding target is equal to zero, then the effective interest rate determined under section 430(h)(2)(A) for the plan year is the single interest rate that, if used to determine the present value of the benefits that are taken into account in determining the plan's target normal cost for the plan year, would result in an amount equal to the plan's target normal cost determined for the plan year under section 430(b) as described in § 1.430(d)-1(b)(1) (without regard to calculations for plans in at-risk status under section 430(i)).
(2) Interest rates used for determining shortfall amortization installments and waiver amortization installments. The interest rates used to determine the amount of shortfall amortization installments and waiver amortization installments and the present value of those installments are determined based on the dates those installments are assumed to be paid, using the same timing rules that apply in determining target normal cost as described in paragraph (b) of this section. Thus, for a plan that uses the segment rates described in paragraph (c) of this section, the first segment rate applies to the installments assumed to be paid during the first 5 year period beginning on the valuation date for the plan year, and the second segment rate applies to the installments assumed to be paid during the subsequent 15-year period. For purposes of this paragraph (f)(2), the shortfall amortization installments for a plan year are assumed to be paid on the valuation date for that plan year. For example, for a plan that uses the segment rates described in paragraph (c) of this section, the shortfall amortization installment for the fifth plan year following the current plan year (the sixth installment) is assumed to be paid on the valuation date for that year so that such shortfall amortization installment will be determined using the second segment rate.
(g) Examples. The following examples illustrate the rules of this section:
Example 1. (i) The January 1, 2009, valuation of Plan P is performed using the segment rates applicable for September 2008 (determined without regard to the transition rule of section 430(h)(2)(G)), and the 2009 annuitant and nonannuitant (male and female) mortality tables as published in Notice 2008-85. See § 601.601(d)(2) relating to objectives and standards for publishing regulations, revenue rulings and revenue procedures in the Internal Revenue Bulletin. Plan P provides for early retirement benefits as early as age 50, and offers a single-sum distribution payable immediately at retirement. The single-sum payment is equal to the present value of the participant's accrued benefit, based on the applicable interest rates and the applicable mortality table under section 417(e)(3). Participant E is the only participant in the plan, and is a male age 46 as of January 1, 2009, with an annual accrued benefit of $23,000 payable beginning at age 65. The actuary assumes a 100% probability that Participant E will terminate at age 50 and will elect to receive his benefit in the form of a single-sum payment.
(ii) Plan P's funding target is $68,908 as of January 1, 2009. This figure is based on the male nonannuitant rates for ages prior to age 50, the applicable mortality rates under section 417(e)(3) for ages 50 and later, and segment interest rates of 5.07% for the first 5 years after the valuation date, 6.09% for the next 15 years, and 6.56% for periods more than 20 years after the valuation date. (See § 1.430(d)-1(f)(9), Example 10, for additional details.)
(iii) The present value of Participant E's benefits as of January 1, 2009, is $68,908 if a single interest rate of 6.52805% is substituted for the segment interest rates but all other assumptions remain the same. Thus (rounded), the effective interest rate for Plan P is 6.53% for 2009.
Example 2. (i) The facts are the same as for Example 1, except that Plan P offers a single-sum distribution equal to the present value of the accrued benefit based on the applicable interest rates under section 417(e)(3) or an interest rate of 6.25%, whichever produces the higher amount. The applicable mortality table under section 417(e)(3) is used for both calculations.
(ii) The present value of Participant E's age-50 single-sum distribution as of January 1, 2009 (when Participant E is age 46) is $77,392. This amount is determined by calculating the projected single-sum distribution at age 50 using the applicable mortality table under section 417(e)(3) and an interest rate of 6.25%, and discounting the result to January 1, 2009, using the first segment rate of 5.07% and male nonannuitant mortality rates for 2009. Because this amount is larger than the present value of Participant E's single-sum payment based on the applicable interest rates under section 417(e)(3) (that is, $68,908), the funding target for Plan P is $77,392 as of January 1, 2009. (See § 1.430(d)-1(f)(9), Example 12 for additional details.)
(iii) The effective interest rate is the single interest rate that will produce the same funding target if substituted for the segment interest rates keeping all other assumptions the same, including the fixed interest rate used by the plan to determine single-sum payments. The only segment interest rate used to develop the funding target of $77,392 was the first segment rate of 5.07%. Therefore, considering only this calculation, the single interest rate that would produce the same funding target would be 5.07%.
(iv) However, the effective interest rate must also reflect the fact that the single-sum payment under Plan P is equal to the greater of the present value of Participant E's accrued benefit based on the fixed rate of 6.25% or the applicable interest rates under section 417(e)(3). If the single rate of 5.07% is substituted for the segment rates used to calculate the present value of the single-sum payment based on the applicable interest rates, the resulting funding target would be higher than $77,392.
(v) Using a single interest rate of 6.0771%, the January 1, 2009, present value of Participant E's single-sum payment based on the applicable interest rates is $77,392, and the present value of Participant E's single sum payment based on the plan's interest rate of 6.25% is $74,494. Plan P's funding target is the larger of the two, or $77,392, which is the same as the funding target based on the segment interest rates used for the 2009 valuation. Therefore, Plan P's effective interest rate for 2009 (rounded) is 6.08%.
(h) Applicability date. This section applies for months that begin on or after February 1, 2024. For rules that apply for earlier periods, see 26 CFR 1.430(h)(2)-1 revised as of April 1, 2023.
[Added by T.D. 9467, 74 FR 53004-53084, Oct. 15, 2009, as amended by T.D. 9732, 80 FR 54373-54402, Sept. 9, 2015; T.D. 9986, 89 FR 2127-2132, Jan. 12, 2024.]
