Transcript Restricted Distributions in DB Plans ASPPA Annual

Benefit Restrictions Including the
High-25 Group
ACOPA Advanced Actuarial
Conference
June 10, 2010
Joan Gucciardi, MSPA, COPA, CPC
Summit Benefit & Actuarial Services, Inc.
Benefit Restrictions Today
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Treasury Reg. § 1.401(a)(4)-5(b)
PPA restrictions under IRC § 436
What We are Covering
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Practical impact of benefit restrictions
Old rules limiting lump sums on HCEs
New PPA rules limiting lump sums for
all employees
Participant communications on
restricted distributions
PPA Benefit Restrictions
Coordination with §401(a)(4) restrictions on
accelerated distributions for HCEs
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Restrictions still apply under Treas. Reg.
§1.401(a)(4)-5(b)
Look at different purposes of rules:
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§401(a)(4): Prevent discrimination in favor of HCEs
PPA restrictions: Improve funding of the plan by
restricting lump sums and prohibiting benefit
increases for certain underfunded plans
Treas. Reg. §1.401(a)(4)5(b) Restrictions
Treas. Reg. §1.401(a)(4)-5(b)
Restricted employees are HCEs or
HCFEs
Required provision in defined benefit
plan document
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Controversy: Can plan say that these rules
are not applicable if plan covers only
HCEs?
Restriction of benefits upon plan
termination
Treas. Reg. §1.401(a)(4)-5(b)
Accelerated distributions cannot be
made to HCEs unless:
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After taking into account the amount of
the distribution for the restricted
employee,
The value of plan assets must equal or
exceed 110% of current liabilities
These restrictions are the most
common restrictions today
Definition of a Restricted
Employee
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HCE or former HCE
One of the 25 (or a larger number
chosen by the employer) nonexcludable
employees or former employees with
the largest amount of compensation in
the current or any prior year.
Should be defined in the plan document
Definition of a Restricted
Employee
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Determined on a controlled group basis
Definition of pay: use §415(c)(3) pay on a
consistent basis
Re-determine the list each year
IRS regulations provide anti-cutback relief
for plan amendments that alter the
restricted group
If a restricted HCE received a distribution
in the past, is he/she still counted?
Determination of HCE
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What does the plan document say?
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Use of top-paid group?
Use of calendar-year data election?
Thresholds before 1987
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$75,000 in lookback year
$50,000 (and in top-paid group) in lookback
year
Determination of HCFE
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Performed no service during determination
year
Treated as HCFE if:
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Had a separation year before determination
year
Was a highly compensated active employee in
the separation year or in any determination
year ending on or after employee’s 55th
birthday
Example 1
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Art is an HCE for the plan year ended 12/31/09
(he earned $150,000 in 2008)
Art only earns $50,000 in 2009, so he is not an
HCE for 2010
Art terminates employment in 2010
Question: Is Art a restricted employee?
Example 1: Solution
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List all highly compensated employees
for the years 1995 (the year the
business started) - 2010
Arrange list in order of compensation,
using the highest compensation
earned by each HCE
Art is number 30 on the list and is,
therefore, not a restricted employee
Definition of Benefits for
Purposes of Restriction
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Lump sum distributions
Loans in excess of §72(p)
Any periodic income
Death benefits not provided by
insurance
QDROs
Restrictions on Distributions
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No more than a straight life annuity that
is the actuarial equivalent of the accrued
benefit
Plus a Social Security supplement (if the
restricted employee is entitled to receive
one)
Determination of Current
Liability and Plan Assets
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“…any reasonable and consistent
method may be used in determining
the value of plan assets and current
liabilities.”
Plan Assets:
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No guidance as to whether actuarial or
market value of assets should be used
Can a receivable contribution be included
in the assets?
Definition of Current Liability
2008 Plan Years and Later
“Current Liability” is not defined for 2008 plan years (and
later)
 IRS has suggested that you may:
 Substitute “target liability” for current liability; or
 Continue to calculate current liability on pre-PPA basis
[EA Meeting 2008 Gray Book Update, Q&A 30]
 Do this calculation annually or update to reflect
additional accruals during the year?
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Example 2
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Calendar plan year
As of 1/1/09, plan assets are more than
110% of current liability (determined after
the theoretical distribution)
Restricted HCE terminates in May 2010 and
wants a lump sum
1/1/10 actuarial valuation has not been
done
What should the actuary do?
Example 2
Assets: $1.2 million as of 1/1/09
Liabilities: $1 million as of 1/1/09
After theoretical distribution
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Assets: $400,000
Liabilities: $200,000
Well over the 110% threshold
Assets as of 5/1/10: $850,000
Make distribution of $800,000? Will leave
only $50,000 in assets in the plan
Example 2: Possible Options
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Advise plan sponsor that restrictions do not
apply
Advise plan sponsor to wait for the calculation
of the 1/1/10 target liability to ensure that
(after the distribution): plan assets > 110% of
target liability
Plan sponsor tells HCE “no distribution” or put
up security
Advise plan sponsor to call ERISA counsel
Security Arrangements
(Participant Action)
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Deposit funds equal to 125% of the
restricted amount in an escrow account
(IRA or personal account)
Post a bond equal to 100% of the restricted
amount (can’t find anyone to do this)
Purchase a bank letter of credit equal to
100% of the restricted amount
Security Arrangements
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Restricted Amount Must be Recomputed
Each Year (if collateral agreement is
used or other security is provided)
During a plan year, the amount that
may be required to be repaid to the plan
is the restricted amount
Security Arrangements
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Restricted amount is the excess of:
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The accumulated amount of distributions
made to the employee during the period of
restriction, over
The accumulated amount of the
unrestricted limit during the restriction
period
Releasing of Security
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Security can be released if:
 Participant drops off high-25 list
 Plan becomes 110% funded
Coordination with IRA Trustee
What happens if Restricted
Lump Sums are Paid?
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Violation of plan terms
Disqualifying defect
What Happens if Restricted
Lump Sums are Paid?
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Seek a collateral agreement or other
security agreement from recipient
Ask for the money back
VCP
Contribute enough to get the plan
assets up to 110% (measured after the
distribution)
Timing determines if VCP is needed
What Happens When Shareholder
Leaves and Plan is Insufficient?
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Assume that plan is not covered by
PBGC
Terminate the plan
Pay full benefits to NHCEs
Pay shareholders to extent funded
Start a new plan
What Happens When Shareholder
Leaves and Plan is Insufficient?
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Assume that plan is covered by
PBGC
Will need to continue the plan
Are there majority owners?
Will majority owners forgo benefits
to allow termination?
PPA BENEFIT RESTRICTIONS
PPA Benefit Restrictions
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PPA restricts distributions to plan
participants from plans that are not fully
funded to the amount of the
participant’s monthly life annuity
Effective for plan years beginning after
2007
PPA Benefit Restrictions
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PPA also requires the freezing of benefits
under certain circumstances
The degree of restriction depends on the
level of funding for the defined benefit plan
Applicable to:
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Benefit increases
Available benefit forms
Benefit accruals
Shutdown benefits
Restrictions Based on AFTAP
Assets – COB –PFB
Funding Target
Adjustment to numerator and
denominator for NHCE annuity
purchases for prior 2 years
Various Types of Restrictions
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436(b) limits plant shutdown & other unpredictable
contingent benefits for plans less than 60% funded
436(c) limits the ability to amend a plan to increase
benefits for plans less than 80% funded
436(d) limits the ability to pay full or partial lump
sum distributions depending on whether the plan is
less than 60% or 80% funded
436(e) freezes future benefit accruals for plans less
than 60% funded
Various Types of Restrictions:
Exception
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Exception to 436(d) limitation on lump sum
distributions
Applicable to a plan frozen on or before
9/1/05
2nd Limit –
Amendment Increasing Benefits
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Any amendment increasing benefits, establishing
new benefits, changing the existing accrual rate or
changing vesting schedule
Exception for flat dollar plans
IRS view is that COLA increases under 415(b) and
401(a)(17) are “benefit increases” but mandatory
vesting changes are not
2nd Limit –
Amendment Increasing Benefits
Increase in 415 Limit is deemed to be a plan
amendment
 If AFTAP < 80%, plan sponsor may elect not to
make 436 contribution to cover cost of amendment
 If AFTAP later increases to >80%, plan sponsor
would need to retroactively pay benefits up to 415
limits (unless automatic COLA is removed from
plan)
[2009 EA Meeting Gray Book, #20]
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2nd Limit –
Amendment Increasing Benefits
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What about an increase in lump sum benefit due to
the annual update to the applicable mortality table?
Is it a deemed amendment for 436(c) purposes?
No!
2nd Limit –
Amendment Increasing Benefits
Plan sponsor wants to provide an early retirement
window
 Current AFTAP is 70%
 Increase in funding target is based on assumed
utilization
[2009 EA Meeting Gray Book, #22]
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2nd Limit –
Amendment Increasing Benefits
Cash Balance plan needed an amendment to get
out of cash balance “jail”
 Amendment is effective back to 2000
 Amendment will reduce AFTAP below 80%
 Amendment is needed for plan qualification
 Plan sponsor must contribute enough to bring
AFTAP up to 80%
[2010 EA Meeting Gray Book, Q&A #33]
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2nd Limit –
Amendment to G/F Frozen Plan:
Will it Cause Plan to Lose Exemption?
Plan is amended to reflect PPA Applicable interest
rate (AIR) and Applicable mortality table (AMT)?
NO
 Plan protects pre-PPA AIR and AMT? NO
 Plan changes lookback month/stability period? NO
 Plan is amended to provide in-service distributions
at NRA or 62? NO
[2009 EA Meeting Gray Book, #23]
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2nd Limit –
Mid-Year Amendment: 3 Possibilities
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1. AFTAP is > 80% after amendment
2. AFTAP is > 80% before amendment and <
80% after amendment AND plan sponsor makes a
436 contribution to bring AFTAP up to 80%
3. AFTAP is < 80% before amendment AND plan
sponsor makes a 436 contribution to fully fund the
amendment
Note: A 436 contribution cannot do double duty: if
used to fund an amendment, then it cannot be
used for 430 purposes
3rd Limit – Accelerated Benefit
Payments
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Plans less than 60% must not allow any “prohibited
payments” for participants with an annuity starting date
on or after the measurement date (exception for de
minimis amounts)
“Prohibited payments” = any payment in excess of the
monthly single life annuity, plus Social Security
supplements
Plans with funding between 60% and 79% may make
“prohibited payments” but only to the extent the present
value of the payments doesn’t exceed 50% of the total
benefits (or the PBGC guaranteed amount if less)
Annuity starting date – regs require participant’s election
Participants with restricted and unrestricted benefits
must be offered the choice to defer payment of the
restricted portion or bifurcate the benefits
Present Value of PBGC Guarantee
Sample Values for 2010 based on $4,500/mo
(Aug. 2009 segment rates: 3.60%, 5.31%, 5.47%)
Age
Present Value
25
$97,502
35
$140,574
45
$219,161
55
65
$354,083
$639,942
3rd Limit – 60% - 79% Range
aka “No-Man’s Land”
Options Offered to Plan Participants
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Take the QJSA or equivalent benefit forms, other
than a lump sum
Take a 50% lump sum (limited to PBGC maximum)
and defer the rest of the benefit until the AFTAP
increases to 80%
Take a 50% lump sum (limited to PBGC maximum)
and receive the balance of the benefit in annuity
form
Defer the entire benefit until the AFTAP increases
to 80%
3rd Limit – 60% - 79% Range
aka “No-Man’s Land”
Options Offered to Plan Participants
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Communication issues
Offer all the options, including relative value
packages
2-Step process
Step 1 Choices
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Defer benefits
50% lump sum now; annuity now
50% lump sum now; deferred annuity
100% of benefit as annuity
3rd Limit – 60% - 79% Range
aka “No-Man’s Land”
Options Offered to Plan Participants
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Communication issues
Offer all the options, including relative value
packages
3-Step process
Step 1 Choices
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Defer benefits
50% lump sum now; annuity now
50% lump sum now; deferred annuity
100% of benefit as annuity
3rd Limit – 60% - 79% Range
aka “No-Man’s Land”
Options Offered to Plan Participants
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Step 2: Participant makes initial election
Step 3: Plan sponsor provides relative values based
on initial election
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If chooses to defer, no further paperwork needed
Have relative value rules been satisfied?
3rd Limit – 60% - 79% Range
aka “No-Man’s Land”
Options Offered to Plan Participants
Suppose that the participant takes the 50% lump
sum and elects to defer the rest of the benefit until
restrictions no longer apply
 AFTAP now is >80%
 Participant has a 2nd annuity starting date and
must be offered the QJSA and QOSA
[2010 EA Meeting Gray Book, Q&A #43]
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3rd Limit – 60% - 79% Range
aka “No-Man’s Land”
Options Offered to Plan Participants
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What if the actuary does not issue an AFTAP?
Then AFTAP is deemed to be below 60%
No 50% lump sum option needs to be provided
Is this administrative discretion on the part of the
actuary?
Might this ultimately violate the terms of the plan?
3rd Limit – 60% - 79% Range
aka “No-Man’s Land”
Designing New DB Plans
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Consider drafting a new DB plan by limiting lump
sum distributions
Lump Sum is only available when AFTAP is 80% or
above
Certainly no help for existing DB plans that offer a
lump sum
3rd Limit – Options when Distribution
Restrictions Cease
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If AFTAP was 60 – 79% and then certified to be 80% or
more, plans must then offer lump sums for anyone with
ASD occurring after the resumption. The restriction is not
retroactive for anyone with ASD during the restricted period
unless the plan so provides or is amended to so provide.
The following options are available:
 Plan can continue to pay benefits in the same form
 Plan may automatically allow participants to change
elections, triggering a new ASD
 Plan sponsors may amend plan with a one-time
opportunity for participants to change their elections
4th Limit – Freeze on Future Benefit
Accruals
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Plans with less than 60% funding must freeze future benefit
accruals
 Once frozen, benefit accruals are not automatically
retroactively restored if funding improves
 Plan may provide or be amended to provide for retroactive
accruals but this is deemed to be a plan amendment
increasing benefits
 Under a special rule, plans that automatically restore
missed accruals when AFTAP improves to 60% do not have
to fund to the 80% AFTAP level unless the accruals have
been frozen for more than one year
4th Limit – Freeze on Future Benefit
Accruals
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UCEBs - reflect if due to event which occurred before the
valuation date
Mid-Year Plan Amendments -if an increase in TNC (due to
amendment) were included in FT would cause 436 restrictions
to apply, then MUST reflect amendment in FT and TNC for that
year.
Prohibited payments (i.e. restricted benefits)- take 436 benefit
restrictions into account if annuity starting date (ASD) is on or
before valuation date
Limitations on Benefit Accruals- FT must reflect any limitation
on benefit accruals under §436(e) applicable before the
valuation date. Exception for automatic restoration of benefit
accruals. TNC must not take §436(e) limits into account. Thus,
do not reflect freeze unless plan is specifically amended to
cease accruals.
4th Limit – Freeze on Future Benefit
Accruals
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Worker, Retiree, and Employer Recovery Act of 2008 will not
impose this restriction for the 2009 plan year if the plan was at
least 60% funded during 2008
Material Change in AFTAP:
Asset Smoothing
After AFTAP certified for 2008, plan sponsor
changes asset smoothing method
 Certified AFTAP > 80%, but now < 80%
 Plan pays full lump sums
 Revised certification is required
 Could subject plan to disqualification if plan
made payments that would otherwise have
been restricted
[2009 EA Meeting Gray Book, #18]
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Can the Plan Pay Lump Sums?
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Under PPA, a plan can pay full lump
sum benefits only if its AFTAP is 80% or
more
WRERA exception: can pay lump sum if
PVAB is less than $5,000
WRERA Exception?
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Lump sums are allowed despite 436(d)
restrictions
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Payment of a benefit under section
411(a)(11)
May be distributed without consent of the
participant
Applicable to beneficiaries, alternate
payees, and 401(a)(9)
Statutory Presumptions
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Intent: Obtain the actuarial certification ASAP during
PY
First Two Ranges are split into two halves
◦ Range 1: 80% to 89% and 90% to 99%
◦ Range 2: 60% to 69% and 70% to 79%
Jan. 1st – current year AFTAP same as prior year
AFTAP
April 1st – if prior year AFTAP was in first half of
either range, current year AFTAP = prior year AFTAP
less 10%
Oct. 1st – current year AFTAP deemed to be < 60%
Range Certification
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Actuary can certify that current year AFTAP is in one
of 3 ranges:
◦ 60% to 79%
◦ 80% to 99%
◦ 100% or higher
Advantage: ignore the first two statutory
presumptions
Disadvantage: must make actual certification of
AFTAP by Oct. 1st + actual AFTAP must fall within the
range
If actual AFTAP is not within the range, plan may
have failed the qualification rules or not been
administered in accordance with its terms
If the actuary makes a range certification, plan is
treated as having a certified AFTAP at the smallest
value within the range
◦ For example, if range certification is 60% to 79%,
What Asset Value is Used?
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Must be same value as used for §430 purposes
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Fair market value on valuation date
Use FMV in calculating average value of assets
FMV does not have to be updated to match
audited assets
 If §430 asset value changes, then AFTAP must
be updated
[2008 EA Meeting Gray Book, Q&A 20]
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Restrictions: For New Plans
(in existence less than 5 years)
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New plans: only restriction in first five
years is the inability to pay lump sums
But certification requirement still applies
New Plans
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Final 436 regs provide that, if FT =0,
then AFTAP = 100%
However, restrictions could still apply
where a new plan provides prior service
credit such that FT >0
Plan Terminations
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No guidance in proposed regs regarding
benefit payment restrictions as applied to a
terminated plan
E.g., plan terminated and AFTAP < 80%
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What to do if lump sums can’t be paid nor
annuities purchased
Some argued that 436 no longer applied
Final regs provide some resolution
Plan Terminations
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Limitations in effect immediately before
plan termination continue to apply
thereafter
Limitations do not apply to prohibited
payments that are made to carry out
plan terminations “in accordance with
applicable law”
Plan Terminations
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A plan sponsor’s purchase of an
irrevocable commitment to pay benefit
liabilities in connection with a standard
termination is OK
Majority owner waivers should be OK
What about non-PBGC plans?
Delay in Issuing AFTAP Certification
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Is it legitimate for employer to ask EA not to
issue AFTAP certification until 10/1 to delay
implementation of benefit restrictions?
Popular option
Employer can simply withhold data
Should actuary warn employer
Should actuary comply with employer’s
instructions?
Delay in Issuing AFTAP Certification:
Ramifications
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Puts PBGC at risk
Harms participants who do not take lump sums
Violation of duty of impartiality
Actuary may be exercising fiduciary powers when
making discretionary decisions
PPA does not require that certifications be made
at any specific time
Problem comes to forefront when underfunded
plan is terminated (distress or involuntary) and
PBGC will not pay lump sums
Participant Communication
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Participants must be notified when any
of the restrictions apply
Within 30 days after date restriction
applies
Failure to provide notice could result in
penalties of up to $1,000 per day
Questions?