Transcript Restricted Distributions in DB Plans ASPPA Annual
Restricted Distributions in DB Plans
ASPPA Advanced Actuarial Conference June 10 – 11 th , 2008 Ilene H. Ferenczy, Esq., CPC Law Offices of Ilene H. Ferenczy, LLC Joan Gucciardi, MSPA, CPC Summit Benefit & Actuarial Services, Inc.
Benefit Restrictions Today
Treasury Reg. § 1.401(a)(4)-5(b) PPA restrictions under IRC § 436
PPA Benefit Restrictions
Coordination with §401(a)(4) restrictions on accelerated distributions for HCEs Restrictions still apply under Treas. Reg. §1.401(a)(4)-5(b) Look at different purposes of rules: §401(a)(4): protect the benefits of NHCEs PPA restrictions: improve funding of the plan
Treas. Reg. §1.401(a)(4) 5(b) Restrictions
Treas. Reg. §1.401(a)(4)-5(b)
Restricted employees are HCEs Required provision in defined benefit plan document Restriction of benefits upon plan termination
Treas. Reg. §1.401(a)(4)-5(b)
Accelerated distributions cannot be made to HCEs unless: 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
Treas. Reg. §1.401(a)(4)-5(b)
Definition of a restricted employee HCE or former HCE One of the 25 (or a larger number chosen by the employer) or former employees with the largest amount of compensation in the current or any prior year.
nonexcludable employees Should be defined in the plan document
Treas. Reg. §1.401(a)(4)-5(b)
Definition of a restricted employee (cont’d) 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
Example 1
Art is an HCE for the plan year ended 12/31/07 (he earned more than $100,000 in 2006). Art only earns $50,000 in 2007, so he is not an HCE for 2008 Art terminates employment in 2008. Question: Is Art a restricted employee?
Example 1
Solution: List all highly compensated employees for the years 1995 (the year the business started) 2008 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.
Treas. Reg. §1.401(a)(4)-5(b)
Definition of benefits for purposes of restriction: Lump sum distributions Loans in excess of §72(p) Any periodic income Death benefits not provided by insurance QDROs for a non-participant spouse
Treas. Reg. §1.401(a)(4)-5(b)
Restrictions on Distributions Limited to 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)
Treas. Reg. §1.401(a)(4)-5(b)
Determination of Current Liability and Plan Assets “…any reasonable and consistent method may be used in determining the value of plan assets and current liabilities.” Plan Assets: No guidance as to whether actuarial or market value of assets should be used.
Treas. Reg. §1.401(a)(4)-5(b)
Determination of Current Liability and Plan Assets (cont’d) Current Liability pre-2008: IRS interpretation: CL must be calculated on a consistent basis within the plan year for any lump-sum distributions during the plan year.
Methodology for the calculation of current liability may be changed from year to year [2005 Enrolled Actuaries Meeting, Gray Book, Question 32]
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]
Example 2
Calendar plan year As of 1/1/07, plan assets are less than 110% of current liability (determined after the distribution) HCE terminates in January 2008 and wants a lump sum What should the actuary do?
Example 2
Possible Options: Recalculate current liability as of 12/31/07 using pre-PPA assumptions and permit distribution if (after the distribution): 12/31/07 plan assets > 110% of 12/31/07 current liabilities Wait for the calculation of the 1/1/08 target liability using PPA assumptions to assure that (after the distribution): plan assets > 110% of target liability Plan sponsor tells HCE “no distribution” or put up security
Treas. Reg. §1.401(a)(4)-5(b)
Security Arrangements Deposit funds equal to 125% of the restricted amount in an escrow account Post a bond equal to 100% of the restricted amount Purchase a bank letter of credit equal to 100% of the restricted amount Security can be released if: Participant drops off high-25 list Plan becomes 110% funded
Treas. Reg. §1.401(a)(4)-5(b)
Security Arrangements (cont’d) 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
Treas. Reg. §1.401(a)(4)-5(b)
Security Arrangements (cont’d) Restricted amount is the excess of: 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
Example 3
Larry, a restricted HCE, entitled to a life annuity of $2,000 per month Plan is subject to the 110% rule, but Trustee of Larry’s IRA executes a collateral agreement with the plan Larry receives a lump sum of $283,058, based on a 5% rate and GAR mortality table An interest rate of 5% is used in the calculation of the restricted and unrestricted amounts Assumes that the §417(e) rate stays at 5%
4 5 1 2 3
(A) Year (B) Unrestricted Amount
Example 3
(C) Unrestricted Amount + Interest (D) Total Value of Benefit
24,000 24,600 283,059 48,000 72,000 96,000 120,000 50,430 77,552 106,029 135,931 297,212 312,073 327,676 344,060
(E) Restricted Amount [(D)-(C)]
258,459 246,782 234,521 221,647 208,129
Example 3
Result: restrictions disappear after 17 years (if the plan is still in existence) Collateral can be released
Treas. Reg. §1.401(a)(4)-5(b)
What happens if restricted lump sums are paid?
Plan is subject to disqualification for violation of nondiscrimination requirements
Treas. Reg. §1.401(a)(4)-5(b)
Possible solutions if restricted lump sums are paid: 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)
PPA BENEFIT RESTRICTIONS
PPA Benefit Restrictions
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
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: Benefit increases Available benefit forms Benefit accruals Shutdown benefits
Can the Plan Pay Lump Sums?
Under PPA, a plan can pay full lump sum benefits only if its AFTAP is 80% or more AFTAP = Adjusted Funding Target Attainment Percentage
PPA Benefit Restrictions
A plan’s funding target attainment percentage is the following ratio: Assets – Funding Standard Carryover – Pre-Funding Credit Balance Target Liability (disregarding the plan’s at-risk status )
PPA Benefit Restrictions
A plan’s adjusted funding target attainment percentage (AFTAP) is the following ratio: Assets – Funding Standard Carryover – Pre-Funding Credit Balance + AP Target Liability (disregarding the plan’s at-risk status) + AP
PPA Benefit Restrictions
AP = Annuity purchases: the aggregate amount of purchases of annuities for NHCEs in the last two years
What Asset Value is Used?
Must be same value as used for §430 purposes 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]
What Must be Contained in the AFTAP Certification?
Must be in writing Must be provided to the plan administrator Provide AFTAP for the plan year Note aggregate amount of annuity purchases for the year taken into account [Prop. Reg. § 1.436-1(h)(4)(i)(A)]
Can the Plan Pay Lump Sums?
De Minimis
No!
No exception under current law Technical corrections would allow payment of small lump sums “Not a reasonable interpretation of the current statute” if pay small lump sums before technical corrections [2008 EA Meeting Gray Book, Q&A 18]
Practical Impact of AFTAP Restrictions
B efore any benefit payments can be processed in the 2008 plan year … B efore any amendments to increase benefits in the 2008 plan year … Must first determine AFTAP to see if any restrictions apply!
Example 4
At 1/1/08, assets = $1,000,000 Credit balances = $100,000 Target Liability = $1,200,000 2008 AFTAP = $900,000 ÷ $1,200,000 = 75% - lump sum distributions are restricted We’ll come back to this example later
Restrictions if the AFTAP is Less Than 60%
Accruals are deemed to be frozen No lump sums can be paid to anyone
No
de minimis amounts (but this may possibly change via technical corrections) No amendments to increase benefits Notice requirement
What is Considered to be an Amendment Increasing Liabilities?
Increase in IRC § 415 limit due to statutory COLA adjustment? YES Increase in IRC § 401(a)(17) limit due to statutory COLA Adjustment? Can’t push AFTAP below 80%, as it only affects future accruals [2008 EA Meeting Gray Book, Q&A 21]
Timing of Amendments Example 5
EA certifies ATAP for 2009 as 82% on 4/1/09 On 7/1/09, plan sponsor adopts an amendment effective in 2009 that would reduce AFTAP to 79% Plan sponsor elects to reduce a portion of Carryover Balance (COB) to increase AFTAP to 80% Must actuary re-certify AFTAP? No [2008 EA Meeting Gray Book, Q&A 21]
Restrictions: If the AFTAP is Between 60% and 80%
No amendments to increase benefits Lump sums are restricted of the PVAB, or the PV of the max PBGC guaranteed benefit – again, no de minimis amount (but this will possibly change via technical corrections) to the lesser of ½ No one can be paid more than ½ of his or her PVAB Notice requirement
Present Value of PBGC Guarantee
Can be found at: http://pbgc.gov/practitioners/miscellaneou s-tables/pvmg.html
Developed using §417(e) segment rates for August 2007 (5.02%, 5.18%, 5.28%) §417(e) applicable mortality table for 2008
Present Value of PBGC Guarantee Sample Values for 2008
Age
25 35 45 55 65
Present Value
$94,951 $136,474 $211,847 $347,406 $610,204
Restrictions: For New Plans (in existence less than 5 years)
New plans: only restriction in first five years is the inability to pay lump sums But certification requirement still applies
Annual Certification Requirement
All plans must have an AFTAP certification done by an actuary every year, which must be provided in writing to the Plan Administrator
Participant Notices
All Participants must be notified within 30 days of any restriction Includes freezing of the plan Restrictions on lump sums No lump sums, or ½ of PVAB
The PPA Certification
If the 2008 certification is not done by 10/1/08 (for a calendar year plan) Plan is deemed to be less than 60% funded All the associated restrictions and notice requirements apply Until 12/31/08, even if the AFTAP certification is done between 10/1/08 and 12/31/08 and the plan is more than 60% funded
The PPA Certification Practical Impact
Must have the 12/31/07 data on every plan early enough for actuary to do all the 2008 AFTAP certifications by 10/1/08 at the latest to avoid the deemed underfunding and the related benefit freeze Big problem for sole props and partnerships (beginning or end of year valuations) – might not get the 2007 Sch. C income until after 10/15/08
Do We Care on a 1-Person Plan?
YES! Because: The deemed freeze applies till the ’08 AFTAP is certified Plan will probably need to be amended to apply accruals retroactively to the beginning of the year When the freeze is revoked, this will probably count as an amendment increasing benefits, so cannot count for the max deductible limit under the 50% cushion rule
Presumed AFTAP
After 4/1/08, can rely on 2007 AFTAP certification for paying benefits in 2008, until 2008 AFTAP certification is done, because: The plan is presumed to be at 2007 AFTAP percentage less 10%, until 2008 AFTAP is certified.
As long as 2007 AFTAP has been certified to be more than 90%, no restrictions in 2008, until the 2008 AFTAP is certified (which must be done by 10/1/08)
Benefit Restrictions
If neither the 2007 nor 2008 AFTAPs have been certified by April 1, 2008, the plan is deemed to be less than 60% funded on this date and the associated restrictions apply!
Restrictions continue until the certifications are done If this happens, participants must have been given notice of the restriction by April 30, 2008
Sample AFTAP Certification
To: Re: Plan Administrator Certification of Adjusted Funding Target Attainment Percentage (AFTAP) The Pension Protection Act of 2006 (PPA) and Section 436 of the Internal Revenue Code require the calculation of a funding ratio called the Adjusted Funding Target Attainment Percentage (AFTAP) to determine for years beginning in 2008 or later whether the Plan is subject to new limits on plan amendments, lump sum distributions, and benefit accruals.
Determination of the AFTAP for your Plan as of January 1, 2007 (2007 AFTAP): 1.
2.
3.
4.
5.
RPA ‘94 Current Liability Assets: a.
Actuarial Value of Assets b.
c.
Credit Balance in funding standard account Assets, not adjusted for Credit Balance Funding Target Attainment Percentage [(2c)/(1)] Adjustment for Annuity Purchases for NHCEs during last 2 years:
2007 AFTAP is 125.2%*
$103,000 $129,000 $ 0 $129,000 125.2% $ 0 ___________________________________ (Actuary signature, enrollment #, date) *If AFTAP is 90% or higher, there are no benefit restrictions before October 1, 2008.
Sample Cover Letter to Client
Dear Client: The Pension Protection Act of 2006 has introduced new reporting requirements, one of which is an annual actuarial certification of your plan’s funding level. This certification is used to determine if there are any restrictions on your plan’s ability to pay benefits. This certification is referred to in the law as the ”AFTAP certification.” We have attached the 2007 AFTAP certification for your plan. The plan’s funded level for 2007 is 125.2%, which means that the presumed funding level for 2008 is 115.2% (10 percentage points less). Because this exceeds 90%, there are no restrictions on the plan’s ability to pay lump sum payments from now until the 2008 AFTAP is certified. The next step will be to certify the 2008 AFTAP. If the 2008 AFTAP is not certified by October 1, 2008, then your plan will be deemed to be less than 60% funded on that date, which means that accruals will be frozen; the plan cannot be amended to increase benefits, no lump sum payments can be made; and participants must be notified of this restriction by October 31, 2008. In order for us to do the 2008 AFTAP certification timely, we must have your December 31, 2007, census and trust data by August 15, 2008, at the very latest. If we get the data after this date, then there is no guarantee that we will be able to get this certification done timely and your plan could end up deemed to be less than 60% funded as of October 1.
Please call if you have any questions about this.
End of Year Valuations for Small Plans (< 100 participants) Proposed regs gave no guidance Notice 2008-21 just issued – good faith compliance to follow the law until 2009 plan year, when proposed regs become effective Applicable for 2006, 2007, and 2008 plan years Determination of FTAP: _____Value of Net Plan Assets_____ Current Liability + Increase in CL
End of Year Valuations for Small Plans (< 100 participants) 2007 presumed FTAP: adjust value of net plan actuarial assets by: Increasing assets by 2006 contributions (regardless of when made) Adjust such assets to be within 90% - 110% of FMV corridor Subtract credit balance at end of 2006 plan year, unless value of plan assets is greater than or equal to 90% of plan’s current liability
Benefit Restrictions
For purposes of the 2007 or 2008 AFTAP, we can include receivable contributions in the assets for 2007 Only 2007 receivable contributions are counted!
For years after 2007, only contributions actually made by the AFTAP certification date can be counted in the plan assets – Wait to do the certification if those assets are necessary to avoid a restriction Credit balances must be “burnt” to the extent necessary to avoid a restriction
Benefit Restriction Example 6
Remember from Example 4: At 1/1/08, assets = $1,000,000 Credit balances = $100,000 Target Liability = $1,200,000 AFTAP = 900,000 ÷ 1,200,000 = 75%
Benefit Restriction Example 6
$60,000 of the credit balances are automatically “burnt” to avoid a restriction AFTAP = (1,000,000 – 40,000) ÷ 1,200,000 = 80% So this plan must burn $60,000 of its credit balance to avoid a restriction.
Restrictions = Consulting
If there are restrictions, actuaries will need to start the consulting process with the client to look at their choices: Impact of restrictions Additional contributions Should you allow benefits to be paid if not yet certified, but if you know they would be restricted if you certified?