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#1 FAPInJax

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Posted 16 September 2004 - 02:21 PM

A participant wants to receive a lump sum distribution at age 49. The plan has a retirement age of 55 and provides for maximum benefits as a life annuity. The participant only has 4 years of participation as of the date of termination.

The actuarial equivalent assumptions are 8% pre-retirement and 5% 1983 IAF setback 5 years post-retirement.

What is the maximum lump sum that the participant can receive???

It seems obvious that the 8% AE assumption will cause that calculation to be used for the benefit. This is because you use the smaller of the AE or 5%/GAR adjusted benefits to determine the lump sum.

The question is on the reductions. The benefit must be reduced from 62 to 49 and then an immediate annuity factor can be used to determine the lump sum.

160,000/12 * .4 = 5333.33

I thought the calculation would be:

5333.33 * (178.4792 / 207.0814) * (1/1.08)^13 = 1,690.19

The APRs and discount are both calculated using the AE assumptions.

However, a different calculation has produced a higher limit:

5333.33 * (178.4792 / 207.0814) * (1/1.05)^7 * (1/1.08)^6 = 2,058.63

Both of these numbers could be multiplied by the annuity factor using the applicable interest rate and mortality table.

I happen to like the second number better because my lump sum is 21% higher but question whether my 'explanation' would hold up.

The reason is the retirement age under the plan and the pre and post interest rates for actuarial equivalent being different.

Does anyone have a problem with the second calculation??

#2 Blinky the 3-eyed Fish

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Posted 16 September 2004 - 03:24 PM

I do. The plan's NRA does not factor into the calculation of the 415 limits. If you want the higher lump sum, amend the plan's pre-retirement interest rate lower.

Edited by Blinky the 3-eyed Fish, 16 September 2004 - 03:25 PM.

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#3 SoCalActuary

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Posted 16 September 2004 - 06:44 PM

The amount in the plan must be converted into an equivalent benefit at normal retirement. I use the post retirement assumptions to adjust from age 62 to NRA for 415 limit purposes. Thereafter, I adjust from NRA to current age using the plan pre-retirement interest.

In both cases, I must also do the IRS method of adjustment, using the greater of 5% or the plan rate, and using the IRS required mortality table.

So the question is: does the plan provide that interest is 8% until NRA and 5% from NRA forward? If so, then the IRS method uses the same interest rate pattern.

Don't forget at the end to compute the lump sum using 5.5% in 2004-5.

#4 Blinky the 3-eyed Fish

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Posted 16 September 2004 - 06:54 PM

Sorry SoCal for messing up the flow. I had second thoughts on my post and wanted to do a little research.

Okay, I am back to try again. My reading of Rev. Rul. 98-1 is that the plan's NRA is not a factor. Nowhere it the promulgation is it referenced (that I can see). What is referenced is that the determination of the equivalent annual benefit below age 62 is based on the lesser 5% and the applicable mortality table OR the plan's AE interest and mortality (or tabular factor) "used for actuarial equivalence for early retirement benefits under the plan", 8% in this case. Of course this promulgation is a bit old in that the reduction from SSRA to 62 is still there, but the pre-62 reduction is still applicable.

Edited by Blinky the 3-eyed Fish, 16 September 2004 - 07:11 PM.

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#5 FAPInJax

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Posted 17 September 2004 - 06:47 AM

The answer to SoCal's question is that the plan does specifically provide that AE is 8% pre-retirement and 5% post-retirement.

However, Blinky still believes that I am stuck with the smaller number (unless I amend the plan).

Unfortunately, I feel most comfortable with the smaller number. I just wondered whether the larger result could be justified (and it can be if using NRA creates a pre/post differential). I am sure that the larger pre is designed to minimize lump sum values but it created an interesting question.

#6 SoCalActuary

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Posted 17 September 2004 - 12:45 PM

My comments lead to this issue: Under 415, age 55 is early retirement. What does the document provide for benefits at age 55? I would interpret my documents to provide 5% interest from 62 to 55, because they are directly affected by the post-retirement period, eg after 55.

#7 Blinky the 3-eyed Fish

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Posted 17 September 2004 - 12:52 PM

SoCal, I am not sure if what I was saying registered. Did you get a chance to read Rev. Rul. 98-1? Notice that it is prescribing the reduction from age 62, not the plan's NRA, using actuarial equivalence for early retirement benefits under the plan. We can agree that that figure is 8% here, correct?

In other words, you determine what AE or plan factors reduce the benefit for early retirement or for benefits payable before the plan's NRA. Then you apply those factors in reducing the benefit payable before age 62 for purposes of determining the maximum distribution.
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#8 SoCalActuary

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Posted 17 September 2004 - 12:57 PM

We don't agree that 8% is the rate.

#9 Blinky the 3-eyed Fish

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Posted 17 September 2004 - 01:12 PM

We don't? How is anything but 8% the rate for determining anything related to pre-retirement in the plan? If you were to determine a distribution before age 55, what interest rate would you use under AE to discount it for pre-retirement? We have to be able to agree it's 8%.

The next step is to now equate that interest rate to what is being defined in Rev. Rul. 98-1. You didn't answer if you got a chance to read it.

Edited by Blinky the 3-eyed Fish, 17 September 2004 - 01:12 PM.

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#10 SoCalActuary

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Posted 17 September 2004 - 06:08 PM

Two issues are involved, both based on the actual plan document.

1. Frank needs to confirm - Is this a plan that allows early retirement annuity benefits?
If so, does the plan have a schedule of early retirement factors at age 49?

If so, then 98-1 would lead to the 8% reduction in the Q-7 Step 2 calculations.

However, many of our plans with age 55 NRA do not have an early retirement provision, and therefore no reference to early retirement interest rates. At age 49, the participant is eligible for lump sum treatment, or deferred benefits at 55. Then you go to the 417(e) rules based on the 415 limit at 55 using the 5% post-retirement rate.

2. In addition, the better designed plans have a specific set of assumptions for 415 limit calculations, usually at 5%, in addition to the other actuarial equivalence assumptions. In these plans, the separate 415 language applies, not the 8% rate.

#11 Blinky the 3-eyed Fish

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Posted 17 September 2004 - 06:36 PM

I think a fundamental difference between us is that you are equating the reference to early retirement benefits in 98-1 to mean solely annuity payments for early retirement, while I contend that it means ANY payment before NRA, whether that be a lump sum or whatever. I don't think it matters whether there are early retirement annuity benefits and I assume since Frank didn't provide a schedule, that the 8% applies for pre-retirement discounting.

I would like to tackle the issue from a different standpoint. Where in 98-1 do you feel you are allowed to reduce from age 62 to the plan's NRA using the plan's post-retirement AE and only then from the plan's NRA to attained age at distribution do you switch to the plan's pre-retirement AE?

As for your point #2, I am not sold that is acceptable. One of the drawbacks of setting AE higher than 5% has been the reduction in the dollar limit. It's almost like you are having your cake and eating it too in that the higher AE will limit ancillary costs (at least it will once 417(e) rates rise again) while the maximum lump sum is not affected. I am sure there are documents with determination letters that have these provisions, but that doesn't mean I necessarily agree.

Edited by Blinky the 3-eyed Fish, 17 September 2004 - 06:37 PM.

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#12 SoCalActuary

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Posted 18 September 2004 - 08:12 AM

Blinky, I understand your position and agree that your interpretation is the most restrictive. It would defeat the purpose of the plan if the IRS accepts your view.

However, I contend that the document language was written and intended to provide 5% interest reductions from 62 to 55. Reductions below 55 were intended to use 8%.

The plan could also have a choice to not pay any early retirement benefits, making the reference in 98-1 irrelevant.

As to the second point, if you look around at the majority of db pension documents for small plans, you will find the separate 415 assumption reference is very widely used. I have not seen it challenged by IRS auditors, even when sent to IRS actuaries for further review. The words stand on their own.

Of course, we could just agree to disagree and leave it to Frank to decide what he wants to do.

#13 FAPInJax

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Posted 20 September 2004 - 09:34 AM

I have seen documents that specify the 415 actuarial assumptions and the IRS has specifically ruled that it was OK (one or more clients have specifically highlighted the particular provision and asked for IRS specific review). I have not used that particular technique yet.

However, I am a little confused. Revenue Ruling 98-1 Q-8 provides the rules for determining amounts subject to 417(e). This appears to be the correct question because the issue is the maximum lump sum that I can pay to a participant 49 years old with a retirement age of 55.

Do we have the same issues IF we are asking how to determine the maximum 415 benefit at NRA 55?

The 415 benefit is computed as the greater of the equivalent annual benefit computed using either the rates (interest and mortality) in the plan OR 5% and applicable mortality. Is this the argument which would permit the 5% rate to be applied form 62 to 55 (even though AE is defined at 8%)??

#14 Blinky the 3-eyed Fish

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Posted 20 September 2004 - 11:26 AM

It would defeat the purpose of the plan if the IRS accepts your view.


Can you explain what you mean by this?

However, I contend that the document language was written and intended to provide 5% interest reductions from 62 to 55. Reductions below 55 were intended to use 8%.


Again, I would love if you could provide a cite to back up your contention. Keep in mind that the document is specifically addressing how it defines AE, not how it is defining the pre-62 415 limit reductions in 98-1.

Do we have the same issues IF we are asking how to determine the maximum 415 benefit at NRA 55?


Certainly. You still have 8% pre-retirement and 98-1 calls for that to be a factor in reducing from age 62.
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#15 SoCalActuary

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Posted 20 September 2004 - 12:48 PM

Frank - I believe you said that the issue is payment of the maximum lump sum benefit at age 49. Let me clarify other issues here.

Does the plan have the 5% language for 415?

Does the plan have an early retirement benefit option?

#16 FAPInJax

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Posted 21 September 2004 - 03:13 PM

The plan does NOT have an early retirement defined.

The plan does NOT specifically have the 415 rates defined in the plan document.

#17 SoCalActuary

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Posted 22 September 2004 - 09:11 AM

With no mention of early retirement in the document, I don't see a clear-cut requirement to use unspecified rates in the 415 calculation.

Similarly, I don't equate lump sum rules with early retirement reductions.

Having said that, you now have three choices:

1. Use 8% as the safest interpretation & lowest benefit at all ages.
2. Use 5% to age 55, 8% thereafter for your reductions.
3. Ask Treasury to define it.

For the sake of the client, if you choose #1, let them know that their benefit at age 55 is a lot less than the law allows. So they should consider amending the plan.

#18 Blinky the 3-eyed Fish

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Posted 22 September 2004 - 09:52 AM

Well as you said we are going to have to agree to disagree here.

Although, I still wish you would provide any sort of cite for your #2 option. That one is pulled out of a hat as far as I am concerned.
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#19 Blinky the 3-eyed Fish

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Posted 24 September 2004 - 12:03 AM

SoCal, I was looking over these posts again and I was intriqued by how many times I asked a question of you only to get no answer. I asked for cites multiple times but got none. Give me something or I will dismiss what you say as irrelevant.
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#20 FAPInJax

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Posted 04 October 2004 - 12:50 PM

Surprises are all over the place. I just spoke with a lady at National IRS and asked the same basic question. However, here is the actual question posed:

A plan has the following parameters:

Normal retirement age 55
Actuarial equivalent
Pre-retirement 8% interest and no mortality
Post-retirement 5% interest and 1983 Individual Annuity Female with a 5 year setback

Annuity purchase rates
62 178.4792
55 195.4910
49 207.0814

It is not necessary to calculate the maximum benefit using 415 assumptions as the pre-retirement interest rate of 8% will obviously produce a smaller benefit.

A participant (current age 49) has a maximum benefit and desires to take a lump sum. How is the 415 limit determined at age 49?

a) 160,000 * (178.4792 / 207.0814) * (1/1.08)^13 = 50,705.80

Reduction using the pre-retirement interest rate from 62 to 49

b) 160,000 * (178.4792 / 207.0814) * (1/1.05)^7 * (1/1.08)^6 = 61,758.80

Reduction from 62 to 55 using 5% and from 55 to 49 using 8%

Amazingly enough (and I know that I can not rely on the answer) BUT the answer is (b)!! Now, this assumes that these are the early retirement actuarial equivalence factors, etc. (the same choices that were discussed earlier - whether the plan document has early retirement at all, whether the actuarial equivalent asusmptions for early retirement are the same, etc.).

The rationale behind the decision is that the plan document specifically defines the actuarial equivalence assumptions PRE and POST. Therefore, everything after 55 is deemed to follow the post retirement and everything from 55 down to 49 is deemed to be pre retirement.