Guest Article

(From the August 8, 2008 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

IRS Issues Final Regulations on Mortality Assumptions for Funding Rules

The IRS on July 30, 2008 issued final regulations on the mortality tables that pension plan sponsors must use to value plan liabilities under the new minimum funding requirements. 73 FR 44632 (July 31, 2008). The final regulations closely follow the proposed mortality regulations the IRS issued last year, but with a few modifications.

The final regulations are effective on July 31, 2008. However, the parts of the final regulations relating to generally applicable mortality tables applies to plan years beginning on and after January 1, 2008. The rules regarding substitute mortality tables apply to plan years beginning on or after January 1, 2009.

Background

The Pension Protection Act (PPA) of 2006 (P.L. 109-280) repealed the current minimum funding rules for single-employer defined benefit plans and replaced them with a new minimum funding regime effective for plan years beginning on or after January 1, 2008. Under the new rules -- which are codified in IRC § 430 -- a plan sponsor's minimum required contribution for a plan year is based on the plan's funding target for that year. Generally, a plan's funding target for a plan year is the present value of all benefits accrued or earned under the plan as of the beginning of the plan year.

Most plan sponsors use the generally applicable mortality tables prescribed by the Secretary of the Treasury for purposes of this and other present value calculations under IRC § 430. However, certain large plan sponsors can petition the IRS to use substitute mortality tables based on their own plans' actual experience. The final regulations explain the methodology the IRS uses to establish the generally applicable mortality tables, and the framework for plan sponsors to develop and use substitute mortality tables. Previously IRS issued Rev. Proc. 2007-37, 2007-1 CB 1433, to explain the procedures for a plan sponsor to apply to use substitute mortality tables. (According to the preamble to the final regulations, an update to Rev. Proc. 2007-37 is forthcoming.)

Additionally, plan sponsors have the option of using separate Treasury-prescribed mortality tables to value liabilities for individuals entitled to benefits on account of disability. The special mortality tables for disabled individuals are addressed in Notice 2008-29, 2008-12 IRB 637, which IRS issued earlier this year.

Generally Applicable Mortality Tables

Under the final regulations the generally applicable mortality tables are based on the RP-2000 Mortality Tables Report. The mortality tables are gender distinct, and provide separate mortality rates for annuitants and nonannuitants. Even though IRS acknowledges the requirement to use separate rates for annuitants and nonannuitants requires changes to actuarial valuation systems, the IRS believes "the improvement in accuracy ... more than offsets the added complexity."

In addition to using the annuitant rates to determine the present value of benefits for annuitants, these rates also must be used to value benefits for nonannuitants for periods they are projected to begin receiving benefits. The nonannuitant tables are used for periods before nonannuitants are projected to begin receiving benefits.

The final mortality tables are based on expected mortality as of 2000 and reflect the impact of expected improvements in mortality. Plan sponsors have two options for applying the projected mortality improvements:

The final regulations include the static mortality tables that apply for 2008 valuation dates. Future tables will be published in the Internal Revenue Bulletin (IRB). The IRS expects to publish a notice in the near future providing a series of tables for valuation dates occurring during 2009 through 2013.

Substitute Mortality Tables

As noted, the final regulations also establish the framework for developing and using substitute mortality tables based on a plan's mortality experience. Basically, new IRC § 430(h)(3)(C) permits certain plan sponsors to petition the IRS to use substitute mortality tables in lieu of the generally applicable mortality tables to calculate present values under the new funding rules. A plan sponsor that wants to use substitute mortality tables must submit its request to the IRS at least seven months before the first day of the first plan year for which the substitute mortality tables will apply. However, a special rule in the final regulations gives plan sponsors until October 1, 2008 to apply for approval to use substitute mortality tables for plan years beginning in 2009.

A properly filed request to use substitute mortality tables is deemed approved unless the IRS specifically denies approval within 180 days of the request, unless the IRS and the petitioning plan sponsor mutually agree to extend this period. If approved, the plan sponsor can use the substitute mortality tables for as many as ten consecutive years, as specified in the request. However, the plan sponsor may not continue using the substitute mortality tables after a significant change in the plan's participants due to a plan spinoff or merger, etc., or after the plan's actuary determines the tables no longer meet the requirements for substitute mortality tables. A significant change generally means a change of at least 20 percent from the average number of individuals included in the experience study.

According to the preamble to the final regulations, "Substitute mortality tables must reflect the actual mortality experience of the pension plan maintained by the plan sponsor for which the tables are to be used and that mortality experience must be credible." Also, the plan sponsor must establish separate mortality tables for each gender, and a substitute mortality table can be established for a gender only if the plan "has credible mortality experience with respect to that gender." If there is credible mortality experience for one gender but not another, the plan sponsor can use substitute mortality tables for the gender with credible mortality experience and the generally applicable mortality tables for the other.

In order for mortality experience within a gender to be "credible," the mortality experience must be based on at least 1,000 deaths within that gender during the period covered by the experience study. The experience study can be conducted over a period as long as five years. (The proposed regulations would have limited the experience study period to a maximum of four years.)

As a general rule, a plan sponsor can use substitute mortality tables for a plan only if the IRS approves the use of substitute mortality tables for all plans subject to IRC § 430 that are maintained by the plan sponsor or a member of the plan sponsor's controlled group. However, the final regulations provide that a plan sponsor is not precluded from using substitute mortality tables for one plan simply because another plan maintained by the plan sponsor (or a member of the plan sponsor's controlled group) cannot use substitute mortality tables due to the fact that neither the males nor the females under that plan have credible mortality experience for a plan year. The plan sponsor has the burden of demonstrating to the IRS each year the lack of credible mortality experience for both the male and female populations in those other plans.

The final regulations require a plan's substitute mortality tables to be generational tables. Plans may, but are not required to, establish separate substitute mortality tables for separate populations within a gender, such as annuitants and nonannuitants or hourly and salaried individuals. However, a plan may use separate substitute mortality tables for a separate population within a gender only if --

The final regulations provide an exception to this rule for plans that want to establish separate substitute mortality tables for annuitants and nonannuitants within a gender. In this case, the requirement that each separate population has credible mortality experience does not apply. Thus, according to the preamble, "the regulations provide that substitute mortality tables for separate annuitant and nonannuitant populations may be used within a gender even if only one of those separate populations has credible mortality experience. Similarly, if separate populations with credible mortality experience are established within a gender, then any of those populations may be further subdivided into separate annuitant and nonannuitant subpopulations, provided that at least one of the two resulting subpopulations has credible mortality experience. In such a case, the standard mortality tables under 1.430(h)(3)-1 must be used for a resulting subpopulation that does not have credible mortality experience. "

Mortality Tables for Calculating Lump Sum Distributions

The PPA also amended IRC § 417(e) to require plans to use a modified version of the mortality table used under IRC § 430 for purposes of determining the present value of lump sum distributions, effective for plan years beginning after December 31, 2007. Plans will not be permitted to use substitute mortality tables or special mortality tables for disabled individuals for this purpose.

Late last year the IRS issued Rev. Rul. 2007-67 to prescribe the applicable mortality table for lump sum calculations for 2008 plan years. The IRS will publish the applicable mortality table for each subsequent year on an annual basis.

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595, Deborah Walker 202.879.4955. Copyright 2008, Deloitte.