Guest Article

(From the June 4, 2007 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

IRS Issues Proposed Mortality Tables for Use With New Funding Rules

The IRS on May 29, 2007 issued proposed regulations on the mortality tables that pension plan sponsors will be required to use to value plan liabilities under the new minimum funding requirements that are effective for plan years beginning on or after January 1, 2008. Comments on the proposed regulations are due by August 27, 2007.

The IRS earlier this year issued final regulations to specify the mortality tables plan sponsors must use to determine their plans' current liability for purposes of the deficit reduction contribution rules of IRC § 412(l) and ERISA § 302(d). Those final regulations apply to plan years beginning on or after January 1, 2007, but generally will be relevant only for 2007 plan years.

Background

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

Most plan sponsors will 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 may petition the IRS to use substitute mortality tables based on their own plans' actual experience. Additionally, plan sponsors will have the option of using separate Treasury-prescribed mortality tables to value liabilities for individuals entitled to benefits on account of disability.

The proposed regulations explain the methodology the IRS would use to establish the generally applicable mortality tables, and the framework for plan sponsors to develop and use substitute mortality tables. (The IRS on May 31, 2007 issued Rev. Proc. 2007-37 to specify the procedures for petitioning the IRS to use substitute mortality tables.) According to the preamble to the proposed regulations, the separate mortality tables for disabled individuals would be provided in separate guidance published in the Internal Revenue Bulletin (IRB).

Generally Applicable Mortality Tables

Under the proposed regulations the generally applicable mortality tables would be based on the RP-2000 Mortality Tables Report. According to the preamble to the proposed regulations, the proposed mortality tables are "based on expected mortality as of 2000 and reflect the impact of expected improvements in mortality."

The mortality tables would be gender distinct, and provide separate mortality rates for annuitants and nonannuitants. The mortality tables the IRS issued earlier this year also provided separate rates for annuitants and nonannuitants. However, those final regulations permit plans to use a blended table instead of separate annuitant and nonannuitant rates for 2007 only. Even though the requirement to use separate rates for annuitants and nonannuitants beginning in 2008 will require 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 would be used to value benefits for nonannuitants for periods they are projected to begin receiving benefits.

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

The proposed regulations include the static mortality tables that would apply for 2008 valuation dates. Future tables would be published in the IRB. The IRS is seeking comments on whether it should publish a series of tables for each of several years (such as five years) along with the final regulations, and then publish tables for subsequent years in the IRB.

The preamble to the proposed regulations provides the following example of using the static tables for the 2008 calendar plan year:

Substitute Mortality Tables

As noted, the proposed regulations also would 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. (Plan sponsors that want to use substitute mortality tables beginning in 2008 will have until October 1, 2007 to apply. See Rev. Proc. 2007-37.) The request will be deemed approved although the IRS specifically denies approval within 180 days of the request, unless the IRS and the petitioning plan sponsor can 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 would be a change of at least 20 percent from the average number of individuals included in the experience study.)

According to the preamble to the proposed 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 substitute mortality tables for each gender, which is possible only if the plan "has credible mortality experience with respect to that gender." Mortality experience is credible for a gender within a plan "if and only if the mortality experience is based on at least 1,000 deaths within that gender over the period covered by the experience study." The experience study can be based on mortality experience over a two, three, or four consecutive year period, so long as the last day of the period is less than three years before the first day of the first plan year the substitute mortality tables are to apply. The proposed regulations also would require substitute mortality tables to be generational mortality tables.

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, under the proposed regulations a plan sponsor would not be 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 burden is on the plan sponsor to demonstrate to the IRS each year the lack of credible mortality experience for both the male and female populations in those other plans. For this purpose, the plan sponsor must use a four-year period for mortality experience that ends less than three years before the first day of that plan year. The preamble illustrates these rules with the following example:

The proposed regulations would permit -- but not require -- plans 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 could use separate substitute mortality tables for a separate population within a gender only if --

The proposed regulations would 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 have credible mortality experience would not apply. Thus, according to the preamble, "the proposed regulations would 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.

The proposed regulations do not address the mortality tables to be used under IRC § 417(e). However, the preamble requests comments on how the proposed generally applicable mortality tables for funding purposes should be modified for use pursuant to IRC § 417(e). Specifically, the IRS would like comments on "whether to use annuitant mortality rates or combined mortality rates and whether use of generational mortality tables is appropriate."

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,Taina Edlund 202.879.4956, Laura Edwards 202.879.4981, Mike Haberman 202.879.4963, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Laura Morrison 202.879.5653, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Tom Veal 312.946.2595, Deborah Walker 202.879.4955. Copyright 2007, Deloitte.