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Guest Article

Deloitte logo

(From the January 7, 2008 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

IRS Issues Proposed Regulations on Valuing Assets and Liabilities Under New Funding Rules


The IRS on December 28, 2007 issued proposed guidance on measuring plan assets and liabilities under the Pension Protection Act's (PPA) new minimum funding rules for singleemployer defined benefit plans. This is the third in a series of proposals relating to the PPA's minimum funding requirements, which are effective for plan years beginning on and after January 1, 2008. Plan sponsors may rely on the proposed regulation until final guidance is issued.

Previously, IRS issued proposed regulations on the mortality tables that must be used to value liabilities for purposes of the PPA minimum funding rules, and on the rules for using prefunding and funding standard carryover balances. (The latter also included guidance on the PPA's benefit restrictions for certain underfunded plans.) The IRS also has issued guidance on the interest rate assumptions plan sponsors must use for valuing liabilities pursuant to the new funding rules.

Determining the Funding Target and Target Normal Cost

Under the new rules a plan sponsor's minimum required contribution (MRC) is the plan's target normal cost (TNC) plus any shortfall amortization charge (SAC) and waiver amortization charge (WAC) for the plan year. The TNC for the plan year is defined as the present value of all benefits that accrue or are earned (or that are expected to accrue or to be earned) under the plan during the plan year. If a plan's valuation date is after the first day of the plan year, the TNC will include benefits actually earned during the year up to the valuation date plus a projection of benefits that will be earned during the rest of the plan year. However, the new funding rules require plans with more than 100 participants to use the first day of the plan year as the valuation date.

A plan's funding target (FT) is the present value of all benefits that have been accrued or earned under the plan as of the first day of the plan year. The FT is used for various purposes under the new rules, including for determining whether a plan has a funding shortfall.

In general, the FT and TNC for a plan year must be determined based on the plan terms that are adopted on or before the valuation date for that plan year and become effective during that plan year. However, pursuant to IRC § 412(d)(2) a plan can elect to take into account amendments adopted after the valuation date that become effective during the plan year.

Under the proposed regulation, a plan's valuation would have to include all currently employed plan participants, formerly employed plan participants (including retirees and terminated vested participants), and other individuals currently entitled to benefits. Unlike the pre-PPA rules, the proposed regulation would not allow plans to exclude those plan participants who could have been excluded from participation under IRC § 410(a) (i.e., anyone less than 21 years old or anyone with less than 1 year of service) from the valuation.

The proposed regulation would specify rules for allocating future benefit payments among previous plan years and the current plan year. Future benefit payments allocated to previous plan years are taken into account for purposes of the current year FT, and future benefit payments allocated to the current plan year are included in the current TNC.

Additionally, the proposed regulation would address the following issues regarding whether and how certain things should be included in the FT and TNC calculations, and the relevant amount.

  • As noted, future benefit payments are taken into account for purposes of both the FT and the TNC.

    • If the future benefit payment will be a function of the participant's accrued benefit when paid, then apply that function to the accrued benefit as of the beginning of the plan year to determine the amount taken into account for the FT, and to the increase in the accrued benefit for the plan year to determine the amount taken into account for the TNC.
    • If the future benefit payment will be a function of the participant's service (but not accrued benefit) when paid -- e.g., an ancillary benefit -- use the participant's service as of the first day of the plan year to determine the amount taken into account for the FT and use the increase in that benefit for the plan year based on the additional year of service to determine the amount taken into account for the TNC.
    • If the future benefit payment will not be a function of either the participant's accrued benefit or service, the portion of the benefit taken into account for purposes of the FT is based on the proportion of the participant's service as of the first day of the plan year relative to service the participant will have when s/he meets the relevant age and service eligibility requirement for the benefit, and the portion of the benefit taken into account for purposes of the TNC is the increase in the proportional benefit for the plan year.
  • A plan may not take into account any benefit limitations or anticipated benefit limitations under IRC § 436 when determining the FT and TNC for a plan year.
  • A plan may not take into account any administrative expenses paid (or expected to be paid) from plan assets when determining the FT and TNC for a plan year.
  • In general, a plan's FT and TNC must reflect any liability for benefits funded through insurance and the value of the corresponding insurance contracts must be included in the plan's assets. However, if the insurance contract was purchased from a state-licensed insurance company, the related benefits can be excluded from the FT and TNC -- and the value of the insurance contract excluded from plan assets -- to the extent the participant has an irrevocable right to those benefits based on premiums paid to the insurance company prior to the valuation date.
  • A plan's actuarial valuation must take into account the probability that future benefits will be paid in optional forms available under the plan, based on the plan's experience and other relevant assumptions. Also, the plan's enrolled actuary must take into account any difference in the present value of those future benefit payments resulting from using actuarial assumptions to determine the payment amount that are different from those prescribed in the funding rules. The proposed regulation would provide special rules for applying this requirement to single sums and other distributions subject to IRC §417(e)(3).

The proposed regulations would require plans to establish their actuarial assumptions and funding methods by the due date (with extensions) for filing the Form 5500 for that plan year. The filing of the first actuarial report (Schedule SB) reflecting the use of actuarial assumptions and a funding method would be treated as establishing the actuarial assumptions and funding method for that plan year. Once the actuarial assumptions and funding method for a plan year are established they cannot be changed unless the IRS determines the assumptions are unreasonable or the funding method is impermissible.

The proposed regulations include a series of useful examples to illustrate the operation of these rules.

Valuation Date and Value of Plan Assets

As noted, the general rule is that a plan must use the first day of its plan year as its valuation date. The only exception is for "small plans," which can designate any day during the plan year as the valuation date. A small plan is a plan sponsored by an employer with 100 or fewer participants in defined benefit plans (other than multiemployer plans) sponsored by the employer or members of the employer's controlled group.

For purposes of valuing plan assets, the general PPA rule is that plans must use the fair market value of assets on the valuation date. However, plans may use an "average" value as of the valuation date so long as the average is between 90 percent and 110 percent of fair market value. The average fair market value is determined using the fair market value on the valuation date and the adjusted fair market value for one or more earlier determination dates. According to the proposed regulations, the period of time between the valuation date and each of the earlier determination dates must be equal (with a period of no more than 12 months). The earliest determination date may not be earlier than the last day of the 25th month before the valuation date. Typically the earlier determination dates will be the two immediately preceding valuation dates. The average fair market value would be increased for contributions included in the plan's asset balance on an earlier determination date, and reduced for benefits and administrative expenses paid from plan assets during the same period.

Interest Rates

The proposed regulations would provide guidance on the interest rate assumptions plans must use to determine present values for purposes of the minimum funding rules. Many of the same issues were addressed in IRS Notice 2007-81. However, the proposed regulations would clarify that the interest rates used to determine shortfall and waiver amortization installments would be determined based on the dates those installments are assumed to be paid. In the case of a plan using segment rates, the first segment rate would apply to the five shortfall amortization installments assumed to be paid during the first five years beginning on the valuation date for the plan year, and the second segment rate would apply to the two shortfall amortization installments assumed to be paid after that period.

At-Risk Plans

Finally, the proposed regulations would provide guidance on determining if a plan is "at-risk" and for calculating the at-risk FT and at-risk TNC. In general, a plan is at-risk for a plan year if for the preceding plan year the plan's funding target attainment percentage (FTAP) is less than 80 percent and the at-risk FTAP is less than 70 percent. The 80 percent threshold is replaced by 65 percent for plan years beginning in 2008, 70 percent for plan years beginning in 2009, and 75 percent for plan years beginning in 2010.

A plan's FTAP for a plan year is determined by dividing plan assets (reduced by any prefunding and funding standard carryover balance) by the FT for the year. The at-risk FTAP for a plan year is based on a similar formula, except the denominator is a version of the plan's at-risk FT for the plan year. The at-risk FT is calculated using certain special actuarial assumptions. A plan's at-risk FT for a plan year cannot be less than its FT for the same plan year.

In order to determine if a plan is at-risk in 2008, the FTAP for 2007 is calculated by dividing the value of plan assets by the plan's IRC § 412(l)(7) current liability on the 2007 valuation date. For this purpose the value of the plan's assets generally is determined under IRC § 412(c)(2) as in effect for 2007, reduced by any funding standard account credit balance. However, the value of plan assets must be between 90 percent and 110 percent of their fair market value before the funding standard account credit balance is subtracted.

Note that if the plan's 2007 FTAP is less than 65 percent, the plan is at-risk for 2008. This is because the 2007 at-risk FTAP must be less than the 2007 FTAP, so the second prong of the atrisk status test necessarily is satisfied.

At-risk plans must use special at-risk FTs and at-risk TNCs for purposes of calculating their minimum required funding contributions. The at-risk FT and at-risk TNC is determined using special actuarial assumptions and, in some cases, a loading factor. The at-risk FT and at- risk TNC are phased in for plans that have been at-risk for fewer than five consecutive years.


Deloitte logoThe 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, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595, Deborah Walker 202.879.4955.

Copyright 2008, Deloitte.


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