Restricted Employee Calculation

[LIBOR]

Top 25 HCE elects lump sum - is restricted ! - gets life annuity payments for a year per restricted rules - a year later he's un-restricted & wants a lump sum - how is the amount he's entitled to calculated ??

[AndyH]

Depends upon the form of payment elected-which should have been one of the options in the document, and that option should have allowed a "change of mind" if you're going to allow it now.

But, the "change of mind" is probably not permissable due to the QJSA waiver rules.

I don't see how somebody can elect a lump sum and magically start receiving a life annuity.

This is a tough issue with some exposure. There's been a good deal of discussion about this on this Board. I'd suggest a search for "restricted payment" or something similar. No good answers, however, other than some kind of hybrid optional form of payment.

You can either look the other way or follow the terms of the document. Problems either way.

[LIBOR]

Andy, I may have been unclear in my characterization of the situation; I'm referring to Reg. 1.401(a)(4)-5(B) for the case of a high 25 HCE who has reached normal, has elected a lump sum, but is restricted - Under 1.401(a)(4)-5(B)(3)(i)(A) the most he can get in a year is the amount that he would have gotten had he chosen a life annuity - he is subsequently paid the life annuity amount.

My question is then : After he's received payments for a year, he asks - am I still restricted ? the answer is no & my question to my practitioner colleaques is : what is the proper way to calculate the lump sum that he is now able to receive ??

[AndyH]

What I was trying to say that it can be argued that he had the following choices:

1. Elect a lump sum and satisfy the bonding/escrow requirements.

2. Defer payment until he can elect an unrestricted lump sum

3. Choose another option under the plan.

If he started collecting lifetime payments, is that not a life annuity election? If not, on what basis under the terms of the plan did he receive payment? If no basis, is that failing to follow the terms of the plan?

Some have suggested adding an additional optional form of payment, some type of modified cash refund, or as an alternative adding an option which remains in force only until such time as the restriction no longer applies. But, then, what happens if the person dies in the interim? Presumably, it would depend upon the temporary option elected, i.e. if life annuity, no future payment.

Doing this would be valid under the terms of the plan and would not be a changed election.

If such a temporary election were made, I would think that the subsequent lump sum would be the actuarial equivalent of whatever "temporary" form of benefit had been elected, i.e. (annuity rate at age of payment) x (initial pension).

This is a little off the wall, but what other alternatives exist?

[david rigby]

Maybe this is just too simple, but would the lump sum just be the actuarial equivalent of all future benefits?

[MGB]

I sort of agree with Rigby, but the actual calculation isn't that simple. You cannot use the present value of the remaining payments (looking prospectively). You must do this with a retrospective calculation.

The person had an amount coming, but was not allowed to take it. Now they can take it (presumably the overall assets gained enough to lift the restriction or the plan is terminating).

In many situations, they did not receive just the single life annuity amount because they weren't "fully" restricted. They may have received more.

The general approach would be to take the lump sum amount they would have had coming at the annuity starting date, subtract what they actually received, and roll it forward to the date of any later payment. This can be done with multiple payments to date, too.

Revenue Ruling 92-76 implies that the rolling forward should only be done with interest, not an actuarial adjustment (with mortality).

In the original question, if you instead calculated the present value of the remaining life annuity, that is mathematically equivalent to rolling forward the previous amounts with an actuarial adjustment. But, that would not be appropriate according to RR 92-76.

[LIBOR]

I'll have to look at RR 92-76 ; actuarially (& logically) the approach outlined by MGB hangs together.

Thanks everyone for the input !!

[Guest merlin]

MGB- I like your answer, but I have some questions as to the mechanics. Assume the following data:

Actuarial equivalent = 7-1/2% UP84,pre-and post-retirement

a65=8.4575

417(e) rate = 6% GATT

a65=10.6467

Annual benefit by plan formula=$100,000 @ NRA = 65

AE lump sum=$845,750

417(e) lump sum=$1,064,667,

"Annual benefit" due to 417(e) rates = $125,884 ($1,064,667/8.4575)

Questions:

1.What is the unrestricted amount at 65? Is it 100000 or could you make the argument that it's 125884?As an aside, I've heard some people take the position that it's the lesser of the two lump sum figures.I think this is way off the mark. Comments?

2.What interest rate or rates do you use and how are they applied to roll forward to 66?

Thank you.

[LIBOR]

I still like MGB's concise response ; the only question in my mind is choice of interest rate for doing the accumulations; RR 92-76 requires the rate to be reasonable; the interest rate underlying the original calculation of the participant's lump sum is probably "reasonable".

[LIBOR]

MGB's response includes wording like "roll it forward" and per RR 92-76 "only be done with interest".

RR 92-76 doesn't really provide guidance on what "specific" interest rate to use - it just says "reasonable".

Just wondering what other practitioners are using or what their thoughts are on this ?

If the original lump sum was calculated using a specific Gatt rate, is that rate reasonable for the "roll forward" ??

Would the plan's actuarial valuation rate - 8% - also be reasonalbe ??

When the numbers get big, the rate used is significant !!

I welcome more dialogue on this !!!

MGB - Any thoughts ??

[AndyH]

Wouldn't this stuff have to be an option in the plan? What happens if the person get's a year or two of the unrestricted amount, then dies? This stuff sounds great, but how is it following the terms of the document? And, again, what happens if the person dies?

[LIBOR]

The plan, in this case, is silent; I was just thinking that this particular situation (i.e. restricted "hi 25" participant receives an unrestricted amount & is not restricted a year later & wants the lump sum he's entitled to) must come up in practice once in awhile & what are practitoners doing ?

For example, if MGB's method is being used what interest rate is used for the roll-forward ?

Andy, your question is a good one but a special case.

I'd be happy with some feedback to my special case : the guy is unrestricted this year & wants his money ! how is everybody doing this calculation.

[AndyH]

Well, in practice, my company, for one, denies the lump sum option unless the conditions are satisfied.

A restricted HCE has the option of a lump sum provided all the conditions (bonding/escrow, etc) are met, an annuity option available under the plan, of deferred payment until a later date (subject to 401(a)(9) of course).

We have allowed someone who elected under these conditions an annuity option to re-elect upon plan termination when the restriction is lifted on the basis that this is an additional form of benefit option (payment at plan termination and unrestricted lump sum).

[AndyH]

How do cash balance plans address the restriction issue?

[LIBOR]

Haven't a clue but this post is definitely getting the hits !!!!

[MGB]

I'd like to resurrect this issue because I am gettin a "split decision" from people within my company. Some are reading the rules narrowly and say the only thing you can do is AndyH's approach. I.e., if they are restricted at all, they cannot take a lump sum. Others are siding with me that there is an "unrestricted amount" that can be paid (e.g., 1% of current liability) with the remainder paid as soon as possible in later years, given restricted calculations at that time.

Anyone else have comments on how they interpret these rules?

[Blinky the 3-eyed Fish]

I have always interpreted the rules to be as described by MGB.

[Guest jim walsh]

assume a restricted amount schedule,done at a currently reasonable interest rate, is drawn up when a participant retires and receives a lump-sum. If interest rates shoot up in the future does the restricted amount schedule have to be recalculated?

[Guest David M]

Another wrinkle to the Top 25 restriction issue: we have had a request to investigate adding to our plan a payment option that would permit any individual, including an individual affected by the Top 25 restrictions, to make a one-time election to receive a lump sum up to but not equal to 1% of current liabilities, with the remainder of the benefit to be received in an annuity form.

Does this approach make sense? If so, what are the pitfalls?

We are also concerned about tax implications with respect to the lump sum and the annuity payments. It would appear that the individual could roll over the lump sum but would need to pay ordinary income tax on the annuity. Is this correct?

Are there other creative options to Top 25 restrictions?

Thanks to all for comments.

[MGB]

After further research on the issue, I completely rescind my earlier remarks. If the person is restricted, they can only receive the single life annuity amount. They may not receive anything greater, even up to the 1% calculation. The 1% calculation is compared to the "entire interest" in the plan, not the current distribution. If their entire interest is over 1%, then the most they can get this year is the single life annuity amount.

Even if you could do what you are saying (I used to think so), you could not restrict this to the high-25 group due to nondiscrimination. The same payout option would have to be available to all.

[AndyH]

David, I don't think any part of the payment schedule you describe is available for rollover because the initial installments are part of a series of payments over more than 10 years. Only the residual balance could be rolloved over in my opinion, once the restriction is lifted.