Must Frozen DB Plans switch to UC Funding (per 2004 gray book)?

[Guest Bill Kalke]

In the 2004 Grey book at the enrolled actuaries meeting, the IRS reps state that a frozen DB plan must in their informal opinion switch to Unit Credit funding method. No rationale is given.

At the podium, IRS reps clarified in particular that Individual Aggregate would not continue to be a reasonable funding method for a frozen plan - though they clarified that by a frozen plan they meant one where by the terms of the plan it was not possible for any additional benefits to accrue - and not for example a plan where only service accruals were frozen but salary increases could still result in benefit increases.

I would like to know whether any one understands the rationale that might be behind this opinion and also what response practioners plan to take in light of this informal opinion.

[mwyatt]

One other observation is that the "soft freeze" referred to in the Dialogue session would also apply to top heavy plans post EGTRRA that continued to be top heavy. Even though service is no longer granted, the TH minimum average salary would continue to potentially increase...

[MGB]

Bill,

Are you asking for the rationale of the Gray Book answer, or the rationale for the "soft freeze" issue brought up in the session?

I agree with their Gray Book answer. It is an issue of the proper allocation of costs to prior and future service (not clearly defined anywhere, though).

Mark Beilke

[david rigby]

I'm not sure I agree with the use of the word "must", but it is a minor point. I agree with MGB's explanation. To the best of my recall, prior discussion on this point included this same IRS sentiment, but not with as much finality. Some of that discussion can be found on this Message Board. FYI, here is the text:

Gray Book 2004-20

Method Change: Required Change in Funding Method for Frozen Plan

Plan A, a calendar year defined benefit plan is frozen, effective December 31, 2003. Under what circumstances is a funding method change required for the 2004 valuation?

RESPONSE

The normal cost for the plan should be $0 beginning with the 2004 plan year. Accordingly, the plan must use the unit credit cost method described in section 3.01 of Rev. Proc. 2000-40.

Thus, if a plan is not using the unit credit cost method, the plan must make a funding method change. Automatic approval to change to the unit credit method in this situation can be obtained using section 4.01(5) of Rev. Proc. 2000-40.

Copyright © 2004, Enrolled Actuaries Meeting

All rights reserved by Enrolled Actuaries Meeting. Permission is granted to print or otherwise reproduce a limited number of copies of the material on the diskette for personal, internal, classroom, or other instructional use, on the condition that the foregoing copyright notice is used so as to give reasonable notice of the copyright of the Enrolled Actuaries Meeting. This consent for free limited copying without prior consent of the Enrolled Actuaries Meeting does not extend to making copies for general distribution, for advertising or promotional purposes, for inclusion in new collective works, or for sale or resale.

[Blinky the 3-eyed Fish]

Personally, I don't see the rationale in saying IA is not reasonable for a frozen plan. If you still have active employees and they have earned benefits, then using IA simply means you are funding the difference between the benefits earned and the assets in the plan over the working lifetimes of the active participants.

What is unit credit doing, but funding this difference over 10 years when the funding method is changed? What is the reasoning for saying 10 years is appropriate, but the future working lifetimes of the active participants is not?

[Guest dsyrett]

Plus under UC in small plans, you will develop gains and losses that may not be amortized until after assumed retirement.

That fails one of the conditions of a reasonable funding method.