Lump Sum Distribution Slipping into 2005

[Guest Bob_DB]

A DB plan was terminated in mid-2004 and the lump sum distributions were calculated as the present value of accrued benefits as of November 30, 2004 (the assumed distribution date) using an interest rate of 5.07%.

One participant has not signed the application for benefits and that person's distribution is going to slip into 2005.

Question: Will that person's lump sum distribution change? If so, how? In particular,

(a) Will the interest rate used to calculate the equivalent present value change? If so, how will the new rate be determined?

(b) Will the assumed date for distribution change?

© That person's benefit at retirement was at the allowed maximum of $165,000. Will the distribution in 2005 be adjusted to reflect the increase in the allowed maximum of $170,000?

(d) Are there any other changes?

Thank you.

[david rigby]

Question: Will that person's lump sum distribution change?

Probably. As of today, it appears to be difficult (perhaps impossible) to completely answer your questions. Nevertheless:

(a) Your given rate of 5.07% is the December 2003 30-year TSR given by the IRS. It is an average determined over the entire month of December. http://www.irs.gov/retirement/article/0,,id=96450,00.html

Assuming you will need the December 2004 rate, that rate will be available about a week into January.

(b) Likely. The lump sum present value is supposed to be as of the actual distribution date. While there are practicalities involved in a difference of a few days, that does not seem to apply here, where the difference is a month or more. You did not state, but it appears the plan document uses a stability period of one year (the plan year = calendar year?), and a lookback period of one month. Thus, all payments made in 2004 would use the December 2003 rate, and all payments made in 2005 would use the December 2004 rate. The point is that the plan already defines how to do this, so check the plan provisions carefully.

© Maybe; check plan provisions. Likely not.

(d) Again, check plan provisions. Don’t forget to use the plan’s definitions of actuarial equivalent, which might mean that the participant’s age is recalculated at a new distribution date, in addition to the change in interest rate.

[Effen]

I'm a little bothered by something that might not be an issue:

One participant has not signed the application for benefits and that person's distribution is going to slip into 2005.

That person's benefit at retirement was at the allowed maximum of $165,000.

Are you saying that everyone else signed the paperwork and had their lump sums paid prior to the rate change? Everyone except for the one of the HCE's who just happened to drag his feet and now the interest rate might be lower and now he gets a bigger lump sum?

Maybe all completely innocent, but it smells a little fishy to me. Did the HCE gamble the rates would be lower and his lump sum would be higher? If so, did he give all of the NHCE's the same opportunity? Did he tell them that if they waited, their lump sum might be higher? Did he make them aware of the basis of the rate? Are there excess assets that would have been re-allocated to the NHCEs?

Again, maybe fine, but I thing you should tread lightly. It could be a "discrimination in practice" issue.

[SoCalActuary]

On your third question, the plan appears to have been frozen in 2004 as part of the termination.

If you use the 415 limit increase to 170k, how can you say it was frozen?

If you use the higher 415 limit, you probably also have 401a4 discrimination problems

since only one HCE is getting an additional accrual since the termination began.

Otherwise, I concur with Pax.

[Blinky the 3-eyed Fish]

If he's at a maximum $limit benefit, well then he is going to get a lower distribution, most likely, due to the requirement that 5.5% be used for maximum lump sum distributions in 2005. But since he is the last man standing, his distribution will zero out the assets. Is the plan underfunded so that he is waiving benefits? Is it overfunded so that the other participants will share in the excess assets? Or is it just right like baby's porridge?

Regarding ©, since your plan terminated in 2004, you can't have future year COLA increases apply. The limit remains at $165,000.

[Guest Bob_DB]

To answer the questions:

-- The plan document does not contain any specifics about how the lump sum is to be calculated.

-- The plan is funded about right. Any underfunding will be made up by the company and any overfunding will revert back to the company.

-- The plan year does equal the calendar year

There seems to be a disagreement between Pax and Blinky re: the interest rate. Pax indicates that the interest rate is set by the 30-year treasury rate for Dec-04, which seems likely to come out just below 5% whereas Blinky indicates that it will be 5.5%. Can this apparent difference be resolved?

Thanks.

[Blinky the 3-eyed Fish]

Bob, there isn't a disagreement, but rather different rules apply for different purposes. 417(e), which is based on the 30-yr Treasury rate, affects minimum lump sums, while the PFEA passed provisions to apply 5.5% to maximum lump sums. I was merely pointing out that if the person is at a maximum benefit limitation, then he most probably is at a maximum lump sum limit and that 5.5% needs to be considered.

I hope there is an actuary somewhere in the picture. If not, I beg of you to find one.

[AndyH]

Hey Bob, if I may chime in, if the plan contains no specifics about how the lump sum is to be calculated then you have a plan that is not a qualified plan and you've got bigger problems than you've identified. Or the plan may incorporate certain rules by reference which is even more difficult to understand.

The plan may not speak in plan English about how the lump sum is to be calculated but you've got a better chance that is has code words that experienced people will know how to interpret to answer your question. Your odds of that are better than finding a three eyed fish in the desert.

Effen et all all raise valid issues. I suggest first that you re-look at the relevant plan language and if you don't understand it feel free to follow up here or engage someone who understands such bizarre code words.

But if you do hear from a three eyed fish in the desert that beats a four leafed clover so you should listen to such fish.

[SoCalActuary]

As a followup on the document, can you tell whether this was a prototype or volume submitter? Do you have the basic document if this was a prototype?

Generally, lump sums (if allowed at all) are measured using the more valuable of the plan rate or the rate using 417(e) assumptions. Once this is calculated using the appropriate 30 yr Treasury rate, you then check to verify that the lump sum does not exceed the maximum allowed under IRC 415, which will require the 5.5% rate for distributions in 2005.

Check your document and talk with your actuary to confirm that these are the calculations used in this plan.

On the issue of waiting until 2005, I would guess that you have facts or circumstances to justify why the owner did not complete the distribution in 2004, such as waiting until the amount is known, or liquidation of the assets. If so, you probably don't have to worry about the fact that new interest rates start to apply in 2005.

However, I suspect you will be better served if the assets are slightly low than too high. If you have surplus assets, then you must either take the reversion with its 50% tax or you must make added distributions to all those already paid. If you are below the proper amount, the final contribution can bring the total to the exact amount at final liquidation.

[mwyatt]

I would chime in that having the owner be last in line for distribution may not be so nefarious as hinted at previously. Only problem you are running into is the switchover to a new basis for 417 rates at this time (and the holidays which probably are slowing down the liquidation of remaining assets).

On a lighter note, here's one law firm's response to a demand for prompt action around the holidays:

Grinch

And believe it or not, this isn't an Urban Legend

Snopes verification

[Guest Bob_DB]

To clarify, I am the person getting the distribution, which has become a total mess for a variety of reasons. I am not an owner of the company. I am (obviously) not an actuary and I am probably getting in way over my head, but ...

The lump sum calculated using the 2004 rules (5.07% rate) is about $130k. Although my full monthly benefit at retirement is at the maximum of $165k (assuming 100% accrual), I have only accrued a small portion of that (less than 20%, calculated based on plan years of service divided by total years to normal retirement age).

With the above, am I anywhere near the maximum lump sum such that the 5.5% rate would kick in for a distribution in 2005?

Also, if a request for a distribution is submitted at the end of 2004 (say today), but the distribution itself is not made until 2005 (due to a requirement that distributions cannot be made until 7 days after the request is received), would the relevant rules be those for 2004 or 2005?

Lastly, can anyone provide a link to the relevant portion of the PFEA and/or IRS code that deals with this?

Thanks again to the board.

[Blinky the 3-eyed Fish]

I don't know how many years you have been a participant, how old you are, or your salary history, but in light of the new facts, I seriously doubt that you are at a lump sum limit. Thus if that is the case, ignore the maximum lump sum discussion and the PFEA changes.

The date of the distribution controlls, so if your distribution is in 2005, then the 417(e) rates in effect then would apply. The 11/04 rate was 4.89%, so chances are that the 12/04 rate (if that indeed is what is being used for 2005) will be lower than 5.07% and you will receive a higher distribution than you would have in 2004. Lucky you.

[Guest Bob_DB]

Thanks Blinky. If it makes a difference, I am 46 and have 4 years of service in the plan.

[david rigby]

Blinky is correct. More directly, you reference the "maximum of $165K". The $165K maximum is not a lump sum limit, but refers to a maximum annual benefit that can be paid by a defined benefit plan. The lump sum equivalent of such amount could be well over $1 million.

So, as Blinky suggests, there are apples and oranges in this discussion, and it appears you can ignore all comments about the maximum. This also means that if your lump sum, re-calculated for payment in 2005, exceeds $165K, do not let anyone tell you it must be reduced to that amount.

[SoCalActuary]

With four years in the plan, your accrued benefit is measured against the maximum benefit allowed under 415. This is the lesser of

a. $165,000(retirement age 62 to 65) x 4/10 if you have been a participant for 4 years,

or

b. your 3 year average pay x 4/10 if you have four years of employment.

If your annual benefit is at either limit, then the maximum lump sum still applies under the 5.5% rule.

[Guest Harry O]

I guess I'm not sure what all the fuss is about here.

The plan used 11/30/2004 as the annuity starting date and presumably issued the QJSA notice and explanation prior to that date (assuming that the plan is not using the retro annuity starting date rules). Let's suppose the plan issued the QJSA notice and explanation on 10/20/2004. If the employee returns the notice within 90 days of 10/20/2004, I believe you can go ahead an pay benefits based on the 11/30/2004 annuity starting date even if the actual payment is not made until early 2005. In fact, the regulations extend the 90-day period further in the delay can be shown to be on account of administrative delay.

So . . . if the employee returns the paperwork on 1/20/2005, the plan could go ahead and pay the lump sum calculated as of 11/30/2004 without adjustment for interest or without regard to the whatever the 2005 section 417(e) now happens to be.

If the employee returns the forms after the 90-day period (possibly extended for administrative delay), then you need to start the whole process over and you will now have an annuity starting date beginning in 2005 subject to the new 417(e) rates and new 415 limits.

[AndyH]

The ability to use 2004 rates in 2005 is news to me, for both 415 and 417(e). Any elaboration would be appreciated. I'm with you on the ASD stuff, just not 415 and 417(e).

[mwyatt]

Just started perusing my EA Transcript CD the other day and this issue is popping back up in my head (from JHolland no less). Will try and find the cite on Monday. If I remember, you have to provide the higher of the two with regards to lump sum, so I don't think the '04 rates (which presumably will be less favorable than the '05 rates given trends in the 30-year) can be used in '05.

[Guest Harry O]

I believe that under the 417(e) regs you determine the applicable interest rate by reference to the participant's annuity starting date. If the participant's annuity starting date is in December, you can still use the December applicable interest rate to value the lump sum even if actual distribution doesn't occur until February. Again, this assumes that the applicable notices and explanations were delivered BEFORE the annuity starting date and that the forms were completed and returned to the plan administrator within 90 days of the date they were provided to the participant (with some possible further extension for administrative delays).

The exception, of course, is for retroactive annuity starting dates (RASDs). The IRS adopted the special "greater of" rule for RASDs out of necessity because once you establish a RASD (say, 3 years ago) the existing regulations would have allowed the employer to use the 3-year old applicable interest rate rather than the current rate. The special "greater of" rule was put into place to get around the general rule described above that you use the applicable interest rate on the annuity starting date. If the "greater of" rule was always the rule for valuing lump sums, there would have been no need to specifically introduce this concept in the RASD regulations.

My two cents . . .

[Effen]

I think I might argue one point.... the annuity starting date for a lump sum is the date "which all events have occurred which entitle the participant to the payment". Therefore, if they didn't turn their paper work in before the end of the year, all events haven't occurred and the "annuity starting date" could not be in 2004.

417(f)(2)(A) IN GENERAL. --The term "annuity starting date" means --

417(f)(2)(A)(i) the first day of the first period for which an amount is payable as an annuity, or

417(f)(2)(A)(ii) in the case of a benefit not payable in the form of an annuity, the first day on which all events have occurred which entitle the participant to such benefit.

Also, Gray Book - Response to Q/A 96-29 (Q dealt w/ 401(k) plan)

RESPONSE

.... IRC 417(f)(2) provides that in the case of a benefit not payable in the form of an annuity, the ASD is the first day on which all events have occurred which entitle the participant to the benefit. It is reasonable to include paperwork as one of these events.

[Guest Harry O]

For purposes of section 417, Reg. 1.401(a)-20, Q&A 10 defines the "annuity starting date" as the "first day of the first period for which an amount is paid as an annuity or other form." Since a lump sum is simply the commuted value of an annuity benefit that would otherwise begin on a certain date, the annuity starting date for a benefit paid in the form of a lump sum is the same date that the underlying annuity would have first been payable.

Your definition of annuity starting date for a DB plan paying a lump sum would effectively mean that you could never have a RASD for such a payment since it is a certainty that the forms will be provided and returned before the date payment begins! Thus you would always satisfy the normal, non-RASD requirement that the forms be provided before the annuity starting date. We know this can't be the case since the RASD regs go into much detail on the proper calculation methodology for lump sums.

The Gray Book Q&A referred to a 401(k) plan where a lump sum is normally not paid in lieu of an annuity.

[Effen]

Your definition of annuity starting

it is not "my" definition, I just quoted the Regs. & Gray Book

the annuity starting date for a benefit paid in the form of a lump sum is the same date that the underlying annuity would have first been payable

This can't possibly be true since most lump sums are simply the present value of some deferred annuity. The annuity isn't payable until some date in the future.

I think the Regs are fairly clear that the ASD for a lump sum is the date which all events have occurred which entitle the participant to the benefit. This must be very close to the actual payment date.

The RASD Regs cover the exceptions, they are not the general rule.

[Guest Harry O]

You can't pay a lump sum unless an immediate annuity is also available at the same time (other than small cashouts of $5,000 or less).

[Effen]

Yes, but the immediate annuity is generally not the "underlying annuity". The lump sum is generally the present value of a deferred annuity. The immediate annuity may or may not have anything to do with the lump sum. That was part of the reason behind the relative value regulations.

[Guest Harry O]

<I know I should just let this thread die . . .>

Effen,

So . . . what precisely is the "annuity starting date" for a lump sum payment made under a DB plan?

[Effen]

I agree, we are beating a dead horse, but...

417(f)(2)(A) IN GENERAL. --The term "annuity starting date" means --

417(f)(2)(A)(ii) in the case of a benefit not payable in the form of an annuity, the first day on which all events have occurred which entitle the participant to such benefit.

Again, it's not MY definition. What do you have to back up your position?

Personally, I feel that if the lump sum is not paid before the end of the stability period, it needs to be recalculated due to the interest rate change. This is where it gets a little gray.... If the PA caused the payment delay, I generally recommend that the participant receives the greater of the two amounts (old rate, new rate). If the participant caused the delay, generally the new rate should be used, regardless of whether it would be an increase or decrease in the lump sum amount.

[Everett Moreland]

For what its worth to the dead horse--

IRM 4.72.9.5.1 (03-01-2002):

"Reg. 1.401(a)-20, Q&A 10 defines annuity starting date as the first day of the first period for which an amount is payable under a qualified plan as an annuity, or in any other form. However, Notice 93-26, 1993-1 C.B. 308, permits a plan administrator to treat the date of distribution as the annuity starting date in the case of distributions that are not in the form of an annuity and that are also not subject to the survivor annuity requirements."

Notice 93-26:

"This notice clarifies that, for purposes of satisfying section 411(a)(11) and section 402(f), the plan administrator is permitted to treat the date of the distribution as the annuity starting date in the case of distributions that are not in the form of an annuity within the meaning of section 72 and that are also not subject to the requirements of section 401(a)(11)."

[Guest Harry O]

Everett -

Notice 93-26 is not applicable here. We are talking about a DB plan; the Notice on its face only applies to plans that are not subject to the survivor annuity requirements.

Effen -

My authority is the regulation I cited earlier. Again, if the annuity starting date for a DB lump sum did not occur until the paperwork was submitted, there would be no need for the retroactive annuity starting date regs to discuss the "better of" section 417(e) calculation. It would be impossible to have a retroactive annuity starting date in such a case. This can't be the answer! I would think your practice of using the rate at distribution if the participant causes the delay is risky, especially if the interest rate has increased (depending on the facts of the situation and exactly what the plan document says about annuity starting dates, etc.).

We'll have to agree to disagree!

[AndyH]

Well I for one appreciate the opinions and comments. I don't think this is a dead horse at all. I still am not sure of the FINAL ANSWER and would welcome more discussion.

[Everett Moreland]

Harry O:

I think the IRM and Notice 93-26 support your position.

[Guest Harry O]

Everett -

Sorry. I see your point now. Too many posts on this topic!!! (But an interesting discussion nonetheless . . .)