mwyatt

I'm glad someone out there remembered the pain that the Small Plan Audit program caused in the 80's. We had a couple of clients sucked into the maelstrom of (IMHO) abusive strategems by what appeared to be predominately West Coast actuaries. We had a client dragged in who was "abusing" the system by funding a 5 life plan to the astronomical tune of $35,000 a year total contribution. Let's all remember not be pigs!

Math on PS contribution: IRC 404 limits you to 25% total eligible contribution NOT including 401(k) deferrals (all effective in 2002). IRC 415 limits individual participant (NOT employer) to lesser of 40k and 100% of compensation. Actually MBOZEK his 401k deferral does count against the 40k 415 limit, but this can actually wash out as this amount can be allocated to spouse instead. So: Total eligible salary equals 250,000 providing 62,500 in 404 eligible deduction PLUS 401k deferrals. You defer 11,000 on 200,000 compensation, get 29,000 PS (up to 415 limit) allocation for a total of 40,000. Your spouse gets balance of 62,500 -29,000 = 33,500 plus 6,500 deferral (can't exceed lesser of 40,000 and 100% of 50,000); hence you both get 80,000 combined for year on 250,000 compensation without having commitment of DB plan (plus without screwing up ability in future to get 100k DB deductions).

I've been kicking this whole idea around today, and I think that this rush to a DB plan at such an early age may not be in your best interests, especially after the repeal of 415(e). Prior to the repeal, using a max DC plan early on would work against the amount you could ultimately contribute to a DB plan; won't bore you with the calcs, but the "old timers" out there are probably familiar with the mathematics of the 1.0 rule. Now, however, there is no penalty involved in making the 40k contribution to a DC plan earlier in your career. DB plans are a pretty simple sell when you can demonstrate that you can trump a DC contribution by a factor of 2 or 3 times the max under a DC plan. You've outlined an 80k combined contribution between your spouse and yourself including a "uni401k" double deferral of 22,000, leaving you with approximately 58k in DB deduction between you and your wife. It might be a little shortsighted to chase that DB deduction right now in the scheme of things, assuming that you continue to sponsor your own plans down the road. Let's say you stick with the DC deduction of 25% of 250,000 (what you have to play with between you and your spouse's income - keep in mind the comments about FICA taxes in pushing income to your spouse - a very real factor that you should factor in). So you put a combined contribution of 62,500 into a DC plan for the next few years. When you are 45 or so, you now have 12 years of the DC contributions sitting in your account with no adverse consequences to the amount you can fund in a DB plan, and your DB plan can now see contributions that have a serious magnitude over what you could do in the DC plan, since 415(e)'s repeal allows you to ignore these prior contributions. Remember, even if you set up this DB plan now, you are going to be taking out serious accruals from the DB 415 limit in the future, since prior DB plans DO reduce the dollar limit down the road. Just a thought, and it's late at night on the East Coast, but you might want to contemplate the big picture before acting. I really don't think in the long run that setting up a DB plan right now will maximize the amount that you could accumulate at retirement.

Since the plan terminated, how was your funding status at the time of distribution (i.e., was the extra $20k needed to alleviate underfunding or did this amount just get added to excess assets under the Plan). Just trying to figure out if this money would qualify for deductibility as a payment to bring the plan into sufficiency.

He could waive (see several past discussions) portion of benefit necessary to bring liabilities equal to assets. The detail that is not provided here is where the $80,000 comes from: is this the amount of asset shortfall after all required contributions under IRC 412 have been made, or is part or all of this amount representing the final contribution developed by the 412 valuation covering the year of termination? IRS has never allowed you to waive a funding deficiency.

Frank: I asked this question awhile ago on the boards. Here is a link to the thread: http://benefitslink.com/boards/index.php?showtopic=12988

Hey Andy: That was me, and I still haven't seen anything in the proposals out there to convince me of any other motive. If we were back in the 70's with a 70% marginal rate, maybe you could make some case for pouring money down a hole (amount over what you can withdraw in a lump sum). However, I would have to think that in Jim Holland's example, putting $5m in the pot to get $2m out sounds like one had best restrict 412(i) marketing to the mathematically challenged client;) .

http://www.nytimes.com/2002/10/20/opinion/20SUN2.html

Actually, wasn't trying to avoid your question. But the key thing is that if you want a "safe harbor" 412i plan, then your formula has to conform to the 25-year rule on participation. This doesn't mean that you can't have a differing methodology of benefit formula in a 412i plan, but if you do it isn't a safe harbor and you'll have to do the General Test.

I think the key phrase here is "safe harbor". If you were setting up a 412(i) for a "one-man" plan, your concerns of safe harbor formulas don't matter.

One other situation to consider: 5500-EZ filings. Note that no question exists on the 5500-EZ filing, so you definitely want to have some sort of written agreement by the plan sponsor. We've been using an attachment for this situation like this (thanks to Larry Deuscht at the 1998 EA meeting for the gist of the language): Attachment to Schedule B of 2000 Form 5500 Justification for a Change in Funding Method Plan Sponsor: XYZ Co., Inc. Plan Name: XYZ Co., Inc. Defined Benefit Pension Plan EIN/PN: 01-1234567/001 Actuarial Certification: I hereby certify that I have changed the funding method for the above plan in accordance with Sections 3.04 and 3.13 of Revenue Procedure 2000-40. I further certify that the funding method that I have used has met the requirements of Sections 5 and 6 of Revenue Procedure 2000-40. As of January 1, 2000, the funding method is being changed as follows: Cost Method: The funding method is being changed from the Level Dollar Individual Aggregate Method to the Level Percent of Compensation Individual Aggregate Method. This change was made in accordance with IR Rev. Proc. 2000-40, Section 3.04. Valuation Date: The valuation date was changed from the end of the plan year to the beginning of the plan year. This change was made in accordance with IR Rev. Proc. 2000-40, Section 3.13. ____________________________________ Actuary #02-1234 __________________ Date As the representative of the Plan Sponsor, I certify that this statement has been prepared in accordance with the requirements of Section 6.02 of Revenue Procedure 2000-40. I agree with the change in the funding method described above in the statement of the Enrolled Actuary. I also note that the 2000 Form 5500EZ makes no provision for my approval of the funding method change. This signed statement indicates my agreement to the funding method change. This change in funding method is to take effect for the plan year beginning January 1, 2000. ____________________________________ Plan Sponsor ______________ Date

I'm not following your expense comments on the annuity (unless you are referencing time in selecting an annuity). You state that this is a money purchase, not a defined benefit plan. If he has a $10,000 account balance, then this is your cost of the annuity. If you are referencing the cost to the participant as to value received for a small purchase, this I can understand, but I don't think there is really any way around the situation (assuming your participant doesn't want the money for creditor reasons - just a guess).

Actually an interesting epiphany just struck me reading Mbozek's comment: one of the complaints about present stock prices is the high P/E ratios compared to historic levels. However, if we can equate a nonsignificant % of the earnings to pension/medical costs, which weren't present in financials prior to 1987 (think effective date of FAS-87 and 106), then maybe these current P/Es aren't so high after all (have to think optimistically, although my faith in most "real life" financial folks ain't so high at present - if they really knew what they were doing, why didn't they cash out before it all got wiped out?).

Just as the tech companies had inflated earnings due to options, creative goodwill, etc. (for me the ephiphany was picking up the paper one morning in 1999 to find that Yahoo had bought Geocities for a higher price the same day that Ford bought Volvo - of course, Geocities' product was free websites for individuals while Volvo only sold expensive cars, but my stodgy mind at the time couldn't understand the "brilliant" logic that valued this deal) similiar manuevers were going on at the larger companies with pension accounting, etc. I agree with MBozek's analysis that even best case with tax credits that they can only recoup about 50% of the overfunding. If they have to reflect reversion on taxes, amount is dimes on the dollar. How you can count on a trust for company earnings really doesn't make a tremendous amount of sense, but I'm just an actuary, not a CFO. None of these manuevers seemed to bother people on the way up the curve (except maybe Abelson @ Barron's). Now that equity markets have tanked, people are looking for someone to blame (in some cases blame is easily assignable, witness Enron and Worldcom, sometimes the masses are looking for scapegoats). Maybe it is time to rethink the real usefulness of FAS-87; impact has strayed from the original intent of providing comparability of future pension liabilities to a tool to inflate company earnings.

The popular (financial) press is indeed focused on the FAS-87 assumption and its impact on companies' earnings. As an actuary I know that FAS-87 has nothing to do with physical dollars required to go into a plan, and that most large plans utilize some form of smoothing method in the 412 valuation to dampen the swings in the market on contribution liabilities. On the other hand, when I read about major (say Dow index) companies that had over 30% of their stated earnings from penson income over the past few years, then I think that we as a profession should have an answer to these inquiries. Warren Buffett, for one, is not anyone to sneeze at (especially after all those .commers are back at McDonalds wearing funny little hats and handing out change again).

Was looking for a fairly ancient mortality table over the weekend on a takeover case and remembered to check the SOA website. The new version of Table Manager contains hundreds of mortality tables (you can select the country of choice so you're not wading through foreign tables) and also has an Excel add-in. Here's the link: http://www.soa.org/tablemgr/tablemgr.asp No connection to the author, but highly recommend this to all. Hope this is of help.

Hey all: I think that we had a pretty good thread on this very point last spring (in fact I think I posed this very question with some good responses by Mike Preston). Here is the hyperlink; if this doesn't work, it started around April 2002: http://benefitslink.com/boards/index.php?showtopic=14313

Hey Mike: Sorry about the previous message's unclarity (the danger of late night posts when writing on the East Coast after a night out on the town.). I guess what I was getting at with my comment WRT EGTRRA changes was the fact that for non-calendar years, you had accelerated adoption of the new 415 changes (i.e., the reference to effective date being plan year ending in 2002, rather than beginning in 2002). Assuming your client did the appropriate EGTRRA amendment, then a 2/1/2001 valuation would be subject to the EGTRRA limits in the year beginning 2001. We had all of our clients adopting EGTRRA changes in 2001 in this circumstance adopt the changes prior to doing the val. My question, without getting into the mechanics/legalities of how you actually use the new limits, was why the acceleration of the DB 415 changes in EGTRRA were made. My gut feeling was that in the end, no additional benefit would be granted to ongoing participants (since the changes would come in eventually) so that in actuality revenue loss would be less to the government since an additional year would be allowed to fund the increases in benefits for non-calendar year plans. I'm a little surprised to hear that you are using the EOY limits for BOY valuations of non-calendar year plan. From a practical standpoint, consider a 2/1-1/31 plan year. Since limits for the next year aren't even released until late fall of the current year (and before they made the change from 4Q to 3Q COLAs, not even until after the year end), are you saying that you hold off on doing any of these valuations until almost the close of the year? (I was always under the impression over the years that your valuation should reflect the dollar limit in effect at the time that you were performing the valuation).

Blinky & Mike: I agree wholeheartedly with you with regards to normal situations vis a vis non-calendar year valuations (i.e., consider the plan year 2/1/2000-1/31/2001: if boy, use $ limit for 2000, and $ limit for 2001 for eoy). However, EGTRRA explicitly stated that the accelerated effective date of changes applied to plan years ending in 2002. This is a little different than our past practices (and past implementation of IRS improvements - or for anyone doing this since pre TEFRA unimprovements). As far as the VS references, we've been using the Corbel/Relius/Sungard/next biggest fish for over 20 years, and 415 limits are incorporated by reference since TRA '86. Otherwise, we all should have been amending our document each year for cost of living increases. And Blinky: that was the most frustrating thing about the EGTRRA increases for our non-calendar year clients. All of a sudden benefits were increasing for our clients regardless of whether we wanted them to or not (as my old prof Charles Kindleberger used to say, sometimes you can kill the kitty with too much cream).

And another wrinkle; EGTRRA accelerated date of implementation of 415 changes for DB plans (I guess the rational is that in the end it wouldn't cost anything from a revenue standpoint as the acceleration created an additional year of funding the increase) but remember that the $200,000 comp limit increase only takes effect in the year beginning in 2002. Same caveats are in order as far as document language governing 415 increases (for the most part, documents cover this by reference starting with the TRA '86 restatements). Also, assume your same valuation for the year ended 2/28/2002 was performed as of the beginning of year (ie, 3/1/2001). Although the valuation date preceded the 5/2001 signing of EGTRRA, the increased 415 limit would come into play also with a beginning of year valuation.

I guess what I was trying to get at (ignoring tax considerations - I was bringing up the EGTRRA change as plans previously had to deduct over 10 years the additional funds added, with uncertain application of the 10% nondeductible excise tax rate) was that real hard cash would be on hand outside of the underfunded plan, either to add to the Plan directly (in the terminal funding standpoint), or by the purchase price of the excess assets. So the real savings for the acquiring entities is the spread between purchase price and the excess assets acquired in the transaction. What sort of discounts are typically offered on the excess assets in these transactions?

Kirk: Interesting insight. Of course, with the changes in EGTRRA allowing for the deduction of "terminal funding", isn't this a little less of an argument for this type of scheme, since the funds available to lessen over funding must be readily available by the sponsor (as they are being applied to the purchase of the over funded plans' assets, albeit at some discount, but not too much or the deal wouldn't be financially attractive).

One thought: if this distribution of 1.6 million is not a lump sum (which I think it is), what is your tax treatment? Since it isn't a lump sum (so you can argue that 415 wouldn't apply to the amount of payment) then I guess this is ineligible for rollover and hence is all ordinary income.

Actually, what would happen in termination would be an annuity contract would have to be purchased from an insurance company covering the 100%J&S benefit provided in the plan (hope that cruise ship comes back to port... good windfall to the insurance company). I would be very skeptical of providing that the "annuity purchase" amount could be distributed on the 100%J&S form of payment to the participant. I would dare to say that 415 would still override on the lump sum distribution. Of course, given current market conditions, an annuity purchase is looking better and better every day (boy, I really wish these financial websites could start using green instead of red on the charts).

One observation is that the IRS wants to get out of the document reviewing business (not quite as bad as when the DOL said that you no longer had to submit SPDs - reason being that they had no room to store the stuff - but somewhat along those lines;) ). As far as submitting for General Test, the one point to consider is whether the IRS's approval really means anything or not. What they are looking at is what you purport to be the client's data; is this the same thing as an audited test? I don't think so. If you know what you are doing, then you know that the client is passing the General Test each year. I really don't think that the extra cost is worth it as even if you get the letter, have you really proved that you passed the GT that year to an auditor? As an aside, please don't rely on "every three years' or "snapshot" testing for your typical doctor client - hard pressed to say that costs were too onerous to collect data on your MD and the three nurses...