David MacLennan

Here are the 100% J&S factors (some formatting has been lost, but for example the APR for age 60/50 = 184.229, age 60/51 = 183.366, age 60/60 = 175.462, age 60/61 = 174.614) ANNUITY FACTOR CALCULATIONS NORMAL FORM JOINT AND 100% SURVIVORSHIP MORTALITY TABLE IP2F0 POST-RETIREMENT INTEREST RATE 6.000 MALE BLEND PERCENTAGE 0.000 YEARS SETBACK/SETFORWARD - MALE 0 YEARS SETBACK/SETFORWARD - FEMALE 0 EXPENSE LOAD FACTOR 0.000 F E M A L E AGE RA-10 RA-9 RA-8 RA-7 RA-6 RA-5 RA-4 RA-3 RA-2 RA-1 RA AGE 60 184.229 183.366 182.494 181.615 180.730 179.842 178.956 178.072 177.193 176.322 175.462 60 61 182.948 182.038 181.118 180.190 179.257 178.323 177.389 176.457 175.532 174.614 173.709 61 62 181.598 180.638 179.668 178.689 177.708 176.723 175.739 174.757 173.782 172.817 171.865 62 63 180.176 179.164 178.140 177.111 176.076 175.039 174.002 172.969 171.943 170.928 169.927 63 64 178.678 177.611 176.535 175.450 174.360 173.267 172.176 171.089 170.010 168.943 167.893 64 65 177.102 175.980 174.846 173.703 172.555 171.405 170.257 169.114 167.981 166.861 165.759 65 66 175.446 174.264 173.070 171.867 170.658 169.448 168.241 167.041 165.852 164.677 163.522 66 67 173.705 172.460 171.203 169.937 168.666 167.394 166.126 164.867 163.619 162.389 161.178 67 68 171.875 170.564 169.241 167.910 166.574 165.239 163.909 162.588 161.280 159.991 158.723 68 69 169.952 168.573 167.182 165.783 164.380 162.980 161.585 160.200 158.831 157.481 156.153 69 70 167.933 166.483 165.022 163.553 162.081 160.613 159.151 157.701 156.267 154.853 153.464 70 ANNUITY FACTOR CALCULATIONS NORMAL FORM JOINT AND 100% SURVIVORSHIP MORTALITY TABLE IP2F0 POST-RETIREMENT INTEREST RATE 6.000 MALE BLEND PERCENTAGE 0.000 YEARS SETBACK/SETFORWARD - MALE 0 YEARS SETBACK/SETFORWARD - FEMALE 0 EXPENSE LOAD FACTOR 0.000 F E M A L E AGE RA RA+1 RA+2 RA+3 RA+4 RA+5 RA+6 RA+7 RA+8 RA+9 RA+10 AGE 60 175.462 174.614 173.782 172.969 172.176 171.405 170.658 169.937 169.241 168.573 167.933 60 61 173.709 172.817 171.943 171.089 170.257 169.448 168.666 167.910 167.182 166.483 165.814 61 62 171.865 170.928 170.010 169.114 168.241 167.394 166.574 165.783 165.022 164.291 163.594 62 63 169.927 168.943 167.981 167.041 166.126 165.239 164.380 163.553 162.757 161.996 161.270 63 64 167.893 166.861 165.852 164.867 163.909 162.980 162.081 161.217 160.387 159.594 158.840 64 65 165.759 164.677 163.619 162.588 161.585 160.613 159.675 158.773 157.909 157.086 156.304 65 66 163.522 162.389 161.280 160.200 159.151 158.136 157.157 156.218 155.321 154.468 153.666 66 67 161.178 159.991 158.831 157.701 156.605 155.546 154.527 153.552 152.622 151.746 150.919 67 68 158.723 157.481 156.267 155.086 153.943 152.840 151.782 150.771 149.817 148.913 148.060 68 69 156.153 154.853 153.585 152.353 151.163 150.017 148.920 147.882 146.897 145.966 145.089 69 70 153.464 152.106 150.783 149.501 148.263 147.075 145.949 144.877 143.862 142.904 142.005 70

Here's the life only numbers (formatting was mostly lost, look at the far right number for the APR): ANNUITY FACTOR CALCULATIONS NORMAL FORM LIFE ANNUITY MORTALITY TABLE IP2F0 POST-RETIREMENT INTEREST RATE 6.000 MALE BLEND PERCENTAGE 0.000 YEARS SETBACK/SETFORWARD - MALE 0 YEARS SETBACK/SETFORWARD - FEMALE 0 EXPENSE LOAD FACTOR 0.000 MONTHLY BENEFIT LUMP SUM PER $1000 REQUIRED PER $1 OF LUMP SUM OF MONTHLY BENEFIT AGE MALE FEMALE MALE FEMALE 60 6.25975 6.25975 159.75079 159.75079 61 6.34981 6.34981 157.48503 157.48503 62 6.44629 6.44629 155.12799 155.12799 63 6.54966 6.54966 152.67967 152.67967 64 6.66041 6.66041 150.14091 150.14091 65 6.77915 6.77915 147.51112 147.51112 66 6.90663 6.90663 144.78841 144.78841 67 7.04378 7.04378 141.96922 141.96922 68 7.19171 7.19171 139.04900 139.04900 69 7.35176 7.35176 136.02185 136.02185 70 7.52530 7.52530 132.88507 132.88507

1 person DB plan (takeover) had the unfortunate overused 10% x YOS formula, and PVAB outstripped assets by 2:1. Divorce occurs, and QDRO dictated split of plan assets 50/50. Benefits were not split 50/50 as this would mean the alternate payee spouse gets all plan assets, so assets were split 50/50. As of a certain date, spouse was paid 50% of FMV assets. If benefit offset for plan sponsor due to QDRO is determined by the actuarial equivalent of the distribution amount, the underfunding becomes worse, because assets are cut in half, and benefits have only been reduced by 1/4. Can one reason somehow that the benefit offset should be half the accrued benefit, as this would help reduce the 412 funding? Doesn't seem possible, but thought I would solicit some advice. Should the QDRO have been worded that she (alternate payee) is receiving half the AB, but the "allocation" is only half to reflect the extent funded (as discussed in other threads on this message board relating to plan termination)? I suppose this still would not be valid for 412 purposes. If plan termination is the only answer for this plan's problems, then would future DB plan's 415 offset be determined by actual distributions to participant and alternate payee, or accrued benefits under the plan?

The plan's post retirement A.E. interest rate (not 417e stuff), is defined to be the rate as of the Dec prior to the plan year, so it changes every year (sorry that was not made clear). Pre-retirement interest is fixed at 8%. Should these annual changes continue with respect to computing the grandfathered lump-sums?

Before you give a formal opinion to the client, I also feel you should contact the actuary, but you should get the consent of the client first (the Code of Professional Conduct recommends this). I think that for the sake of the client, and for your own sake, you should seriously consider declining the case. Remember that most E&O policies prohibit anyone from admitting an error. Chances are you won't endure abusive language - you'll just waste lots of time. If pressed, the actuary either will not respond or will make a frivolous argument that he/she is correct. The JBEA regs state that an actuary must respond to a plan administrator's request for more information, but as I found out from a similiar case, the JBEA refuses, or cannot for some reason, enforce this (and it took them 2 years to give this shameful response). You likely will spend lots and lots of time on this that the client doesn't want to pay for. Perhaps it is best just to tell the plan sponsor you would have to revise prior valuations and let them decide. Prior actuary pay the excise tax? - in reality I think it would be entirely voluntary on his/her part since the chance of this going to court is probably small. And don't forget to tell the client that IRS enforcement is practically nil. In this case, even if the plan were audited the chance of this particular issue being examined is extremely unlikely, in my opinion. Maybe others have more experience on this. Re the ABCD, would they make a judgment re right and wrong on technical issues, however clear the error? I would guess they do not - it would be left up to a court if it ever got that far. I thought they were more geared toward "professionalism" type of issues. Does anyone have experience with ABCD on this? Also, if the actuary is just an EA and not a member of SOA, ASPA, etc., then ABCD would not even apply. I suspect you don't have too many takeover cases, or you would not even be surprised. In my opinion the pension actuarial profession has a real problem with technical proficiency (or delegation of work to non-actuary employees), as a substantial percentage of my small plan takeovers have serious problems (although there is probably some selection going on in this percentage). However, even "high profile" actuaries make mistakes as I have found, so some of this is just part and parcel of doing business in real time frames, and being human.

Keeping in mind the Dec 2001 interest rate could be less than future GATT interest rates possibly resulting in much smaller lump-sums, one would still not grandfather just the Dec 2001 interest rate, but rather use for the grandfather calc whatever Dec rate preceded the year of distribution? This seems to be a kind of "super-grandfathering" from the employer's perspective (if interest rates go down), and lack of grandfathering from the employees' perspective (if interest rates go up).

If actuarial equivalence assumptions in the plan document are amended, what is the proper way to grandfather the lump-sum benefit? Here are two approaches (assume 12/31/02 as the amendment adoption/effective date): 1) Absolute dollar: Future lump sum cannot be less than the PVAB as of 12/31/02 of the 12/31/02 AB under the old A.E. assumptions. 2) With interest: Future lump sum as of any future date cannot be less than PVAB of the 12/31/02 AB under the old A.E. assumptions. I always thought #2 was the correct approach, but it never hurts to revisit. Now, I have a takeover plan where the plan A.E. is defined (prior to GUST restatement) to be 8% pre and GAM83 50/50 as of the Dec preceding the distribution year. 417e assumptions were the usual PBGC interest rates. (I believe this was someone's attempt at early GATT compliance.) Lets ignore 417e for this discussion. Would future lump-sums be grandfathered using the Dec 2001 GATT interest rate for all future calcs, or, would lump sums be grandfathered using whatever Dec interest rate preceded a future year of distribution?

Yes I would agree that sometimes you have a situation where to get over the CL FFL requires some past service grant. The thing that I often encounter in takeover cases is the "10% times YOS" w/o any thought being put into it. You guys would not do that kind of thing for sure.

I would avoid past service with a 1-person plan - it can prevent zeroing the contribution if benefits are frozen, and if ees are added later and the plan becomes insured by the PBGC, the premiums can be enormous. I like to use past service only as leverage for the common max/min poblem with owners/employees.

If using a safe harbor formula, best result is usually with the step-rate unit credit formula with fractional accrual (1.401a4-3b4iC1 safe harbor). This can even yield a better result than a general tested formula in some cases. For reasons I don't get, this is not used very often in small plans, even when it is really a no-brainer that it is the best safe harbor for a max-min solution (e.g., older owner and younger ees).

Was wondering if anyone knows where a cash-balance sample document (single or occasional use) could be purchased. I have checked with some of the more popular providers and can't find one. Only PenDoc said they would have one available, but late Summer at the earliest. Client does not want to use an attorney. I would prepare the benefit and actuarial related sections with the usual caveats about seeking legal counsel. Seems like one could convert a regular DB document to a cash balance without too much modifications, but not having done it I may be oversimplifying.

Generally no. The IRS postion is that pension plans cannot have in-service distributions, unless normal (or early?) retirement age is attained. However, if you're talking about a rollover account or voluntary contributions, the answer is probably yes, as long as the plan document allows for it.

The regs under 1.404e-1Af2 appear to be the answer to my question on how DB deductions are allocated in a partnership - it is determined by their partnership percentage, unless the partnership agreement states otherwise. I spoke to another actuary today who conveyed this same opinion. He also said that he has heard that IRS auditors have been inflexible on this. My first impression is that the conclusion from 6 to 7 is ridiculous. The argument says that because the words "made on his behalf" in the singular are absent from the f2 part of the reg, then it must reduce SE Income. It seems to me the intent of the reg is clear, even if it uses the plural "on behalf of self employed individuals" rather than the singular. But, if somebody wants to get out from paying SE tax on your DB contribution, I guess here is the argument to save for the auditor! I've seen many times sole props trying to sneak their pension plan contribution onto their Sch C, but I didn't know PWC was in on this too! Does anyone take this seriously? Maybe I'm missing something and the argument is more compelling than it appears.

I had stated above that I was not aware of any regs that specifically addressed how to allocate the a DB deduction among partners. I was reading the instructions to Form 1065 today and, low and behold, found this statement: • Payments for a partner to an IRA, qualified plan, or simplified employee pension (SEP) or SIMPLE IRA plan. If a qualified plan is a defined benefit plan, a partner’s distributive share of payments is determined in the same manner as his or her distributive share of partnership taxable income. For a defined benefit plan, attach to the Schedule K-1 for each partner a statement showing the amount of benefit accrued for the tax year. This relates to line 11 of the Sch K-1. However, the partner's deduction is taken on Form 1040 item 31, so this may not be a definitive answer to the question. Allocating the deduction via the partnership share percentage does not always make the most sense. Not sure how Line 11 is used and if it logically follows to use this on the 1040 (and don't really have the time to look into it right now). Comments anyone?

I have a 1-participant DB plan takeover case where the contribution figures are quite high. The actuarial assumptions appear to not be fully disclosed in the Sch B attachment as required, since I cannot even get close to the numbers using the disclosed assumptions (the Sch B attachment is a word processor type version, not output from any valuation software). The only way I can duplicate the prior year's numbers is to use a post-retirement COLA in the benefit - with this I can come very close. The problem is that the COLA increases go beyond the current year 415 $ limit. Revenue Ruling 81-195 and IRC 404(j) prohibit this. The valuation software I use appears to compute the reserve at NRA by using a new interest rate (1+i)/(1+j) to model the COLA. However, there is no 415 $ limit cap to the post-retirement COLA increases coded into the software either. Assuming I'm correct in my conclusions, I don't feel this is necessarily a mistake on the part of the valuation software, just a software parameter that should be used with caution. Another actuary and I have contacted the software company, but haven't yet received a full reply - I expect to hear from them this week. The client does not want me to contact the prior actuary, probably to limit any problems for them if another professional catches a mistake (although I find major errors in takeover cases all the time, and E&O coverage seems to prevent anyone from ever admitting a mistake has been made). I always proceed with caution before concluding a prior admin firm did something incorrect, so I'm wondering if anyone has a different opinion or insight, or can confirm. This issue will probably prevent me from taking over the case, as I'm sure the client probably won't want me to revise all prior year's valuations - I don't see how I can avoid this. Anyone have a different approach?

Mike, I wasn't really referencing that code section re community property. Mostly my argument is based on what I see as a logical approach (perhaps I'm too logical!), and on what I've read in IRS publications. Many years ago I did look into this issue as thoroughly as I could, as often a DB plan sponsor will want to include the spouse to increase deductions or get out of overfunding. Publication 533 on SE tax states: Husband and wife partners. If you and your spouse join together in the conduct of a business and share in the profits and losses, you have created a partnership. A partnership must report business income and expenses on Form 1065, U.S. Return of Partnership Income, along with Schedules K–1 showing each partner’s share of the earnings. Both of you must report the earnings on Form 1040 and file a separate Schedule SE (Form 1040) to report your individual SE tax. However, if your spouse is your employee, not your partner, you must withhold and pay social security and Medicare taxes for him or her. For more information about employment taxes, see Publication 15. I think that we all know that spouses often participate in a sole proprietor's business, but the FICA tax can be reduced, so the result is that it is ascribed to one spouse as a practical matter rather than forming a partnership. I seem to recall this was stated in the instructions to the Sch SE many years ago, but the 2002 instructions only make reference to this under the community property section. I think the IRS really wants spouses both with earned income to report it as such, but to do so really means you have a partnership. Two Schedule SE's attributable to the same business? Again, to me this just means you have a partnership. Two Schedule C's for the same business - to me that is really an untenable practice. Sure you can do it, and I suppose the IRS will never know it's one business, and may not even care, etc. Is that CPA based in Eugene OR? If so, he may be an anarchist.

I have a detailed worksheet I am willing to share. Email me at actuary@definedbenefit.com and I will reply with the file attached.

I think the tax approach is improper. Two schedule C's are for two businesses, not one. IRS rules ascribe all the earned income in a sole proprietorship to one spouse, whoever carried on the business to the greatest extent, based on facts and circumstances. Only one spouse should be filing a Schedule C. If the other spouse wants to participate in a pension plan, he/she needs earned income, and you must form a partnership or pay him/her a W-2 from the sole proprietorship. You seem to have a partnership and they should be filing a 1065. Given a partnership form, there are no regs to my knowledge that address how to allocate the deduction. I think the IRS would find acceptable any reasonable method, as long as it is followed consistently from year to year. Allocation based on earned income, or the normal costs, would be my suggestions.

I'm having the same problem tonight with one of the DB plan message threads. Somthing is apparently wrong with the software? I was able to solve it by removing benefitslink message board as my home page and/or changing to automatic log on.

Mike, I haven't heard anything about what the IRS position may be on the validity of the cross reference in the regs. I actually had only reviewed the code section changes and hadn't given it too much thought. You would think that somebody in pension-land must have given this issue some consideration by now and come to a conclusion. I'll need to know for sure since I'm setting up quite a few 401k + DB plans for sole proprietors.

Isn't the provision in 415c3D, that you count 401k deferrals as comp for the DC 100% limit, absent in 415b3 for the DB Hi-3 Avg limit? If so, it seems Mike's last statement would be incorrect, unless I misunderstood. Am I missing something? AndyH, did your question address the 404a8C limit? I know you said 415, but based on my reading of 404n the 404a8C limit would be reduced by the 401k deferral, resulting in 90k deduction limit for the DB. This is for a sole proprietor case, so is not applicable to mbb initial question.

I think your question can be answered by noting what "employer" means under the applicable Code sections. There is no common ownership between the 2 businesses at any point in time, so there cannot be a common control group. Thus, they are 2 separate employers. Even if owner 1 still had 50% ownership in the partnership, and he also had his own practice, there would not be a common control group (would require > 50% ownership for "effective control" test), so both are separate "employers" under the code (I am assuming there no ownership attribution relationships, such as owner 1 and owner 2 are father and son, etc.). Because they are 2 separate employers, using the past comp and service in the new business' DB plan would be no more legitimate than using his comp and service when he worked at, say, XYZ corp before he had ownership in a business. The good news is, the new DB plan has a fresh 415 limit (meaning no offset if the partnership had a DB plan). But, you can't use that past service and comp history. Now, if you want the past service and comp history (and are willing to accept the offset if he participated in a DB plan under the partnership), it seems your only options would be: 1) Create a common control group between the 2 businesses, such as by convincing owner 2 to give former owner 1 an option to buy owner 2's business (may sound impractical, but if the price is high enough and if there is a cordial relationship?). 2) Try to get a favorable det letter. Put it in the document and be sure to highlight the issue so that it will be included in the determination letter. Who knows, it may get a nod since employer aggregation is complex. It seems to me you would then have reliance. This option, in my opinion, requires the client's professional advisors believe it is a "gray area", because otherwise it is "sneaky". I don't believe it is a gray area, so I wouldn't recommend this option. The cites would be 414c and the corresponding regs. Getting counsel involved is always a good safeguard, but you may have a little trouble finding one knowledgable about this stuff.

I have some experience with this situation. Mike Preston is right that IRS doesn't take well to the 414k account idea. I think it may have started with some comments from IRS spokepeople at the LA benefits conference a year or 2 ago about how 414k accounts had to be transferred out of the plan and back again to be valid. However, the ERISA attorneys I have spoken to think that what the IRS spokespeople said was untenable and they would lose badly if it ever went to Tax Court. Also, it would contradict a long history of favorable determination letters given for 414k account procedures (lots of DB documents have 414k provisions). I would check to see that the plan document effective at the time of the "paper transfer" has the 414k language and that it was followed. If so, and you have a determination letter, you are probably OK since you have reliance. In addition, make sure the GUST document does have 414k language and get a det letter (my approved GUST prototypes all have liberal 414k language). Also, if only the GUST doc has the language and letter, that's better than nothing. There's prob lots of money at stake here, right? I would also submit a 5310. I have done this for several plans with "paper" 414k accounts and received favorable letters. I'm not sure about the waiver issue. Mike Preston is right that it is questionable. Waivers cannot be recognized for funding purposes, but the issue is muddled here by the 414k transfer. I think the more important issue is whether the 414k is legit as opposed to any funding deficiency. Be sure to inform the client about the risks and that you can't guarantee anything. Good luck. Here's some Q&A from 2001 EA Conference: QUESTION 25 Section 415: Effect of Transfer of DB Benefit to 414(k) Account Does the transfer of an accrued benefit under a defined benefit plan into the plan’s 414(k) account at the time of a distributable event have the effect of converting that accrued benefit into a defined contribution account which is no longer subject to the 415 limit applicable to a defined benefit plan? IRS RESPONSE Transfer rules under 411(d)(6) regulations (see Reg. 1.411(d)-4, Q&A 3) do not allow defined benefit characteristics to be given up with a transfer within a single plan. One would need to roll the money out of the plan (could then be rolled back in). The accrued benefit under the defined benefit portion of the plan needs to be restricted to the applicable 415(B) limitations at the time of rollover.

I think your fix is OK, but to ensure the deduction on 2003 return of the 1.5% 2002 plan year ctb, they should fund it after the due date of their 2002 tax return, so that it is a "includible employer contribution" under the 404 regs (see below). FYI, Reg 1.404(a)-14(e): (e) Special Computation Rules Under Section 404(a)(1)(a)(i) (1) In General. For purposes of determining the deductible limit under section 404(a)(1)(A)(i), the deductible limit with respect to a plan year is the sum of-- (i) The amount required to satisfy the minimum funding standard of section 412(a) (determined without regard to section 412(g)) for the plan year and (ii) An amount equal to the includible employer contributions. The term "includible employer contributions" means employer contributions which were required by section 412 for the plan year immediately preceding such plan year, and which were not deductible under section 404(a) for the prior taxable year of the employer solely because they were not contributed during the prior taxable year (determine with regard to section 404(a)(6)).

Isn't the method discussed here, the "prospective" comp method with BOY val date, more or less equivalent to an EOY val date, but using a asset valuation method that lets EOY Assets = BOY Assets x (1+i)? Is this an unreasonable asset valuation method? It may be unusual but it is not unreasonable. For this reason, I don't subscribe to the absolute valuation date "shapshot" idea. The actuary is given latitude in deciding the valuation method. (Changing it with automatic approval is another issue.) Also, I use DATAIR software and it allows one to use current year comp with BOY val date - they call it "prospective" comp. I know a software company like DATAIR is not authoritative in any way, but they are a useful repository of accumulated experience/methods. Based on my takeover cases, I would say a large percentage (maybe nearly half) of small DB plans use DATAIR for actuarial valuations, and a significant number of these use "prospective" comp method. Regardless of what IRS folks say, I think this method is grandfathered in.