MGB

I would say that it is not a pre-approved method. Any divergence from the stated methods should be construed as a different method.

It is not an analysis of what the person actually does. The IRS determines the appropriateness based on industry standards for their occupation. Even then, they won't allow some young ages. For example, about 20 years ago a rock band in LA was challenged by the IRS for saying they would be retired within 10 or 15 years. Even though statistics could be shown that they probably would not still be working in that profession after that many years, the IRS refuesed to allow the very early retirement age they were trying to use. If they are not in the police, firefighters, pilots, etc. categories, using anything under 55 will be challenged. Even 55 doesn't always pass muster, depending on the occupation.

Note, too, that some states don't allow governmental systems other than their own. For example, Wisconsin law only allows the County of Milwaukee and City of Milwaukee to have their own system. All other governmental employees (from municipalities to the state itself) must be in the state retirement plan. So, although the state might not require J&S, if these plans have it, then it is the same as requiring it through law.

I am not sure of the actual title, but Jim Holland is Manager of the Technical portion of the Employee Plans Division. The entire actuarial staff of the IRS is under him (he is an actuary). No guidance comes out of the IRS without his input. His views carry the most weight of anyone at the IRS and he has been there for about 25 years. Around a decade ago, they split up the division into two parts, with him over only one side (sort of a demotion and loss of power). Ken Yednock was one step over him. However, Ken retired in the past year and Jim moved up into his position. There is probably no one else that knows as much about every detail of every rule off the top of his head, along with the history of the reasoning for them. When he speaks at conferences, people take it as gospel rather than opinion.

Yes, there is a correlation over the long run (too many shocks for the short run), but it is a second-order effect. The inflation is correlated to the wage increases, but then there is the demographic effect that makes correlations between the wage increases to the average wage very complex. Isolating the demographic effect over the long run requires inputs of new entrants and exits to the workforce which has major shifts over time due to immigration, economic conditions of the elderly, changes in fertility, etc.

I am not sure what your IRS sources are, but here is Jim Holland's opinion: All plans need an amendment. Those plans that refer to the applicable mortality table do not have definitely determinable benefits during 2002 because there are two possible applicable mortality tables. Therefore, you need a clarifying amendment to specify the effective date of adopting the new table. (And, once you have an amendment, then all plans are subject to 204(h) notices.) On the other hand, I have also heard second-hand that the author of the Revenue Ruling did not intend for this result. He thought that he was writing it in such a way that the effective date by default was 12/31/02, and only those plans that actually formally adopted it earlier had a different effective date. Although that is what he thought he was doing, a careful reading of it does not lead you concisely to that conclusion, and that is why Jim Holland feels differently. So, as is usually the case, sloppy writing is making law instead of intent. Again, Jim Holland's opinions generally trump those of a lower level writer of a Revenue Ruling. I have also received more information on the cash balance grandfathering. The issue is that the IRS does not have the authority to grant 411(d)(6)(A) protection for the calculation of the accrued benefit (which is what you are doing in the cash balance conversion). They only have authority under 411(d)(6)(B), which is in conjunction with optional forms (so the changes in 417(e) for lump sums don't have to be grandfathered). That is why Holland has been claiming the protection stated in the Revenue Ruling cannot be extended to the cash balance annuity calculation.

The following is the only additional information from the IRS on the subject of when to calculate CL. This is from the 1996 EA Meeting Gray Book Q&A 34: Regulation §1.401(a)(4)-5(B) contains restrictions on payouts to the 25 highest paid employees. There are exceptions if, after a lump sum payment is made, the remaining assets are equal to at least 110% of the current liability or if the lump sum payment made to the participant is less than 1% of the current liability. Reg 1.401(a)(4)-5(B)(3)(v) indicates "for purposes of this paragraph (B), any reasonable and consistent method may be used for determining the value of current liabilities and the value of plan assets." a) Are all types of current liability (CL) required under IRC 412 reasonable - for example, old law CL for the 150% full funding limit, RPA CL for the additional funding charge, or gateway test CL? The different mortality and interest could make a significant difference in the results. b) Should the most recent valuation results be used for the entire year or may current liability and assets be remeasured as of the proposed payout date? Note: by remeasuring, actual benefit payments and contributions could be taken into account. c) Assuming calculations are as of the payout date, may the interest rate as of the payout date be used, or must the interest applicable for the plan year be used? RESPONSE The regulation indicates that any reasonable, consistently applied interpretation is acceptable. Any of the above methods seems reasonable.

Well, as long as we are talking about useless mathematical calculations -- do you know how the national average wage index is computed? Actually, that was the subject of my doctoral dissertation along with the effects that calculation has on SS and other indices over time. The NAW is the average of all wages reported on 1040s. Individuals are not limited to the wage base for this, as is often incorrectly assumed. So, the IRS gathers the information, forwards it to the SSA and they do their thing with it. Given that you can file a return as late as October (with the extra 2 month extension beyond the automatic 4 month extension), it takes them until now to gather all of the input for the 2001 number that produces the 2003 wage base that was illustrated above. Now, the real question is the following (which most people will answer wrong): If everyone's wages went up 5%, how much will the NAW go up? The answer is about 4%, not 5%. The reason is the demographic affects. The cohort group (mostly new retirees) leaving the average have high wages, and the cohort group (mostly young first-time job holders) being added to the average have low wages. Also, there are usually more entering the calculation than leaving it (an expanding population). This drags down the average computation. The thing to remember is that this is the average of wages, not the average of wage increases. Also, there are always "shocks" to the calculation, such as time periods when large amounts of layoffs or early retirement programs occur. One very noticable shock was during Clinton's first year in office. His administration kept touting the 10 million new jobs they created while the Republican retort was that they were all at McDonalds. Although average wage increases were over 4% that year, the NAW only increased less than 1% due to the high influx of low-wage workers. Similar affects have come from recent welfare reform as well as the prior increased participation of women in the workforce at lower wages. Another recent and future effect is all of the retirees that have been forced to return to the workforce at low-paying jobs that are often part-time. They are also included in the average. What does this mean to SS benefit calculations? Researchers (especially anyone involved with SS reform proposals) constantly use an "average person" calculation in discussing what people get from SS currrently. They describe this as "...assume a person has had wage increases that are the same as the NAW increases." A person actually earning the NAW at retirement would have a SS benefit of about 42% of their wages under this setup and this number is often tossed around. However, if you take into account that the average individual has wage increases 1% per year higher than the NAW increase, the SS benefit is much less (their prior earnings are much lower than previously assumed) for the person earning the NAW at retirement. AND, if you also factor in that the average person retiring is earning more than the NAW, then the real average SS benefit is only about 32% replacement ratio, not 42%.

Even new plans may get caught in the moratorium, although some get through. The IRS will not give determination letters until they finalize regulations concerning conversions. The proposed version of this should be out by the end of this year, according to recent statements by IRS officials. Of course, it could take a long time to finalize the proposed, so I wouldn't expect anything for another six months or more. Also, the proposed rules coming out may only address age discrimination in a conversion. It is possible they will still hold these up until more thorough regulations are issued on topics such as whipsaw in lump sum calculations. That could take a lot longer. It has been over three years since they have been piling up the determination letter requests (over 300) without acting on them.

But, has the CPA considered the effect of a loss in Social Security benefits due to this change? The public perception that saving on FICA is always the best thing to do is not always correct, depending on the individual's circumstances. In particular, if the self-employed person had many years of zero or near-zero earnings (or negative), then later building up their compensation history for SS purposes can result in a huge payoff. Similarly, a young person with a family that is subject to high risks of mortality and/or disability will get a huge payback in SS benefits compared to the FICA paid if one of these events occur (it can actually be cheaper than buying private insurance). Again, the universal "truism" that reducing FICA is always the appropriate thing to do is simply hogwash. I have been fighting for 20 years against communication "experts" that always promote FSAs as being a great tool to reduce FICA without ever explaining that the person may not actually want to do this.

The most complex part of this is the officer definitions because it does not include all officers. Those AVP bank tellers would probably not be included. Generally, you are only talking about a handful of the top officers. And, often, officers of wholly-owned subsidiaries are not included in the group. The main issue to realize is that the company should already know who this group is (the definition of the group has not changed under the new law) and the information on who is included should be coming from them. No plan administrator or recordkeeper should have anything to do with making this determination.

Be sure to get your boxes straight.... I was in a courtroom in LA a couple decades ago waiting on a case trailing another. The lady being charged in a criminal case was obviously not guilty and the jury came back with the verdict. It was handed to the judge and he read wide-eyed "...find the defendent guilty." Huge gasps went across the courtroom, the lady dropped her head into her hands on the table, her lawyer stands up and threw his hands up in the air. After a brief silence, the jury foreman leaps out of the box screaming and waiving his arms wildly..."I checked the wrong box! I checked the wrong box!" The judge changed the verdict and commented he had not seen or heard of anything like this in his 25 years on the bench (he was also finding it hard to deal with the scenario because he was extremely ill and could barely talk). I was surprised someone didn't have a heart attack, the situation was that weird. About that same time (eary 80s), a guy was jogging on the beach (I think it was under a Manhattan Beach pier) and a piece of concrete fell from above, turning him into a parapeligic. Although he deservedly received a sizable award, what happened next was startling. His ex-girlfriend (they had already broke up) sued for loss of sexual gratification. She was awarded $45 million by a jury. That case caused all municipalities in California complete loss of insurance coverage because no company wanted anything to do with covering entities subject to the same California jury pool as this case. The municipalities had to create their own private risk-pool after that.

I said similar things in my oral testimony directly to the IRS two weeks ago. That was a hearing on the minimum distribution regulation nightmare (1.401(a)(9)-6T), which outlaws COLAs (other than CPI), variable annuities and many forms of death benefits ater the annuity starting date. One more nail in the DB coffin. Of course, it didn't faze them a bit. They gave the distinct impression that they see DB plans as nothing more than tax-avoidance schemes rather than retirement plans. Perhaps we need to reverse the 1978 reorganization plan that moved most of the jurisdiction from the DOL to the IRS. We obviously need someone in government overseeing these rules that has a view other than "how much tax revenue is being lost?"

If you really want to follow the law closely, be sure to note that the date is NOT 1/1/2003, it is 12/31/2002. For a calendar-year plan, the new table must be in effect for at least one day this year, which also means the amendment must be adopted prior to year-end.

As is so often quoted, "what does the plan say?" If the plan had specific language describing the old limits, then it is an optional change to go to the new higher limits. (The IRS always allows you to impose lower limits than the legal maximum, which is what you would be doing by not amending.) If the plan incorporates 415 by reference without spelling out the specific limits, then the plan automatically goes to the higher limits without an amendment. If the plan sponsor does not want to accept the higher limits, then it would be required to adopt an amendment rescinding the higher limits and impose a lower one.

mbozek, If you read the DOL's amicus brief on the Enron case, they argue that employer stock investments mandated by the plan are not exempt from fiduciary liability. They make absurd suggestions such as disqualifying the plan by selling off the stock when it is not performing well. They imply fiduciary breaches are a higher priority than both qualification and breaching insider-trading rules from acting on non-public information.

Why is it that we didn't see these editorials when the actual return was two to three times greater than the assumed return. When the chips are down, everyone starts looking for evil in the closet. What they don't stop to realize is that reported earnings over the past few years (including the present) would be much GREATER than it had been reported if actual earnings were used, as called for here. Currently, most plans still have net actuarial gains that are being amortized. All of that would have already been reported through earnings instead of spread under these radical approaches. These editorials have a very myopic viewpoint and do not look at the bigger picture.

Harry O: I agree with your reasoning about significance in later years. However, look at what happens in the first year following the change for someone with many years of past service. Due to the grandfathering, the one-year accrual of an annuity benefit may be cut in half or more (it can even be zero for older participants). That is a significant reduction. The new regulations require an analysis in every individual year in the future. You are not allowed to look at the bigger picture over the long run. Whenever you have wearaway under a grandfather (like this situation), a 204(h) notice is required. Taking this to its absurd conclusion, imagine a final-pay plan that is amended to have a minimum flat-dollar benefit that is higher than some participants' accrued benefit. Under the amendment, they have a wearaway grandfather. During the first few years, they have no accrual. Now, even though everyone has higher (or the same) benefits at all times after the amendment than they did before the amendment, is this a 204(h) notice? This has been posed to those at the IRS that worked with the 204(h) notice regulations and they say yes. Their focus is on the rate of accrual in each individual year. And, because some people would have accrued a benefit in the next year and now will not (because they already accrued it under the amendment), you have a 204(h) notice. This conclusion is all a result of the outcry over cash balance conversion wearaways that previously may not have been fully disclosed. The government is not about to back off of this stance.

I disagree with your conclusion. The present value is irrelevant. The issue is whether the accrued benefit (defined as an annuity) is decreased by adopting the new table. If you are projecting and converting using the old table and now will switch (this includes making use of the safe harbor approaches for cashing out the cash balance), then there is a decrease due to the amendment and you must grandfather the existing annuity amount at the time of the switch. The only open issue is whether or not a plan that references the applicable mortality table under 417(e) (instead of specifically stating the table) is actually going through an amendment subject to anti-cutback. My position is that this is reference to an outside index similar to the interest rate that does not need to be grandfathered. However, in unofficial verbal guidance, Jim Holland has indicated that this, too, is subject to grandfathering. For most people, Jim's opinion trumps my opinion. To make matters worse, however, I (and many others) believe that this is a 204(h) notice situation for all cash balance plans, which needs to be sent out by November 16.

I agree with you. There is no COLA adjustment for this person in the PIA calculation.

There is no such thing as nonqualified deferred comp. for a sole proprietor. Whether retained earnings are "deferred" by the individual or are just held by the "company," it is taxed as income to the individual. The question makes no sense whatsoever.

These "small annuity rules" were very common in plans administered by insurance companies a couple decades ago. The rules have since been overridden by the 5000 cashout rule under the Code. As long as the results are that anything in excess of 5000 PV has consent, then any more restrictive rules (i.e., annuities over 100 that are less than 5000 PV) are permissable. You will not find anything about a small annuity rule in the Code. If any of your combinations results in a cashout in excess of 5000 (inclusive of the employee contributions) that doesn't have consent, you are violating the Code. However, it doesn't appear that way.

When the employee terminated, he was given options to rollover, take cash or leave the money. Obviously, he must have elected to leave the money in the plan. What happens under the plan when he does this? Is he now locked into the old plan until retirement? It sounds like he is now requesting a distribution at a time that is not "on account of termination."

You are correct that 401(k) deferrals have FICA on them and therefore are wages for determining the PIA, but you read the original posting wrong. The setup was a tradeoff between 401(k) deferrals and employer contributions to the plan, the total of which would max out at the 415 limit. By decreasing deferrals, they increase the employer contribution and vice versa. It is the employer contribution that is not accounted for in FICA and PIA.

I agree you have a permanency issue whether you use one plan or two.