Lorraine Dorsa

While it's fun to communicate online, it's also nice to actually meet people face to face [at least once in a while ]. Since many of us will be at the Enrolled Actuaries Meeting, let's plan to meet at the bar in the hotel lobby on Monday afternoon right after the end of the sessions. No need to RSVP, just show up!

If the HCE takes the series of lump sums noted above, he would still have a significant remaining benefit in the plan any some reasonably soon after he began taking payment (less, of course, as time goes on). So if the plan terminated in an underfunded status, he could be made to share the hit for the underfunding. I think attorney's concern re 'getting used to' a specific dollar amount each year is really a concern re the client thinking he had elected an annuity with a life guarantee rather than a series of lump sums. I agree that documentation would have to be most clear, but the employer in question is a law firm and the HCE in question is a senior attorney and the pension attorney wants to make sure that there are no loopholes that he'll have to deal with later.

I have a client who came close, but did not get caught by this on the distribution to an HCE last year. However, since several other HCEs will retire in the next 5 years, it is likely that this will come up in the future so the attorney did some research. The attorney's position was that the participant had to elect the form in which he would receive his benefits (in accordance with the terms of the plan document) and could not later re-elect to receive a different form. Therefore, the HCE could not elect an annuity now and then elect a lump sum later. My suggestion to the attorney was why not have the HCE elect a lump sum if that's what he wants and then have the plan limit his payment to the maximum allowable amount (=amount of a life annuity payment) each year and then, if at some time the restriction no longer applied, pay him his remaining amount in a lump sum. This distribution would not be an annuity (no life guarantee), but simply a string of lump sum payments. Attorney does not see anything wrong with this legally, but he's uncomfortable with the practicalities of this--he would like to be able to tell the participant for sure how much he would get each year, when he would get the balance of the lump sum and is worried about the participant getting used to the annual distributions and assuming they were guaranteed for life and then having the money run out. This is still an open issue for this plan since the other HCEs are not at retirement age yet, but it's coming up in the next year or so.

You probably need to talk to both a benefits attorney and a professional administrator. I'm a pension actuary and we are often involved with plan mergers and spinoffs resulting from corporate transactions. The attorney will help you review the plan document to determine which benefits must be continued and which can be modified/discontinued. The administrator can work with you to determine any actions which must be taken (for example, in the pension area appropriate notices must be given to participants before any changes can become effective, certain benefits can be paid out and others must be maintained, etc). On occasion we've found out about corporate transactions affecting pension plan after the fact and sometimes the resulting benefits and benefit liabilities accruing to the acquirer or acquiree were not what was expected, but the event had taken place and it was too late to change. Be sure you research the issues before anything is finalized!

A 412(i) plan is simply a defined benefit plan fully funded with insurance contracts. You can certainly calculate the benefit using an integrated formula. Once the monthly benefit is computed, the funding (purchasing of contracts) is the same as any other 412(i) plan.

We've had positive experience with the PBGC in recent years. I'd give them a call as soon as possible, explain why the client missed the deadline and ask for their advice re how to work this out. They've been very good with working with us on minor slip-ups on timing and paperwork.

Correct me if I misunderstand, but it sounds like we are talking about 3 issues--1) what is the participant's 415 limit? and2) what benefit can be funded for and 3) what distribution(s) can/should he receive if he takes 70.5 or other distributions after NRA? The 415 limit question was originally phrased as "reducing 3 yr high average for distributions" but really the issue is computing the 415(B) limits which, assuming 3 yr avg compensation less than the dollar limit, is the 3 yr high average. For funding, the 415(B) limit itself does not decrease for distributions, but the remaining benefit to be funded for is reduced by the value of the benefit(s) previously paid. These two questions have relatively clearcut answers, but the question regarding the distributions allowable after NRA is a little murkier. The question revolves around whether a benefit which is delayed beyond NRA can increase to its actuarial equivalent if that actuarial equivalent is greater than the 3 yr high average compensation. Example: If the 415(B) limit is $50,000/yr and NRA = 65, what is the maximum the participant can receive if he delays distribution to age 70.5? If the actuarial equivalent of $50,000/yr payable at 65 is $55,000/yr payable at 70, can he receive that benefit (or the pvab of that or a series of payments equivalent to that)? Or is his benefit "stuck" at $50,000/yr and therefore loses value each year he does not take it? Is this the issue we are trying to resolve?

The following question was addressed to the Plan Design Q&A column. I referred the questioner to the materials from the recent ASPA conference for details about the mechanics of this issue, but I think that discussion by practitioners who have used this method, or who have chosen not to, would be valuable to both the questioner and many others. Any comments? Recently, I read about the so-called "flip-flop" method of taking deductions for corporations sponsoring both a DB plan and a DC plan (see the details in the DATAIR Winter 2000 news letter). Under this method, a business owner may contribute 30K to a MP plan each year and the full amount to a DB plan each year, and deduct both contributions and still comply with 404(a)(7). The deductions are taken not in the same year for both plans, but 2 years of 30K DC contributions are deducted in one year, and 2 years of DB contributions are deducted in the following year, and so on. The timing of the contributions must be carefully laid out and followed. I have never heard of this method before, and would like some comment from other practitioners. It would obviously be very valuable to some high-income small business owners.

If you can pass 410(B) using the ratio % test, you can exclude employees by name. And if, as presumably is the case, only HCEs are being excluded, the ratio % test should be easily passed and the name issue never even come up. I've had cases where the client wanted to exclude certain individuals and we were able to do so by using job titles (in many case there is only 1 President, Accounting Manager, etc) or by a combination of job titles and locations.

If you are referring to the safe harbor requirements of IRC 1.401(a)(4) with regard to the amounts of benefits, there is a safe harbor for flat benefit formulas which requires the 25 year reduction you mention. However, a qualified DB plan can use any formula which will satisfy the non-discrimination rules. You can use the flat benefit formula without reduction, but you will have to use either the non-design based safe harbor which requires limited testing or the general test which requires full testing.

Unfortunately (or fortunately in some cases), there is no specific language requirements for a 204(h) notice. I tend to be very explicit and repear the language from the statute re "reduction of future accruals" to avoid any question that the notice is a 204(h) notice, but I've seen them phrased in all sorts of ways. Some employers want to water down the language for employee relations purposes, but I'm concerned that if the participants can't clearly see what is happening that the notice could be challenged and deemed invalid, in which case benefits must continue at the old rate until a new notice is given. ------------------

I can comment on pension issues, but not tax issues. 1. Permanency is an issue, but I've put in many plans which only last for a few years due to the retirement of the principal(s) and the subsequent dissolution of the company/firm/practice and had no objection from the IRS upon termination. 1a. There is also another issue to consider--non-discrimination under IRC 1.401(a)(4)-5 re timing of plan amendments with the effect of significantly discriminating in favor of HCEs. Example 1 of this section refers to a DB plan which has its benefit increased after all employees other than the HCEs have been terminated. I think you can avoid this issue with proper plan design (providing benefits only for service after the change in the company), but it needs to be considered. 3. Defined benefit plans must be funded using a reasonable funding method and following IRC 412 re minimum funding standards and IRC 404 re deductions, the practical result of which is that the plan must be funded over its lifetime. If a large amount is deposited the first year as you propose, the amount over the maximum deductible amount of IRC 404 is not only not deductible but subject to a 10% excise tax. And if it cannot be deducted in the following year, the excess over the deductible amount in that year is again subject to another 10% excise tax (and on and on for future years until the entire amount can be deducted). 4. The 415 $ limit is reduced prorata for years of participation less than 10, so if the principals will have only 5 years of participation at retirement, the limit is 5/10 of $135,000 (= limit indexed to 2000). However, benefits and contributions for older participants can still be significant so don't let this stop you from adopting the plan. ------------------

IRC 415 is a maximum benefit issue (and only peripherially a funding issue). I've never worked with variable annuities, but I know of no exception to IRC 415 which would allow payment of benefits in excess of the limit. ------------------

The language in 1.404a4 re the 5% safety valve is very different from the language in 1.401b re facts and circumstances in the average benefits test so I'm hesitant to assume they both mean the same thing--that you can apply the facts and circumstances and make your own decision (subject to override by the IRS if they disagree). ------------------

I'd like to use the 5% safety valve which permits the plan to satisfy 401a4 amts testing if up to 5% of the HCEs are treated as non-benefiting. The regs state that this is available "if the Secretary determines" certain conditions to be met. Does this mean that I actually have to apply for a ruling to use this method? If so, does anyone have any experience with how to do this, what type of documentation is needed, etc? ------------------