Frozen Initial Liability question

[Guest MikeMiller]

I have a defined benefit pension plan (plan year = 3/1 - 2/28; funding method = FIL) that had been frozen since 3/1/93. We defrosted the plan as of 3/1/2000. My Unfunded Accrued Liability (UAL) and Normal Cost as of 3/1/99 were $0. In defrosting the plan, we made an assumptions change and amendment change which created amortization bases of ($237,025) and $771,392 respectively. Thus, my Remaining Unfunded Liability (RUL) as of 3/1/2000 equaled $534,367.

However, when completing the Schedule B for the 2000 Form 5500, my equation of balance is off by $20,612. This $20,612 is my credit balance from the 1999 Schedule B.

How do I correct my valuation so that the equation of balance is balanced?

[MGB]

There was actually a third base (done first) for a change in funding methods. By the numbers you stated, I assume at that point you were in negative UAL territory, so no base is established. The change in assumptions is next. It appears that you would still have been in negative UAL territory, so no base should have been recognized. The third change (plan amendment) brought you out of negative territory and it should only recognize the amount of UAL that puts you into balance, i.e., adjusted for the credit balance. That only leaves you with one positive base.

Alternatively, steps two and three could be reversed. I.e., recognizing the plan amendment before recognizing the assumption change. At the time of recognizing the plan amendment, you would only recognize the amount that puts you into balance, which is going to be less than the actual amount of the AL of the plan amendment because some of it gets eaten up as you come out of negative territory. Then the assumption change is an actual change in AL difference due to assumptions, given the new plan provisions. I assume this would be a very different number than what you are now using.

I do not like the second approach, above. From a theoretical purist point of view, I think the ordering should be:

G/L

Method change

Assumption change

Plan amendment

In each step, the amount of change recognized has to limit the prior step to zero (adjusted for the credit balance) if the net at that point is a negative UAL.

However, there is no actual rule from the IRS on the ordering, so other ordering is allowable.

[david rigby]

I think there is some rule on the ordering.

Where a method determines a gain/loss, that should come first.

[Guest MikeMiller]

How did a change in funding methods occur?

Eventhough the assumptions change produced a gain and results in a negative UAL, doesn't the change have to be amortized through the creation of a base?

[david rigby]

Good question. Per 412 regs., aren't all bases under the FIL method determined by the change in the Unfunded Entry Age Actuarial Accrued Liability, which is automatically limited to zero?

[MGB]

Sorry, I interpreted your "defrosting" as meaning you no longer were doing FIL.

With staying on FIL, my same comments as before: If you recognize the change in assumptions first, you cannot have a negative amount because that would be recognizing a negative UAL, which is not allowed. Thus, you do not have a base for the change in assumptions. The amendment base needs to be adjusted for the credit balance.

Again, you could alternatively do the amendment first, and then the assumption change. But, the AL associated with the amendment will probably be different because it is based on old assumptions.

I have a different problem with this. If you had zero UAL before with a credit balance, then you shouldn't have been using FIL. This is one of the situations in Rev.Proc. 2000-40 that states you must revert to another method because the FIL is not acceptable at that point. That is what I thought you were referring to when you said "defrosting".

[Guest MikeMiller]

Sorry for the confusion. The plan has been under the FIL funding method since inception. When I said the plan was frozen, I mean that benefit accrual was frozen. By defrosting, I mean we amended the plan to allow for benefit accrual.

The plan's assumptions were changed first, and then the amendment was done to "defrost" benefit accrual.

I was unaware that you could no longer use FIL if the UAL went to $0 and you were carrying a credit balance.

What do you suggest?

[david rigby]

Under FIL, when the UAL goes negative, I think there are three alternatives:

1. Change to any method, either using the automatic approval of Rev. Proc. 2000-40 or by making application to the IRS if 2000-40 does not fit.

2. Change to the Aggregate Method. (I think this is a subset of 2000-40.)

3. Keep the FIL method, but it will be applied (mechanically, that is) just like the Aggregate Method. Thus, if you have a credit balance, you will have a NC for 412 that differs from your NC for 404 purposes.

That said, you may have other reasons for heading in one direction, such as a change in the demographics of the group, or a plan design change.