Frozen Initial Liability

[Blinky the 3-eyed Fish]

Calling all actuaries! My question pertains to a plan using the FIL funding method. Once the FIL is fully funded, I know the plan is then operated as if the funding method is aggregate.

However, if the plan then becomes "underfunded", what is the course of action (i.e. does the plan continue to be funded as if the funding method were aggregate or is there an alternative)?

[MGB]

This was covered in the 2001 Gray Book (IRS Q&As) from the Enrolled Actuaries Meeting.

You officially continue on with aggregate. That is the funding method at this point. However, if you want to go back to FIL, that is a change in method that requires approval.

[david rigby]

Here is the text of the Q&A mentioned by MGB:

QUESTION 18 (2001)

Method Change: Automatic Approval to Remedy Unreasonable Allocation of Cost

Section 4.01 of Rev. Proc. 2000-40 gives approval to funding method changes that are necessary to remedy an unreasonable allocation of costs. One situation where this special approval applies is where the unfunded liability under the frozen initial liability method becomes negative. Under this method, the unfunded liability may be reduced to, or below, zero under any of the following circumstances:

- All bases are fully amortized

- All bases are eliminated due to the plan being in full funding

- Excess contributions are sufficient to eliminate the unfunded liability

- Charge bases are amortized more rapidly than credit bases, resulting in required contributions sufficient to eliminate the unfunded before the expiration of all bases

1) If the unfunded liability is reduced to exactly zero, must the funding method be changed?

2) If the unfunded liability is reduced below zero, must the funding method be changed, or may the unfunded liability be restricted so as to be no less than zero?

3) If the funding method must be changed, and the unfunded liability measured using the entry age normal method is less than zero; must the plan use either the aggregate method, or an immediate gain method?

4) If the answer to (3) is yes, and that the plan switches to the aggregate method, the funding method may be changed back to frozen initial liability once the plan has a positive unfunded liability under the entry age normal method. Would this change be eligible for automatic approval even if the plan had received automatic approval for a change to this same method pursuant to section 3.06 of Rev. Proc. 2000-40 (or its predecessor) within the last four years?

5) If the answer to (4) is no, would the IRS grant approval for such a change pursuant to a request made in accordance with Rev. Proc. 2000-41, notwithstanding section 4.02(2) of that Rev. Proc?

RESPONSE

1) No. However, if all bases have been eliminated due to the application of the full funding limit, the method may be changed. In the future, any contribution in excess of the normal cost would result in a negative unfunded liability the following year. At this point, the method would have to be changed.

2) The method must be changed unless the description of the method defines the unfunded liability in such a way as to prevent it from becoming negative. Such description would need to specifically state the methodology that would be applied to prevent the unfunded liability from becoming negative.

3) If the method must be changed from FIL due to a negative unfunded liability, and the entry age normal unfunded liability is less than zero, automatic approval would not be available for a change to FIL. However, the actuary may submit a request to the IRS under Rev. Proc. 2000-41 for a change to a variation of FIL that prevents the unfunded liability from becoming negative.

4) No, the change would not be eligible for automatic approval.

5) In considering the request for approval in this particular situation, the IRS would not reject the application merely due to a recent change to the same method.

[Blinky the 3-eyed Fish]

Thank you MGB and pax.