General testing and 417(e)

[AndyH]

May I please get the opinions of people on this board who do general testing about the use or non-use of 417(e)-generated lump sum values on the Most Valuable Accrual Rate.

Half the people I've spoken to ignore lump sum values artificially inflated by low 417(e)-based interest rates. The other half do reflect those values in the calculations.

Last October at the ASPA national conference I sat in on two back to back sessions on DB general testing mechanics. One said no (Larry Deutsch) and the other said yes (Carol Sears). Both would reflect a fixed rate but they had opposite opinions on 417(e) "market" rates.

Opinions please. Thanks.

[Mike Preston]

I'd be very interested in Carol's cite.

[AndyH]

Her outline from the session (#60) "Walking step by step through the general test" does not address the issue, as far as I can see. The question came up during Q&A (the tape of which is available). I asked it a couple of different ways, since I had just heard Larry Deutsch specifically discuss the issue and reach the opposite conclusion. And, Scott Miller was with Carol, and Scott told me the previous year that in his opinion 417(e) lump sums would be part of the MVAR calculation.

Carol's answer was quite specific, although nobody requested a cite. My impression is that it was simply an interpretation of the regs.

Larry Deutsch was careful to caviat his comments with words such as "apparently" and "based upon my experience". His wording was careful on the subject but he quite clearly stated that a DB plan with a lump sum provision and AEQ assumptions equal to testing assumptions (i.e. no fixed rate for lump sums below 7.5%) had a MVAR equal to the NAR in tests he has submitted for IRS approval (and never had challenged). And I specifically asked him in followup Q&A about 417(e) rates and he said no, he does not reflect them, but he understands there is some uncertainty about the issue.

Mike, can I infer from this that your opinion is no?

[Mike Preston]

I have submitted a fair number of general tests and have never referenced the 417(e) rates. The IRS has never brought up the issue.

[MGB]

I agree they should not be used. The general idea is that, by law, the qualified J&S is supposed to be the most valuable form. Therefore, it must be used.

[Blinky the 3-eyed Fish]

This whole issue has bewildered me for years. As MGB points out the most valuable accrued benefit by definintion is the qualified J&S. So how did it come about that we need to test the lump sum option for the MVAB?

However, our firm does test the lump sum as well, and we do factor in the 417(e) rates. Though we are reconsidering whether or not we need to.

[AndyH]

Thank you all for your comments.

Even more comments would be great, because I know others use 417(e) in the calc. But, it sure is a lot easier without it.

Amazing that we can't find an authoritative answer to something like this in print.

[Mike Preston]

Blinky, I think you changed the subject a bit. In the case of a lump sum that is subsidized (a rate that is less than the testing rate) the subsidization is naturally reflected in the increased MVAR. But that doesn't mean the 417(e) makes its way into that calculation. Am I misunderstanding your comment?

[Blinky the 3-eyed Fish]

I told you I was bewildered.

[Mike Preston]

And rightfully so, I might add. I think one of my rationale's (rationalizations?) as to why the 417(e) rates are ignored when general testing (is that a true verb?) is that the concept was born when 417(e) rates were the PBGC rate sets. There is just no way that the 1992-1993 political environment would have allowed the IRS to issue regulations that required the MVAR determination to be based on duration-based interest rates. There was no such thing as GATT at the time, of course.

[AndyH]

Maybe it's a simple as a careful reading of the regs. Under 1.401(a)(4)-3(d)(1)(ii), "....Thus, the most valuable accrual rate reflects the value of all benefits accrued or treated as accrued under section 411(d)(6) that are payable in any form and at any time ...."

Maybe it's simply the fact that the lump sum value determined by applying the 417(e) rate(s) is not by protected from decreasing under 411(d)(6)?

[Mike Preston]

Interesting interpretation. But clearly the lump sum feature itself is protected under 411(d)(6). And clearly, absent the special provisions, the methodology of selecting the 417(e) "rates" is protected under 411(d)(6). So, to say that lump sums aren't protected is wrong. To say that the method of determining the lump sum values isn't protected is wrong. But to say that the lump sum values themselves aren't protected is not necessarily a false statement. So, in a long winded way, I think you may have hit on the interpretation that the IRS has made!

[AndyH]

Just an update on this subject and a question as to whether any opinions have been altered.

I started this thread before last year's 2002 ASPA national conference. Larry Deutch had previously opined that the 417(e) rate need not be considered in the MVAR calculation, but at last year's ASPA conference he said Jim Holland told him he was wrong, and that as a result he had (reluctantly) changed his position.

Mike, MGB, et al, have you also now changed your opinions or do you still feel that the 417(e) rate can be ignored?

[flosfur]

Since the testing is done year by year, the fact that S417(e) lump sum value can change next year should be of no consequence in testing for current year? As of a testing date, accrued benefit and lump sum value thereof is known - so shouldn't all of the known factors be used for testing?

As an aside:

If the S417(e) lump sum must be taken into account then people using "some" of the commercial softwares for their testing are currently out of luck in implementing that rule and have been testing incorrectly.

[Guest pension222]

Assuming that the plan's normal form is a single life annuity, I agree that if one were to "normalize" all of the optional forms of benefit that are, according to the plan, are of (actuarially) equivalent value to the normal form that some of the optional forms (such as 50% J&S and a lump sum payment) may turn out to be of greater dollar value as a normalized SLA than the original SLA.

My question is, are they really more valuable than the original benefit? For sure under the plan, unless they are somehow subsidized (say by application of the 417 lump sum factors) they are not more valuable than the original SLA on which they are based.

So if the original unsubsidized optional form of benefit is actuarially equivalent to the normal form SLA, is it really more valuable just because when it is "normalized" the resulting SLA is of greater dollar value than the original benefit?

My understanding of the concept of the most valuable accrual rate and resulting normalization is that they are to take into account any subsidization of benefits such as subsidized early retirement benefits or a subsidized QJSA, neither of which specifically actuarially equivalent to the underlying normal form SLA. If I am wrong (and I admit that I might be) can someone please point me in the correct direction? Any citations would be greatly appreciated.

[Guest RSNOW]

I agree with you that in reality the optional forms of benefits (annuity) are not truly more valuable when they are the actuarial equiv. of the SLA. However, I'm not sure there is a good argument out of the mathematical results that often follow from normalizing the benefits using the required 7.5%-8.5% interest rates. In early years plan sponsors were notorious for unreasonable actuarial equiv. (e.g., 15% interest for lump sum distributions) and the 417(e) rules and probably a4 regs are there in response to the abuses and to provide comparability amongst sponsors with different rates.

The def'n of most valuable accrual rate under Tres. Reg. 1.401(a)(4)-3(d)(ii) seems to clearly state that the MVAR is the "normalized" QJSA (not just subsidized QJSA) and it reflects the value of ALL benefits accrued (not just early retirement subsidies and subsidized QJSAs).

I feel the same frustration as you when otherwise vanilla DB plans get hung up on the normalization process on simple actuarial equiv. forms of benefits, but I think you would need a cite OUT of this issue to have justification to do it differently (or just concede and change conversion factors for optional forms of benefits to use a rate between 7.5-8.5%) given the language in a4 regs, even though I agree the emphasis is on (but not limited to) the subsidized benefits as the big inclusions in the MVAR.