Change in funding method

[FAPInJax]

I have a client with an Entry Age Normal valuation. The assets have increased enough so that the total unfunded accrued liability is negative.

I believe this is one of the prohibited situations for a reasonable funding method.

An actuary wants to maintain the entry age method and just automatically set the unfunded liability to zero. They claim to have done this in the past. Union negotiations are involved - therefore, they are confident that after the next round of negotiations that the unfunded liability will be positive again - in a year or two.

Doesn't the IRS require the change to the aggregate funding method (or something similar) in this situation??

Any help is greatly appreciated. Thanks in advance.

[Blinky the 3-eyed Fish]

Limiting the unfunded liability to zero is a component of the funding method. Whether you can do this or not depends if: this situation has not occurred before and whether a description of the funding method clearly indicates that the unfunded can go below zero. If not, I would say that there is no problem in limiting the funding method to zero.

If the above does not apply you could automatically change the funding method pursuant to Rev Proc. 2000-40 to the EAN described. Provide, of course, that you meet the criteria described.

Your statement that the plan must switch to aggregate funding method is if it was FIL and the unfunded went below zero, not in this situation.

[MGB]

Frank,

Limiting it to zero (in any immediate gain method, including EAN) is the only way the IRS wants (or allows) you to do it. It is not a change in funding method.

The whole point is to not create net negative amortizations that can cause the credit balance to increase from anything other than contributions. The IRS says to limit it this way, although there is no statutory authority to do so...it is just their made-up way to come up with the result that they want.

[Blinky the 3-eyed Fish]

MGB, I have taken over plans where the unfunded had not been limited to zero and new bases were created each year when the plans were vastly overfunded. Our software system allows this method as well.

I have always thought this to be unreasonable and limited the unfunded to zero. But, I also have always jumped through the change in funding method hoops because I believe it to be one. According to the IRS, if you blink your eyes three times instead of two before signing the Schedule B, that is a change in funding method.

Are you saying you would just limit the unfunded to zero in a situation like this and not declare anything?

[david rigby]

I agree. Also look at IRS Reg. 1.412©(3)-1(B)(1), where the IRS gives the complete "equation of balance" rather than the abbreviated version we so often use. When the UAAL goes negative, the IRS says to set it to zero (Revenue Ruling 81-213, section 5.01), and then create an amortization base that, effectively, rebalances your equation, usually equal to the credit balance.

[FAPInJax]

Thanks for all the responses.

OK. Let me see if I can provide an example and show how it will work.

I have a plan with several bases from prior years with total outstanding balances of $3,000.

This year's valuation produces an unfunded accrued liability of a negative $5,000. This gets set to zero because under RR 81-213 there is the phrase ".....excess, IF ANY, ....." (emphasis added).

A new base is created (assuming no credit balance) equal to a negative $3,000 forcing the plan into balance.

Now, different periods for the amortization bases still appear to provide an opportunity to "increase" the credit balance because of the short amortization of the gain base (versus the other bases)

Velly interesting!!