Projected Unit Credit

[FAPInJax]

OK. Client has a plan with 100% of pay as the benefit which produces 14,166.67 (415 limit). Only active participant has 4 years of service and 28 years at retirement (for fractional accrual) BUT first year of the plan so only 1 year of participation.

For whatever reason, they are running projected unit credit.

Should the benefit for normal cost be 505.95 (14,166.67 / 28) and the past service be 3 * 505.95 = 1517.85??

OR, should 415 be imposed which means that because of only a single year of participation that the past service is equal to 1,416.67 and the normal cost is zero???

Thanks for any and all comments.

[David]

Frank, I believe Rev. Rul. 85-131 describes how to handle this situation. I think the NC accrual would be PB/TS but limited to 1/10th the 415 limit. I suppose if the denominator in the accrual fraction was capped you would/could factor that in.

[Mike Preston]

Check out Q&A 23 from the 1991 Grey Book from the Enrolled Actuaries' meeting:

"When using the Projected Unit Credit funding method, what is the correct time to apply the 415 limits? Before or after you pro-rate the service?

RESPONSE 23

The reasonable funding method regulations (1.412©(3)-1 (e)(3)) generally require that liabilities be allocated in proportion to the rates of benefit accrual in a plan. The rates of benefit accrual in a plan, and the effect of the §415 limits on these rates of benefit accrual, depends upon the plan provisions, however.

For example, a plan may accrue benefits based on an accrual rate until the §415 limits are hit, and then accrue no future benefits. On the other hand, the projected plan benefit, as limited by §415, could accrue ratably over a participant's service to NRA. The normal cost and accrued liability under the Projected Unit Credit method should track the resulting accrual rates under the plan."

Now, it sounds like your plan is definitely using the former method, at least insofar as the first year of participation in the plan. Since the impostion of a participation requirement after 1986 with respect to 415, the general rule is that one limits the benefits in accordance with the 10 year phase in.

But there is an exception to the 10 year phase in with respect to 1/10 the dollar limit.

So, I think it boils down to just what the IRS said in their Q&A, above. What is the actual accrued benefit under the terms of the plan? If the 10 year phase in is ignored to the extent of 1/10th the dollar limit, then the accrued benefit at the beginning of the year is 1/10th the dollar limit and there is no further benefit accrual. Therefore, everything is past service and there is no normal cost. If, OTOH, the 1/10th "free pass" is not implemented in the plan document, the entire accrual in the first year would be normal cost.

I would think that most plans would include the 1/10th free pass, so it looks to me like the whole thing is past service and there is no normal cost.

But you would have to check the terms of the plan to be sure.

Keep in mind that the Revenue Ruling cited was an attempt to limit the recognition of benefits falling into normal cost, where all such benefits were funded over a 1 year period. You don't have such a situation here. But, nonetheless, there is a bias towards putting benefits into past service on a reasonable basis.

I would think that "no normal cost" in your circumstance would clearly be reasonable. I'm not sure that a normal cost based on $505.95 and a past service amortization of 1,416.67 - 505.95 would be unreasonable, though.

However, I'm not sure I can buy into a normal cost of 505.95 and a past service liability of 1517.85. At least, not since 1987.

This brings up enough stuff from long enough ago that I feel the need to caveat it with respect to doing a complete research project. But the above is my off the top of my head reaction.

[FAPInJax]

Thanks for all your input. I appreciate the cites especially (I did not look back far enough for the data - golly over 10 years ago )

I found some older data regarding the 415 limits so felt relatively comfortable with all past service and no normal cost prior to your responses. Now, I feel very comfortable.

Thanks again!!