Recognition of Future Benefit Increases - Plan Not Described in 413(a)

[Guest PensionNW]

Section 412©(12) requires that the funding method of a collectively bargained plan described in Section 413(a) must anticipate benefit increases scheduled to take effect duright the term of the collective bargaining agreement.

Does this prohibit a plan not described in 413(a) from recognizing future benefit increases?

Suppose a single employer calendar year DB plan adopts an amendment in calendar year 2003 that schedules a benefit increase effective July 1, 2004. Can the January 1, 2004 valuation recognize this future benefit improvement?

[david rigby]

IRS Reg 1.412©(3)-1(d) should provide the answer:

(d) Prohibited considerations under a reasonable funding method

(1) Anticipated benefit changes

(i) In general.

Except as otherwise provided by the Commissioner, a reasonable funding method does not anticipate changes in plan benefits that become effective, whether or not retroactively, in a future plan year or that become effective after the first day of, but during, a current plan year.

(ii) Exception for collectively bargained plans.

A collectively bargained plan described in section 413(a) may on a consistent basis anticipate benefit increases scheduled to take effect during the term of the collective-bargaining agreement applicable to the plan. A plan's treatment of benefit increases scheduled in a collective bargaining agreement is part of its funding method. Accordingly, a change in a plan's treatment of such benefit increases (for example, ignoring anticipated increases after taking them into account) is a change of funding method.

(2) Anticipated future participants.

A reasonable funding method must not anticipate the affiliation with the plan of future participants not employed in the service of the employer on the plan valuation date. However, a reasonable funding method may anticipate the affiliation with the plan of current employees who have not satisfied the participation requirements of the plan.

[Mike Preston]

It may not be recognized until the year it becomes effective. Hence, it would not be recognizable in the 2002 valuation. It can be taken into account in the 2004 valuation. See RR 77-2 (cite from top of head, if anybody thinks it is incorrect, please provide correct cite).

[MGB]

I agree with the prior responses.

I have run into a couple of situations recently that are difficult to determine the correct answer.

1. Assume the opposite and the benefit accrual rate in the future has been negotiated to be lower, rather than higher, than it is now. For example, they have been getting 20 each year of accrual and starting next year it will be 15. Given that this is a 413 plan, it appears you can recognize this in the current valuation. However, there is a catch. The law only allows you to recognize INCREASES in the future. The question here is, under the EAN method, what would you project as the accrual rates in the future? (My answer, though I don't like it, is you must project 20.) If this was not a 413 plan, would you recognize the 15 in a projection method? (Again, the answer is no.)

2. Getting away from 413 plans, assume a plan adopts an amendment to freeze the final pay at 12/31/2005. The plan will continue to credit service. Under any projection method, would you recognize the freeze? (Again, I don't like it, but the answer seems no.)

3. Assume you have a vanilla x% of final pay times years of service. You pass an amendment putting a cap on service of 25 years. Would you use this cap in a projection method for those that have less than 25 years? If you've answered this differently from (2), what makes these two scenarios different under the law?

The problem with reconciling the above with the law is the phrase "effective, whether or not retroactively, in a future plan year" in the regulation. Are the above amendments really effective in the future, or are they effective when the amendment is passed?

[Guest PensionNW]

Two of these answers seem to be in conflict with each other.

The response from Pax quotes IRS Reg 1.412©(3)-1(d): “Except as otherwise provided by the Commissioner, a reasonable funding method does not anticipate changes in plan benefits that become effective, whether or not retroactively, in a future plan year or that become effective after the first day of, but during, a current plan year.”

But Mike Preston indicates that "the amendment may not be recognized until the year it becomes effective. Hence, it would not be recognizable in the 2002 (I assume he meant the 2003 valuation) valuation. It can be taken into account in the 2004 valuation."

So which is it? The plan is not a 413 plan, the amendment is adopted before the beginning of the plan year (during 2003) with a benefit increase effective part way through the plan year (July 1, 2004), so can the January 1, 2004 valuation take into account the increase? The response from Pax seems to indicate no, while the response from Mike looks like a yes?

[MGB]

Read Rev. Rul. 77-2. It very clearly states what to do.

If the amendment is adopted on or before the valuation date, you recognize the change pro rata (do a valuation with and without; pro rate between them based on the number of months into the year that the change is effective).

If the amendment is adopted after the valuation date you have the option of doing the pro rata approach or ignoring the change completely.

So, for yours, you must recognize it in the 1/1/2004 valuation, but only partially.

The inconsistency of the responses are the "except as provided by the Commissioner". The Commissioner provided a pro rata rule in 77-2 that is not in the regulation.

[Mike Preston]

MGB: interesting scenarios. I'll try to get to them over the weekend. However, with respect to 77-2, my recollection is that you can, if you so choose, use the effective date for purposes of your pro-rata calculations. At least the IRS has accepted the use of the effective date in pro-rata calculations for many, many years.

I think to do otherwise creates a situation where a 412©(8) amendment has no impact, since it is, by definition, adopted after the end of the plan year (certainly after the valuation date).

[david rigby]

Revenue Ruling 77-2

http://www.taxlinks.com/rulings/1977/revrul77-2.htm

[Mike Preston]

Originally posted by MGB

1.  Assume the opposite and the benefit accrual rate in the future has been negotiated to be lower, rather than higher, than it is now.  For example, they have been getting 20 each year of accrual and starting next year it will be 15.  Given that this is a 413 plan, it appears you can recognize this in the current valuation.  However, there is a catch.  The law only allows you to recognize INCREASES in the future.  The question here is, under the EAN method, what would you project as the accrual rates in the future?  (My answer, though I don't like it, is you must project 20.)  If this was not a 413 plan, would you recognize the 15 in a projection method? (Again, the answer is no.)

I agree with the first scenario in that only increases are allowed to be recognized, so the resulting projection should be based on 20 until the plan year during which the decrease takes effect, at which point you would use 77-2 to guide you insofar as your choices go. As far as the non-413 plan, in all years before the effective date of the amendment, again I agree that you would not recognize the decrease and use 20.

2.  Getting away from 413 plans, assume a plan adopts an amendment to freeze the final pay at 12/31/2005.  The plan will continue to credit service.  Under any projection method, would you recognize the freeze?  (Again, I don't like it, but the answer seems no.)

During what year? 77-2 says that I can recognize it in any valuation that was for a plan year that included 12/31/05, but not before.

3.  Assume you have a vanilla x% of final pay times years of service.  You pass an amendment putting a cap on service of 25 years.  Would you use this cap in a projection method for those that have less than 25 years?  If you've answered this differently from (2), what makes these two scenarios different under the law?

Again, for what year? I think the answer should be consistent with the answer given for (2). That is, if the valuation is for a plan year that includes the effective date of the amendment, you include the impact of that amendment, or not, as 77-2 provides.

The problem with reconciling the above with the law is the phrase "effective, whether or not retroactively, in a future plan year" in the regulation.  Are the above amendments really effective in the future, or are they effective when the amendment is passed?

I think the common interpretation is that one uses the existing terms of the plan to perform projections. If those terms include a servce cap, then the existing terms impose the restriction and the amendment is effective when that restriction is first effective. It is not effective individually with respect to given participants only once they have been credited with service that equals the cap.

I think a different example may be a tougher call. Say an amendment is adopted 1/1/2003 which limits compensation for benefit purposes to no more than $100,000. I would surmise that most people would have no trouble including the impact of this amendment in their 2003 valuations. Change the amendment just a little to provide that compensation in excess of $120,000 shall not be considered for years ending before 2004 and $100,000 after that. Is the $100,000 "cap" (or the additional potential $20,000 that would be ignored if earned between 1/1/2005 and retirement) to be used in the determination of final average salary for the 2004 (or earlier) valuation?

Since I don't deal with any plans that have attempted to limit compensation in this manner, I can't say that I've researched this issue at length. But my gut feeling is that service related issues (service caps) are taken into account upon adoption. This additional $20,000 reduction in compensation would therefore not be taken into account until the 2005 valuation.