Reasonable funding method? What to do?

[Blinky the 3-eyed Fish]

Situation: terminated DB plan now with only inactive employees has been funded under the individual aggregate funding method. The liabilities exceed the assets. My first question is how is this a reasonable funding method when there is no methodology over which to spread the PVFNC? Would you consider no normal cost reasonable?

That being said, I don't see that I have the option to change funding methods pursuant to section 4.02 of Rev. Proc. 2000-40. The PVAB exceeds the assets as of the date of plan termination.

I am looking for recommendations and thoughts.

[david rigby]

How about 4.01 (5) ?

[Blinky the 3-eyed Fish]

Not available because the plan terminated late enough in the year for people to accrue a benefit. The company then dissolved before the end of the year valuation date creating no active employees.

[Mike Preston]

Would 3.13 help?

[Blinky the 3-eyed Fish]

I don't think 3.13 is available due to the plan termination restrictions described in 6.01(5).

[Mike Preston]

6.01(5) only restricts 3.02 through 3.09, not 3.13. Does that help?

[Blinky the 3-eyed Fish]

Where do you see that 6.01(5) only restricts 3.02 - 3.09? I have a feeling I am going to look foolish, but I don't see that language.

Mike, I think you are talking about 6.02(5), which applies to a frozen plan.

[Mike Preston]

You are correct. I was reading 6.02(5) and thought I was reading 6.01(5).

Any chance they can rescind the termination of the plan, so that the formal termination doesn't take place until the first day of the next year?

[Kirk Maldonado]

Blinky:

To respond to your first question, I don't see how the use of individual aggregate method would be a reasonable funding method under these circumstances.

[david rigby]

Kirk is correct, at least according to IRS viewpoints. The following questions are from the Gray Book. The first in 1993 is rather tame, but the IRS gives a much stronger opinion in 1999. Mathematically, there is no reason that an aggregate method could not be used to fund over the remaining lifetime of retirees, etc. However, there is probably a public policy reason to avoid this. It appears the IRS is of the opinion that a reasonable funding method should allocate costs over working lifetime. In Reg. 1.412©(3)-1(b), the IRS also gives a clue when they talk about "present value of normal costs ... over the future working lifetime of participants."

(This is of course just what FAS87 desires also for expensing purposes.)

QUESTION 93-10

Aggregate Funding Method -- No remaining actives

A sponsor has a defined benefit plan at a location where the company closes down the operation for economic reasons, effective as of the first day of a plan year. After the closing, the plan will cover only terminated vested and retired employees and their beneficiaries. The funding method is the aggregate cost method. Assume the following with respect to the plan year:

Present Value of Benefits: $20,000,000

Valuation assets: $19,000,000

Under these circumstances, is the average future working lifetime for each participant equal to 1 year and thus the normal cost and maximum deductible limit equal to $1,000,000? Would the answer be different if the closing did not occur until sometime during the plan year?

RESPONSE

No. It would not be acceptable to use one year as the average future working lifetime where there are no remaining actives. One acceptable approach is to use the expected retirement ages as if the employees were still active.

QUESTION 99-6

Funding: Spread Gain Method for Plan with No Future Benefit Accruals

Plan A uses the aggregate method (level percentage of compensation) to determine funding requirements. As of December 31, 1998, all active participants are terminated, but the plan remains in existence.

(a) How is the normal cost for 1999 determined?

(b) Would the answer be different if the plan was frozen, but participants continued in active service with the sponsor?

RESPONSE

(a) The funding method must be changed to an immediate gain method. Under any immediate gain method, the normal cost would be zero and the accrued liability would equal the present value of benefits. Any unfunded liability initially recognized should be amortized over ten years.

(b) No. The response in (a) would also apply to a frozen plan covering participants who are still employed by the plan sponsor.

[Mike Preston]

The second part of the answer in 1999 appears to be inconsistent with the answer in 1993. That is, the IRS seems to be saying that with respect to a frozen plan, the only acceptable funding method is an immediate gain method. I've seen tons of frozen plans funded using a spread gain method using the future working lifetime of those who are still active to spread the PVFNC. I think the 1999 answer, at least the (b) part of it, is a bit of an overreach, don't you?

In Blinky's case, however, there aren't any future years of employment over which to fund anything. I wonder if it might not be possible for the IRS to view it as the circumstances being a cause to effect a new path under the same funding method? That is, if the funding method was originally described as individual aggregate whenever future service is greater than 0, with the modification that if future service is zero there is then a base established to fund the difference between assets and PVB. This is not without precedent. Actuaries will frequently run into situations where the published description of the funding method does not contemplate a certain benefit or subsidy, and then, once implemented, the funding method is not deemed to have changed. If faced with this situation I might just call Jim Holland and see whether this might be viewed as acceptable. If so,then it isn't a change in funding method, just a change in the calculations to adhere to the funding method.

[Blinky the 3-eyed Fish]

Mike, rescinding the termination is not an option since participants were paid out based on the termination of the plan prior to the business dissolving.

So, it looks as if I have to keep the IA funding method and decide to go with the 93 Gray Book answer and fund as if the terminees were still active or some other variation like Mike's suggestion.

BTW, I agree that part b to the 99 Gray Book answer is a bit ridiculous.

[Mike Preston]

I think the IRS takes the position that it was ok to have made those distributions even if the plan termination is later rescinded.

[Guest Brian4]

Depending on the timing of the situation, here is an idea. Use the automatic approval to change the valuation date for the year prior (or before) plan termination to the first day of the year. This would need to be done before filing the Schedule B for that year. Then, this avoids the reasonable funding method issue with spreading normal costs in the year of termination, as there would be active participants on the first day of the plan year. You would need to know that the plan had terminated or was anticipated to terminate within the first 9.5 months of the plan year to have time to do this.

[Blinky the 3-eyed Fish]

It's about a year too late to do that in this situation. As a general rule, I always like to switch the valuation date to the beginning of the year in the year prior to termination to avoid hassles with an EOY val in the year of term.