New regs on QJSA/QPSA explanations

[Belgarath]

Could anyone tell me in relatively plain English what 1.417(a)(3)-1©(2)(i)(B) means when it provides for "Stating the amount of the annuity that is the actuarial equivalent of the optional form of benefit and that is payable at the same time and under the same conditions as the QJSA." They don't seem to provide an example of this approach. Thanks!

[jevd]

Several summaries in today's benefits link.

[Mike Preston]

I think it has to do with double comparisons. Let's assume you have a lump sum of $100,000. Let's assume that the QJSA is payable in 5 years (but not today) in the amount that is actuarially equivalent to $150,000 today. You know that your QJSA has a significant subsidy. The participant doesn't. Let's assume the QJSA payable in five years is $2000/month (random number, I'm not doing any calculations). You could state that the annuity associated with the lump sum optional form of benefit is an annuity payable 5 years from now in the amount of $1333.33.

Hence, $1,333.33 is the amount of the annuity that is the actuarial equivalent of the optional form of benefit (lump sum) payable at the same time and under the same conditions as the QJSA (5 years from now).

[Belgarath]

Gotcha. Thanks!

[Guest Harry O]

How can you have a lump sum payable today without also having an immediate QJSA?

[Mike Preston]

You can't. But the QJSA you have today is not necessarily the QJSA you have in 5 years! Let's say you have an early retirement subsidy that is payable only once an individual attains early retirement age, but they can quit before early retirement age and just wait to get their early retirement benefit. Assume somebody quits 5 years before their early retirement benefit is payable with the early retirement subsidy. They can, if they choose, take a current lump sum. As you point out, if they can get a current lump sum, they also have to get the right to start an annuity immediately, although it won't have the early retirement subsidy. I think that is the issue the reg cite was trying to address.

[MGB]

Mike,

I am not sure I understand how the referenced part of the regulation has anything to do with future subsidies. I have viewed these regulations as having a huge loophole (i.e., not accomplishing the original intent of the regulations) in that you do not have to disclose any information about that early retirement subsidy in five years and only have to use the current QJSA (without subsidy) in illustrations.

This is my understanding of (A), (B) and © (original post only asked what (B) is), by way of illustration:

(A) The optional form is 92% of the QJSA currently available.

(B) The optional form is actuarially equivalent to a currently payable $92 QJSA (compared to the $100 QJSA currently available).

© The optional form is worth $9200 compared to the $10000 value of the QJSA currently available.

I think that is all the three listed approaches are trying to say and (B) is just a formulation in the form of the QJSA. "...same time and same conditions as the QJSA." to me means you are commuting the optional form into a QJSA.

Of course, you can add the additional information that you are suggesting, but I don't think that just doing that would satisfy the rule. It is the current QJSA that the participant/spouse must decline through these procedures and it is the one that is the focus of the comparisons.

[Mike Preston]

MGB, it looks like your interpretation is better than mine. I just naturally assumed that if the intent of the reg is to eliminate the uninformed participant that the existence of a future benefit entitlement would need to be disclosed. I see that might have been an expansion of the actual words in the regs.

I'm only on my 18th time through them, so I'll reserve judgment on what they really mean (it takes me a long time to sift through the cross-references before I feel comfortable with something like this).

It does seem like the focus is on those plans that provide two (or more) current options, one of which is a seriously unsubsidized benefit (typically the lump sum) and the other of which is subsidized (typically the QJSA) benefit. They want the participant to know that if they select the lump sum they are giving up a lot.

In plans where the lump sum involves a subsidy, however, I'm struggling with just what they want to see disclosed. Seems like a simple statement along the lines of: "Gee, every benefit you can get from this plan is equivalent to the QJSA (which is typically the life annuity option), except the Lump Sum, which has an estimated relative value of X%" Where for this purpose, x% will generally exceed 100%.

But since we can use "reasonable" rates for purposes of determining relative value, if the 417(e) rates are considered, by definition, to be reasonable, then relative value will always be 100% for the lump sum. I think you have to use the same reasonable rates for all comparisons, though, so if we use 417(e) rates as our reasonable rates, we can find that the other benefit options in the plan (such as an actuarially equivalent J&S) will now have different relative values because they might be based on, for example, 6%, 83-IAM-M, rather than 417(e) interest and 94GAR mortality.

My preliminary conclusion is, therefore, to simplify the disclosures, that it would be better to use the plan rates as the reasonable rates for this purpose and then either add a statement that says the relative value of all benefits other than the lump sum is 100% and the relative value of the lump sum is x% (or, alternatively, to provide a chart that lists the relative value of the lump sum at representative ages - or at each age) and then at each place where a lump sum relative value is mentioned, also compute the lump sum for an immediate commencement $1000/month life annuity.

But this will look very strange, because the immediate commencment lump sum at age 21 will be a very large number and it will decline each year as the chart shows higher ages.

There has to be a better way.

My focus is those plans that don't have early retirement or J&S subsidies and, instead, provide that all optional forms are actuarially equivalent to the single life annuity - with the exception of the lump sum, which due to 417(e), is the subsidized benefit.

I would welcome more thoughts on the regs and how best to comply.

[MGB]

"Gee, every benefit you can get from this plan is equivalent to the QJSA (which is typically the life annuity option), except the Lump Sum, which has an estimated relative value of X%" Where for this purpose, x% will generally exceed 100%.

The value of the lump sum should not end up higher than the QJSA because you are forced to use 417(e) assumptions on the lump sum converting it back to an annuity (even though you may be using other assumptions for comparisons of other forms).

There is a small discrepancy where you could end up with the lump sum being slightly higher than the QJSA. Assume the conversion from the normal form (life annuity) to the QJSA is done using reasonable assumptions (other than 417(e)). Depending on the assumptions and their relation to current 417(e) assumptions, it is possible that the conversion of the lump sum directly to the QJSA will result in the lump sum being slightly higher (which is just the difference between 417(e) and the reasonable assumptions in a conversion from life to QJSA). This is OK (you are not forced to defend the QJSA as the most valuable based on 417(e)).

In fact, you can bypass this happening by showing everything on the basis of the life annuity form, in which case the lump sum will be 100% of the life annuity (because you must use the same assumptions in determining the lump sum and this conversion back).

(My reference to 417(e) is not really correct...if the plan has assumptions that create a larger lump sum than 417(e), you are allowed, but not required, to convert the lump sum back to the QJSA (or life annuity) using the same assumptions as were used to produce the lump sum. Again, you do this even though your other comparisons are using a different set of reasonable assumptions.)

[Mike Preston]

[WARNING - THESE POSTS ARE GETTING LONG]

I appreciate you helping me through this. You bring up the relationship between the most valuable benefit and the lump sum and that this relationship is specifically not addressed in the regulations, although there does seem to be one comment that lends support to your theory (if I understand your theory, which admittedly I might not).

I'll address that first, and then get back to some specifics on your post.

I am on record as saying that the 1.401(a)-20 regulation does, indeed, require the QJSA to be the most valuable benefit in all circumstances. Hence, if the 417(e) rates force a current lump sum to be increased above what it would otherwise be based on the plan's definition of actuarial equivalence, then there must be a corresponding increase in the immediately payable QJSA. Many people dispute this. I think your comment disputes it.

I have heard, in support of what I think your comment is saying, that this was NOT the intent of the regulation, and I don't doubt that at all. But I've never seen anything from the IRS that makes it clear. And as I read the regulation it does not leave much wiggle room.

In the newly published regulation, in the background section, there is one sentence that lends support to the position I think your comment espouses, but doesn't come out and say it: "Further, the anti-forfeiture rules of section 411(a) prohibit a participant's benefit under a defined benefit plan from being satisfied through payment of a form of benefit that is actuarially less valuable than the value of the participant's accrued benefit expressed in the form of an annual benefit commencing at normal retirement age."

No mention of 417(e) there at all. In fact, this "tension", as it was referred to in the ASPA ASAP that was just published on this issue (author Barry Kozak of Chicago Consulting Actuaries) is specifically not addressed (directly, anyway) and the "Explanation of Provisions" section of the new regulation highlights this by saying: "Several commentators raised questions concerning whether the methods used in disclosing relative value of a plan's optional forms of benefit in accordance with these regulations affect the application of the requirement at Section 1.401(a)-20, Q&A 16, that the QJSA for married participants be at least as valuable as any other optional form of benefit under the plan. While this issue is not addressed in these final regulations, there is no requirement, or implication, that the same actuarial assumptions used by a plan for purposes of disclosing relative value in accordance with these regulations must be applied for purposes of the requirement in Section 1.401(a)(-20, Q&A -16, that the QJSA for married participants be at least as valuable as any other optional form of benefit under the plan."

Not even I would think that these new sets of assumptions, which we are going to need solely for disclosure under the new regulations, would cause the actual benefits under the plan to vary.

The statement from the reg. makes it clear that you can use different assumptions from those that are specified in the plan when developing disclosures. But it leads to a serious problem with communication if you intend to use the “example” approach. If I’m going to show that $1,000 of single life annuity is, as a lump sum, worth something other than $172,306 at age 55 (based on 94GAR/5.14%) and yet show that this person, who might have a single life annuity benefit of $1,000, is entitled to a lump sum of $172,306 my forms are going to look very funny indeed.

The value of the lump sum should not end up higher than the QJSA because you are forced to use 417(e) assumptions on the lump sum converting it back to an annuity (even though you may be using other assumptions for comparisons of other forms).

I’m not sure what the above means. Are you saying it shouldn’t end up higher because of this reason, but it might end up higher for another reason? Or are you saying that it won’t end up higher because you are in my camp and believe that the QJSA must be the most valuable benefit so if the lump sum has a subsidy over the otherwise payable life annuity, that subsidy cascades to the QJSA? Example: $1,000 life annuity at age 65. Plan rates are 6%/GATT. Lump sum at 65 = $127,756.20. Participant is age 50, so plan rates lump sum (no preretirement mortality) is $53,308.20. However, 417(e) for a benefit distributable in January, 2004, based on 94GAR and interest of 5.12% (two month lookback – best example I could come up with because December rates still not published) require lump sum to be $66,249. Now, the actuarial equivalent annuity at age 50 using 6%/GATT would be $320.81 if I ignore 417(e). But if the increase in the lump sum from $53,308.20 to $66,249 must be recognized in the QJSA, it looks to me like I use 94GAR/5.12% at age 50 and come up with an annuity of $356.34.

Or, of course, it might be neither of the two.

I know this is not directly on point with respect to the new regulations, but it does highlight the circular nature of these disclosures.

There is a small discrepancy where you could end up with the lump sum being slightly higher than the QJSA. Assume the conversion from the normal form (life annuity) to the QJSA is done using reasonable assumptions (other than 417(e)). Depending on the assumptions and their relation to current 417(e) assumptions, it is possible that the conversion of the lump sum directly to the QJSA will result in the lump sum being slightly higher (which is just the difference between 417(e) and the reasonable assumptions in a conversion from life to QJSA). This is OK (you are not forced to defend the QJSA as the most valuable based on 417(e)).

Can you give a short numeric example to see if we are talking about the same thing?

In fact, you can bypass this happening by showing everything on the basis of the life annuity form, in which case the lump sum will be 100% of the life annuity (because you must use the same assumptions in determining the lump sum and this conversion back).

But if there are other alternatives under the plan, if you use the lump sum rates for purposes of determining this particular optional form’s relative value (which I admit will be 100% of the life annuity because, by definition, if you use the same rates for converting one to another and then back again, you have to end up at 100%), won’t this just create a situation where the other optional forms now end up being something other than 100%?

(My reference to 417(e) is not really correct...if the plan has assumptions that create a larger lump sum than 417(e), you are allowed, but not required, to convert the lump sum back to the QJSA (or life annuity) using the same assumptions as were used to produce the lump sum. Again, you do this even though your other comparisons are using a different set of reasonable assumptions.)

If I’m understanding this correctly, you are saying that it is ok to use different sets of actuarial assumptions for comparison of different optional forms. I’m not sure I see where in the regulation it allows this. If it does, then there is virtually no disclosure required at all in the case I posit: the plan that has no early retirement subsidies and all annuity options are actuarially equivalent to the life annuity payable.

Talk about loopholes!

Let’s work backwards. The new regulation appears to want disclosure of the LACK of subsidy built into a lump sum. Theoretically, this is so a participant doesn’t accept the lump sum when the annuity would clearly be more valuable. But if the EXISTENCE of a subsidy in the lump sum can be masked, aren’t we just moving the problem around on the table and putting the participant in a position where they might accept an annuity even though the lump sum is clearly more valuable?

I guess to simplify, I’d like to know what is thought the necessary disclosures are in the numeric case I posited above: terminee age 50 with a benefit payable at age 65 of $1,000 month, and the plan has a lump sum option where the actuarial factors are clearly not as generous as the 417(e) rules require.

[MGB]

I am on record as saying that the 1.401(a)-20 regulation does, indeed, require the QJSA to be the most valuable benefit in all circumstances. Hence, if the 417(e) rates force a current lump sum to be increased above what it would otherwise be based on the plan's definition of actuarial equivalence, then there must be a corresponding increase in the immediately payable QJSA. Many people dispute this. I think your comment disputes it.

I only dispute this because of your reference to the actuarial equivalence in the plan. I have never seen any tie-in to the AE in the plan as having anything to do with the "reasonable assumptions" that must be used to demonstrate that the QJSA is the most valuable form.

Proving that the QJSA is the most valuable form and proving that 411 is satisfied by not providing a form that is less valuable than the normal form are concepts that must be upheld outside of the plan. 417(e) rates and AE definitions in the plan have no bearing on this. For example, there are plans with no AE definition in the plan (e.g., simplified commutation factors are used to convert from one form to another) and you still need to be able to show that these two issues are satisfied under reasonable assumptions.

[MGB]

Or are you saying that it won’t end up higher because you are in my camp and believe that the QJSA must be the most valuable benefit so if the lump sum has a subsidy over the otherwise payable life annuity, that subsidy cascades to the QJSA? Example: $1,000 life annuity at age 65. Plan rates are 6%/GATT. Lump sum at 65 = $127,756.20. Participant is age 50, so plan rates lump sum (no preretirement mortality) is $53,308.20. However, 417(e) for a benefit distributable in January, 2004, based on 94GAR and interest of 5.12% (two month lookback – best example I could come up with because December rates still not published) require lump sum to be $66,249. Now, the actuarial equivalent annuity at age 50 using 6%/GATT would be $320.81 if I ignore 417(e). But if the increase in the lump sum from $53,308.20 to $66,249 must be recognized in the QJSA, it looks to me like I use 94GAR/5.12% at age 50 and come up with an annuity of $356.34.

I don't see any reason to make any adjustment to the QJSA based on anything going on with the lump sum. That should never happen from an administrative standpoint. However, if the QJSA is not the most valuable when reviewing the provisions of the plan, then it may require an amendment to make it the most valuable. But, I don't see any need to do it in this case.

The lump sum is actuarially equivalent to the normal form (using 417(e)). The QJSA is actuarially equivalent to the normal form (using reasonable assumptions such as 6% and "GATT" (I don't know what that means)). Therefore, the law is satisfied. The fact that the law requires the use of 417(e) to determine a lump sum does not make it more valuable than other benefits that don't use 417(e) to determine them.

[MGB]

If I’m understanding this correctly, you are saying that it is ok to use different sets of actuarial assumptions for comparison of different optional forms. I’m not sure I see where in the regulation it allows this. If it does, then there is virtually no disclosure required at all in the case I posit: the plan that has no early retirement subsidies and all annuity options are actuarially equivalent to the life annuity payable.

That is correct.

[Mike Preston]

The fact that the law requires the use of 417(e) to determine a lump sum does not make it more valuable than other benefits that don't use 417(e) to determine them.

I guess it comes down to what is meant by "most valuable". I think Q&A 16 of 1.401(a)-20, in the case of a married participant, is about as clear as it can be: "In the case of a married participant, the QJSA must be at least as valuable as any other optional form of benefit payable under the plan at the same time. "

I find a lump sum to be an optional form of benefit.

Transparency is what these new regulations are all about.

And if the lump sum is based on 417(e) rates of, 4.37% (check out the June 2003 GATT rates at http://www.irs.gov/retirement/article/0,,id=96450,00.html) it will be the most valuable benefit in every plan I've seen. That is, I've never seen a plan with more generous actuarial equivalence provisions, whether tabular or explicit.

But I rarely see a plan offer to a terminating participant the immediate commencement of a QJSA that is actuarially equivalent to the, in this case anyway, "more valuable" lump sum.

You say that you don't see any reason to adjust the QJSA based on anything going on with the lump sum. And I agree that your position is the norm. I've just never thought it to be compliant with the regulation in the case of a married participant.

Not without more stretching of the plain language of the regulation (that is, interpreting how one determines "most valuable") in a way that is more likely to make the sound of a rubber band snapping than the 404a7 discussion in another thread. All, IMO, of course.

I know my position is unpopular and I'm pretty sure that the intent of the regulation was not to cause the subsidized lump sum to increase the annuity required under the QJSA. But the reg was drafted long before 417(e) went into effect and the IRS could have, had they decided to, amended 1.401(a)-20 to clarify the issue by now. They haven't.

Maybe the "intent" of the new regulations, which I perceive to be transparency for the benefit of the participant, will push the IRS to make a change to 1.401(a)-20 so that it is clear there is, in fact, no reason to adjust a QJSA based on anything going on with the lump sum. That would be fine.

About the only way I can surmise that compliance with the reg is perceived is by stating that the lump sum is to be compared to the QJSA on the basis of the factors that are used to determine the lump sum. If that is the logic that is used, by definition, it must be the "same" value and therefore wouldn't violate the requirement for the annuity to be the most valuable. I just don't see it as being that clear.

In fact, I think transparency would argue that it is unreasonable to assume that 4.37%/94GAR (aka 417(e)) rates are reasonable at the same time rates of say, 6%/83GAM-U, are being used as reasonable rates for other disclosures. Certainly a participant has the right to know that the lump sum based on 4.37%/94GAR is more valuable than an annuity that is actuarially reduced based on 6%/83GAM-U.