Need some help on floor offset arrangement

[Guest ActuaryWannabe]

I am relatively new to floor offset and am hoping that one of you seasoned veterans can help me. It involves a 412(i) plan and I am REALLY new to that area.

Someone else in our office prepared calculations for this plan, but that individual has left the company and I have to finish the year end work. There are a couple of things that do not seem right to me, but, what do I know?

The first question is about the accrued benefit under the 412(i) plan. Since the accrued benefit is the cash surrender value of the insurance policy, it seems like there is the ability to control this number by timing the premium payment. That does not seem right, and in this case there appears to be some variation on that from year to year.

The second question is about the offset piece. In this case, we are in the second year of the plans. Only one year's premium has been paid on the 412(i) plan, and the cash surrender value reflects that. However, there are two years' contributions included in the calculation of the offset. That also does not seem right.

Any pointers would be appreciated. Also, how do the new regs affect these issues, if at all?

[AndyH]

"It involves a 412(i) plan and I am REALLY new to that area."

Read: "Prepare to pay big tax bill."

http://benefitslink.com/boards/index.php?a...indpost&p=89025

Seriously, Wannabe, I'd help you if I could, but I am unable to provide any help other than the suggestion that you run from it if at all possible.

[Blinky the 3-eyed Fish]

Now Andy, there still are some viable 412(i) options.

Wannabe, are you sure the document describes the accrued benefit as equal to the CSV and does not in some way reference the benefit formula?

[AndyH]

I am hung up on comments that I recall at the 2002 ASPA National Conference Q&A session by Jim Holland that if a 412(i) needed a 11(g) corrective amendment then it probably was no longer a 412(i) plan. And there was some vague inference about whether a general tested 412(i) plan was in fact still a 412(i) plan, so that's where I jump ship on this question.

As I said, I don't pretend to know the answer; just that the murky waters may contain some unusual and untested denizens of the deep that may not be discovered until more exploration by the appropriate officials, which is just starting, is complete.

As my HS Principal used to say every day on the intercom, "A word to the wise should be sufficient".

[Blinky the 3-eyed Fish]

Andy, did you read that nice article by Larry Deutsch in the Sep-Oct 2003 issue of the ASPA Journal? He poses some additional problems with 412(i) offsets as he sees it.

I didn't agree fully with his article. One being that the accrued benefit in a 412(i) plan must be defined as the CSV of the policies.

[AndyH]

Actually, I saw it but forgot to read it. I lent it to somebody else but never got it back. I will; thanks for the reminder.

[Guest ActuaryWannabe]

Yes, Blinky, I'm sure.

[Mike Preston]

That, at least, is a good thing. My understanding is that the AB is indeed the value of the contract.

[Blinky the 3-eyed Fish]

Mike, I have a 412(i) plan with the following language:

"Notwithstanding anything herein to the contrary, a Participant's Accrued Benefit attributable to the retirement benefit formula at the close of any Plan Year coinciding with or next following the Participant's attainment of Normal Retirement Age shall be equal to the monthly retirement benefit formula determined pursuant to Section 5.1(d) based upon service and Average Monthly Compensation determined at the close of any such Plan Year."

5.1(d) is the benefit formula

I see that 411(b)(1)(F), the cite quoted by Mr. Deutsch as the basis for his statement that the AB equals the CSV, is one way to satisfy 411 for a 412(i) plan, not the exclusive way.

Also, what happens when the TH benefit is greater and a side fund is created. Certainly, the contract value is less in that case.

Wannabe, I am not sure what to do in your situation.

Andy, this is not an abusive situation I assure you.

[Guest ActuaryWannabe]

"Notwithstanding anything herein to the contrary, a Participant's Accrued Benefit attributable to the retirement benefit formula at the close of any Plan Year coinciding with or next following the Participant's attainment of Normal Retirement Age shall be equal to the monthly retirement benefit formula determined pursuant to Section 5.1(d) based upon service and Average Monthly Compensation determined at the close of any such Plan Year."

How is the AB for a Plan Year subsequent to NRD relevant to this discussion? Am I missing something?

[AndyH]

All right, Blinky. Post your "Big tax bill" document here and we'll chow down and give our takes.

[Mike Preston]

I agree that it must be at least equal to the CSV. But if it is more, and it is NOT merely because of the top-heavy exception, then I think the net effect is that you end up with a non-412i plan.

[Blinky the 3-eyed Fish]

Ah Mike, but why do you think it must be at least equal to the CSV?

I know it's a different situation, but you can pay out a terminee a vested amount less than the CSV.

[Mike Preston]

I'm not sure I understand. The requirements of 411B1f seem clear to me. If the AB is not at least equal to the CSV, the plan fails.

Are you saying that the argument above is not logical because a 50% vested employee can receive a benefit equal to 50% of the csv?

[Blinky the 3-eyed Fish]

But where does it say that 411(b)(1)(F) is the ONLY way for a 412(i) plan to satisfy 411? I see it as one way, an extra way that is only available to 412(i) plans, although I could be wrong.

[Mike Preston]

411b1F indeed only says that the ab must be AT LEAST as large as the csv. But as I tried to communicate, but obviously did a bad job of it, if the ab is anything other than the csv, then you have a plan that will fail to satisfy one of the other 412i requirements. Don't have time to research the particular sections today, but, IIRC, one of the requirements is that the contributions be determined on a level premium basis. If the ab is greater than the csv then, if someone terminates, the net result is that there must be additional funds found somewhere. Oopsies! No 412i. The only exception is the allowance for a side fund specifically for top-heavy benefits. So, think of the language of 411b1F as allowing the top-heavy side fund, but no other.

[Blinky the 3-eyed Fish]

I am going for the "WOW".

If the ab is greater than the csv then, if someone terminates, the net result is that there must be additional funds found somewhere. Oopsies! No 412i.

But why do you not think it satisfies 412(i) if the AB is more (or less for that matter) than the CSV? Here is Section 412(i).

(i) Certain Insurance Contract Plans

A plan is described in this subsection if--

(1) the plan is funded exclusively by the purchase of individual insurance contracts.

(2) such contracts provide for level annual premium payments to be paid extending not later than the retirement age for each individual participating in the plan, and commencing with the date the individual became a participant in the plan (or, in the case of an increase in benefits, commencing at the time such increase becomes effective),

(3) benefits provided by the plan are equal to the benefits provided under each contract at normal retirement age under the plan and are guaranteed by an insurance carrier (licensed under the laws of a State to do business with the plan) to the extent premiums have been paid,

(4) premiums payable for the plan year, and all prior plan years, under such contracts have been paid before lapse or there is reinstatement of the policy,

(5) no rights under such contracts have been subject to a security interest at any time during the plan year, and

(6) no policy loans are outstanding at any time during the plan year. A plan funded exclusively by the purchase of group insurance contracts which is determined under regulations prescribed by the Secretary to have the same characteristics as contracts described in the preceding sentence shall be treated as a plan described in this subsection.

I only see in (3) the requirement that the AB equal the CSV at NRA, not at any other time. 1.412(i)-1(b)(2)(iii) has the same stipulation.

The only exception is the allowance for a side fund specifically for top-heavy benefits. So, think of the language of 411b1F as allowing the top-heavy side fund, but no other.

Regarding the TH side fund, here is 1.416-1, M-17:

Q-17. Can a plan described in section 412(i) (funded exclusively by level premium insurance contracts) also satisfy the minimum benefit requirements of section 416?

A-17. The accrued benefits provided for a non-key employee under most level premium insurance contracts might not provide a benefit satisfying the defined benefit minimum because of the lower cash values in early years under most level premium insurance contracts, and because such contracts normally provide for level premiums until normal retirement age. However, a plan will not be considered to violate the requirements of section 412(i) merely because it funds certain benefits through either an auxiliary fund or deferred annuity contracts, if the following conditions are met:

(1) The targeted benefit at normal retirement age under the level premium insurance contract is determined, taking into account the defined benefit minimum that would be required assuming the current top-heavy (or non top-heavy) status of the plan continues until normal retirement age; and

(2) The benefits provided by the auxiliary fund or deferred annuity contracts do not exceed the excess of the defined benefit minimum benefits over the benefits provided by the level premium insurance contract.

If the above conditions are satisfied, then the plan is still exempt from the minimum funding requirements under section 412 and may still utilize the special accrued benefit rule in section 411(b)(1)(F) subject to the following modifications: Although the portion of the plan funded by the level premium annuity contract is exempt from the minimum funding requirements, the portion funded by an auxiliary fund is subject to those requirements. (Thus, a funding standard account must be maintained and a Schedule B must be filed with the annual report). The accrued benefit for any participant may be determined using the rule in section 411(b)(1)(F) but must not be less than the defined benefit minimum.

I agree that the side fund for TH is the only allowable side fund to satisfy 411(b)(1)(F). Though, note the last sentence certainly says the AB may still use 411(b)(1)(F), indicating a 412(i) plan is not required to use it.

So, forgive me for still searching for why an AB not equal to the CSV, TH aside, throws the plan out of 412(i) compliance.

[Mike Preston]

I think it will be a very cold day in a very warm place before you earn a wow, or a WOW. At least from me.

I don't mean to sidestep the issue, but there is another important piece to the puzzle besides the Code and regs. The IRS also has issued some revenue rulings to help us understand when a plan is entitled to be classified as a 412(i) plan.

Revenue Ruling 81-196 is one of these. I seem to recall that there was a revenue ruling (and the number 106 is sticking in my head, but darn if I can find it now) that also laid out some specifics.

But lets just look at the regs for a second. They are amazingly short. But they clearly state that the plan must be funded exclusively by the purchase of contracts from an insurance company and that there is an exception for accrued benefits from employee contributions. The 416 exception doesn't appear here, it appears in the 416 regs.

How do you satisfy that if the accrued benefit at any point in time exceeds the csv? If a fully vested participant terminates you would have to satisfy the benefits via a supplemental payment. As stated in my prior message, that is an "Oopsies!".

I think you are reading 1.412(i)(b)(2)(iii) the wrong way. "The benefits provided by the plan for each individual participant must be equal to the benefits provided under his individual contracts at his normal retirement age under the plan provisions." I think this section is there to ensure that there not be any unfunded benefits at NRD (no backloading). Nothing more. It doesn't imply that you can frontload, however, by providing for benefits in excess of what the insurance contracts will pay in the interim.

I'm going to keep searching for the RR (or whatever other source I think exists - I know it is out there, I just can't find it at the moment). It might provide a clearer path to what I'm trying to communicate.

[Blinky the 3-eyed Fish]

I will await with baited breath.

[AndyH]

WOWs are hard to come by. They usually follow wildly erroneous comments by persons claiming vast experience and knowledge, and who frequently are associated with products such as 412(i) and/or annuities. Hmmmm.

[Blinky the 3-eyed Fish]

Well then let me inform you how to avoid all income and property tax by declaring your home residence a soveriegn state.