Lump Sum conversion to immediate J&S

[JAY21]

I believe if a plan offers a lump sum distribution option before retirement age (e.g., upon termination of employment), and the lump sum amount is over $5,000, then an immediate J&S annuity must be determined/offered at the current age.

If the lump sum is base upon GATT (plan provides for lump sum equal to greater value of (a) actuarial equiv or (b) Gatt mortality/rates) does the GATT PVAB at the current age get divided by an immediate annuity factor based on plan's normal actuarial equivalence (used for alternative forms of annuity distributions) - OR - by an immediate GATT annuity factor using the Gatt table/required interest rate ?

Thanks !

[AndyH]

You are correct about the need to offer the immediate annuity in the situation you describe.

But, no, the GATT/GAR rate is not normally a factor in the calculation of the immediate annuity. The immediate annuity is ordinarily the NRA annuity reduced by whatever the plan says it is reduced by.

If the plan defines actuarial equivalence for all purposes as being the GATT/GAR rates, then it is possible that the result is as you describe, but I believe that would be the exception rather than the rule.

The determination of the immediate annuity is plan specific.

[JAY21]

Andy, for some reason I thought the immediate annuity had to be the actuarial equivalent of the PVAB (including any GATT subsidy on the lump sum). So am I wrong in that thinking ? It seems you'd get a different result than the actuarial reduction scenario you described.

[AndyH]

The GATT/GAR rate is caused by IRC 417(e). This only applies to lump sums. These factors are not required to be used for early retirement annuity calculations. They seldom are.

I think the first guidance on this was IRS Notice 87-20, if you want to track the history and origin.

[MGB]

Jay,

You have come across what the Academy of Actuaries has been struggling with under the "relative value disclosure" regulations.

The reduction from NRA to the distribution date must follow plan provisions. As already stated, this is seldom, if ever tied to 417(e) rates (just look at any early retirement provision). This is an annuity to annuity calculation, the PVAB is irrelevant.

Then, there is also a lump sum that is calculated as the PVAB of the NRA annuity using 417(e) assumptions (or better if plan so provides).

Now, in order to do a "relative value" disclosure comparing the current QJ&S and the lump sum, it will almost always be a fact that the lump sum is much more valuable than the QJ&S because of the mismatch of assumptions in calculating each, even though they both started from the deferred NRA annuity.

However, in the regulations, it states that you can optionally call these "actuarially equivalent" and never mention that the lump sum actually works out to 150% or 200% (for younger participants) of the QJ&S.

Note that if an actuary helps in this determination, they are violating Precept 8 of the Code of Professional Conduct that states our work product should not be used to mislead a third party. (Note that the Actuarial Board of Counseling and Discipline has already indicated this result is for real to the Academy's pension committees.)

So, one of the reasons for the delay in the relative value regulations was to have a chance to address this conundrum that actuaries are in. Unbelievably, the solution to the problem is to change the regulation from "may" to "must" call these actuarially equivalent. Then we are only following the rules (albeit misleading) rather than being party to a decision that can mislead a third party.

[JAY21]

Thanks Andy and MGB. Much appreciated.

[Effen]

it will almost always be a fact that the lump sum is much more valuable than the QJ&S because of the mismatch of assumptions in calculating each

Mark, as you know, this is highly dependent on the AE used to determine the immediate J&S. We are finding that quite often the QJSA is actually worth more and we need to provide the relative value disclosures. For example, if the plan contains a significantly subsidized early retirement benefit and if the value of the immediate QJSA contains this subsidy, you can easily have a situation where the QJSA is worth more. Also, if the person is near retirement age, the difference in the simplified conversion factors used by the plan and the 417(e) rates can result in QJSA's "worth" > 100% of the lump sum. Not a lot more, but as I read the Regs, 100.01% means you need to provide the relative value disclosures.

I just wanted to caution the readers that based on our experience, the lump sum is not "almost always" greater in value than the immediate QJSA.

[MGB]

Yes, I was referring to the pre-early eligibility situations (which generally do not include the early subsidies in either calculation).