FIL Funding Method

[ac]

We have a takeover plan that uses the Frozen Initial Liability Cost Method. The initial FIL base is considered amortized due to the ERISA FFL in past years. The plan was amended to freeze benefit accruals. This amendment reduced the unfunded accrued liability.

Do you set up a base for the reduction in the accrued liability?

[JAY21]

Once the unfunded liabiliaty become negative (e.g., wiped out by ERISA FFL) you can try to restablish the UFIL base, but if it's still negative afterwards, you can change to the Aggregate method (either as level dollar or percent of pay method). Also if you plan was frozen before the first day of the plan year in question then you have automatic approval under Rev. Proc. 2000-40 to change to the Unit Credit Funding method.

[ac]

I guess once the initial unfunded liability got wiped out, the funding method was basically aggregate. I just don't know what happens when you change assumptions or amend the plan after the initial unfunded is wiped out. Has anyone reestablished the initial unfunded liability base?

[david rigby]

I disagree (now there's a surprise). Just because the Unfunded FIL is amoritzed/wiped-out, does not mean you have the Aggregate method. What you have is governed by the definition of the method you are already using.

-- You might still have FIL, with a zero unfunded, which behaves like the aggregate method (for example, your 412 normal cost will differ from the 404 normal cost if you have a Credit Balance). This is important because your unfunded can become non-zero through normal plan operation. (It may not be a good idea, but it can happen.)

-- Alternatively, your FIL method definition could state that it will automatically revert to aggregate in this situation (which is a method change under 2000-40). But the method definition should already state this (yes, I acknowledge most definitions are silent on this).

Back to the freeze question. The comment about automatic approval for UC is correct, but not quite strong enough. The IRS has stated "must change to UC", although I'm not aware of it in any official document. At any rate, IMHO, it is not worth fighting.

Try a search on this message board (the DB one) for this issue. Several related prior discussion.

[MGB]

The "reasonable funding method" regulations from 1981 (yes, there actually are still some things from them that apply) include the statement:

"Under a reasonable funding method that allocates liabilities among different elements of past and future service, the allocation of liabilities must be reasonable." 1.412©(3)-1©(5)

(Note that the aggregate method is not subject to the above statement because it does not allocate liabilities.)

And, they even go into more detail on this as it applies to the unit credit method under 1.412©(3)-1(e)(3). "...this allocation must be in proportion to the applicable rates of benefit accrual under the plan."

The IRS views a frozen plan as having no "future service," so if an allocation of liabilities occurs, all liabilities must be allocated to past service. The only method that does this is the unit credit method (which then must follow the benefit accrual pattern which is zero going forward; so all statements of allocation fit nicely together with no loopholes).

I get the impression from them that they view this as "obvious," (I agree) so it is not in any official promulgation, but certainly has been voiced by IRS representatives.

[Blinky the 3-eyed Fish]

I realize this is a tangent to the original question, but since it appears to be answered, I will indulge myself.

The IRS views a frozen plan as having no "future service,"

I get the impression from them that they view this as "obvious," (I agree)

I am one who does not agree with the IRS' stance, because I don't agree the plan should be interpreted as having no future service. If the plan has active participants, indeed there is future working lifetime the costs can be spread over. Instead of truly freezing the plan, in most circumstances one could simply amend the plan with wear-away and achieve the same "frozen" effect. Would the IRS then call for UC to be used, when the plan is not frozen? My rant is over now.

[MGB]

An interesting twist.

Be careful what you rant over. It may induce the IRS to start thinking that no service should be recognized in any ongoing plan for years where wearaway is projected to occur for purposes of spreading costs in the future.

That is the IRS's way of dealing with such arguments. What starts as a limited scope issue suddenly applies across the board to the vast majority. Typically, this jumps up at us in situations where there has been nothing specific in writing (like this one).

Perhaps the reason nothing has been clearly stated in an official promulgation is they feel they would logically have to extend it to all situations and know the ranting that would occur if they actually did that.