Calculating Normal Accrual Rates and Equivalent Allocation Rates

[Guest Grumpy456]

I am new to DB plan general testing and cash balance plans. I've been trying to figure out how to calculate a normal accrual rate and equivalent allocation rate for a cash balance plan. In the text below, I've shown my attempt to calculate both rates. Can someone who is familiar with these concepts take a quick look at these calculations and let me know if they are correct and, if not, why not? I greatly appreciate any help--I'm largely operating on my own and don't have the benefit of working with an actuary or compliance testing specialist. Thanks again!

Data:

Mary Smith

Pay = $220,000

AA = 48

RA = 65

Cash Balance Plan Hypothetical Pay Credit = 7.5%

Hypothetical Interest Credit = 6%

Part 1--Calculating Mary's Normal Accrual Rate

 Using the current year as the measurement period.

 Since using the current year as the measurement period, Mary's testing service is equal to 1.

 Using current year pay as average annual compensation.

Step 1: Mary's hypothetical pay credit @ 48 = $16,500 (i.e., $220,000 * 7.5%)

Step 2: Mary's accrued benefit @ 48 = $16,500 projected to RA using hypothetical interest credit (6%)

= $16,500 * (1.06)65-48

= $16,500 * (1.06)17

= $44,431

Step 3: Convert the accumulated value of the hypothetical pay credit to a single life annuity ("SLA") payable at age 65 using the cash balance plan's definition of actuarial equivalence (assume GAM83 @ 6.5%)

= $44,431 ÷ 10.45

= $4,252 annual benefit

Step 4: Divide the annual benefit by Mary's annual pay

= $4,252 ÷ $220,000

= 1.93%

Normal Accrual Rate = 1.93%

(ignore Most Valuable Accrual Rate for now)

Have I computed this figure correctly? If not, why not?

Part 2--Calculating Mary's Equivalent Allocation Rate

Step 1: same as above

Step 2: same as above

Step 3: discount the $44,431 to age 48 using a standard interest rate (say 7.5%)

= $44,431 (1.075)-17

= $12,994

Step 4: Divide the discounted benefit by Mary's annual pay

= $12,994 ÷ $220,000

= 5.9%

Equivalent Allocation Rate = 5.9%

(ignore Most Valuable Equivalent Allocation Rate for now)

Have I computed this figure correctly? If not, why not?

[Blinky the 3-eyed Fish]

I agree with your Part I methodology but didn't match your purchase rate of 10.45.

As for Part II, the EAR is the present value the benefit at the testing rate used. Your benefit is the value determined in Part I, so your calculation is as follows (assuming testing rate is 7.5% and 83GAM mortality)

APR age 65 7.5% 83 GAM = 8.9353

EAR = $4,252 * 8.9353 / [(1.075) ^ (65-48)] = 11,110

11,110 / 220,000 = 5.05%

[Guest Grumpy456]

Blinky, thanks so much for your reply! It helped a lot!

If you don't mind, can I pick your brain with respect to the most valuable accrual rate component of Part I?

What is the "most valuable accrual rate"?

As I read the Treas. Reg. Sec. 1.401(a)(4)-3(d)(1)(ii), the term "most valuable accrual rate" is "the increase in the employee's most valuable optional form of payment of the accrued benefit during the measurement period, divided by the employee's testing service during the measurement period, and expressed either as a dollar amount or as a percentage of the employee's average annual compensation." For this purpose, "the employee's most valuabel optional form of payment of the accrued benefit is determined by calculating for the employee the normalized QJSA associated with the accrued benefit that is potentially payable in the current or any future planyear at any age under the plan and selecting the largest (per year of testing service)."

I've attached an example from the 1991 version of the 401(a)(4) regulations that attempts, I believe, to explain this calculation (this is the clearest most comprehensive example I have been able to find).MVAR.doc

Since lump sum payments are subject to 417(e) and oftentimes produce benefits that are larger than other types of benefits provided by a DB plan, are lump sums considered in calculating the most valuable accrual and allocation rates?

More specifically,

(1) If a DB plan provides a lump sum as one of its optional forms of payment, is the lump sum ever taken into account in calculating the most valuable accrual rate?

(2) In the context of a cash balance plan where the assumed form of payment is a lump sum, do you have to take the lump sum into account in calculating the most valuable accrual rate?

I am really interested in your answer to (2) because I am currently working on a cash balance plan design and I've been told that in doing the 401(a)(4) testing, the most valuable accrual rate will be the greater of (1) the normal accrual rate we discussed in Part I of my last question or (2) the normal accrual rate calculated as in Part I of my last question (calculated using a standard interest rate and standard mortality table). Does this sound right to you?

Thanks so much for your help!!!

[AndyH]

http://benefitslink.com/boards/index.php?showtopic=33016

[Guest Grumpy456]

Will someone post the TAM that was issued last month explaining this issue (or at least post a citation so we can obtain a copy through Westlaw or LEXIS)? Thanks!