FASB Question for a Small Plan

[mwyatt]

Recently established a small DB plan (1 100% owner @ 55, 8 employees, some highly paid, all significantly younger). The reality is that this plan will be in place until the owner reaches age 65 and then be terminated. Definitely would not continue in the future after the owner's retirement.

Given small population, not getting involved initially w/ pre-retirement death decrements as death benefit is PVAB and feeling is that death rates would be "false precision" given the small number of participants. However, am thinking of a turnover assumption to reflect the likelihood of plan termination after 10 years.

My question is this: for FASB purposes, I'm projecting COLA increase in the salary and 415 limitation to retirement. However, my preliminary numbers, given the fact that many of the younger people are at the limits right now anyway, gives a NPPC twice as high as the regular valuation cost, mainly due to projections to NRD of their salary and 415 limitations. With this approach, the sponsor will be accumulating accrued pension costs each year drastically higher than the actual contributions going into the plan. However, the plan will end in 10 years (if not sooner), where this liability will go poof (to use an actuarial term). Given this situation, what would people think of some sort of turnover assumption being used reflecting the overwhelming probability of the plan not continuing past the owner's expected retirement? Would still reflect future salary and limitation increases over the next 10 years in the PBO and Service Cost, but not beyond that point. Any thoughts?

[SoCalActuary]

I like your thought of projecting turnover or assumed termination for FAS purposes, even though it is not a normal IRS assumption.

As to the PBO vs ABO issues, your choice of assumptions is key to getting a reasonable result.

If you end up with an overstated PBO at plan term, then the employer gets a gain on their financial statement.

[Andy the Actuary]

I would be interested to know the circumstances of why FASB projections are required. I've never seen a plan of 9 participants -- likely a closely held company -- where the employer/accountant did not ignore FASB.

[Mike Preston]

I have seen situations where firms have insisted upon GAAP financial statements to satisfy significant lines of credit. Typically, although not limited to, construction firms.

[AndyH]

mike, interesting question. I have never seen what you describe but that doesn't mean that you can't do it.

One question though: Are you anticipating termination of the employees, or are you really anticipating termination of the plan? If the latter, isn't that within the realm of FAS88 curtailment and the rules there about when a curtailment should be recognized?

Just a thought. Hope all is well.

[SoCalActuary]

The number of small businesses that need audited financial statements is small, but if you see enough plans, you will encounter a few. As Mike mentioned, often these have leveraged assets like construction projects or import/export work, or possibly real estate management.

It is useful to remember that the FAS calculations are not subject to IRS review, but rather they rely on a general legal principle: that the users of this information are basing their financial decisions on the answer.

Thus, a FAS 158 report that is unrealistic will lead to the possible consequence that the mis-led will sue.

You need to consider your choice of plan design, the matching of pension cost to realistic pension risks of the company, and the relationship you present between PBO and plan assets. For example, do you pick a safe harbor plan based on FAE over 25 years, or do you choose a unit benefit accrual for the expected period until the owner retires? Do you grant past service credits because it allows more leverage for the owner, even though it creates a higher unfunded PBO? Do you plan your assumptions for a 10 year horizon or for a lifetime annuity of an ongoing firm that will keep the plan after the owner retires? You have to make those decisions.

[Mike Preston]

Rarely do I read a message that I wish I had wrote verbatim. SoCalActuary has produced one. WHAT HE SAID!

[flosfur]

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You need to consider your choice of plan design, the matching of pension cost to realistic pension risks of the company, and the relationship you present between PBO and plan assets. For example, do you pick a safe harbor plan based on FAE over 25 years, or do you choose a unit benefit accrual for the expected period until the owner retires? Do you grant past service credits because it allows more leverage for the owner, even though it creates a higher unfunded PBO? Do you plan your assumptions for a 10 year horizon or for a lifetime annuity of an ongoing firm that will keep the plan after the owner retires? You have to make those decisions.

What do the plan design considerations have to with FASB calcs? Plan designing in small is most often (dare I say always) affected by the contribution goal of the sponsor.

[flosfur]

I would be interested to know the circumstances of why FASB projections are required. I've never seen a plan of 9 participants -- likely a closely held company -- where the employer/accountant did not ignore FASB.

I have been asked to provide FASB numbers for one person plan because the creditor(s) wanted to have them!

[Mike Preston]

What do the plan design considerations have to with FASB calcs? Plan designing in small is most often (dare I say always) affected by the contribution goal of the sponsor.

The tracking between ABO and funding used to be a very critical plan design consideration. Now, the tracking between PBO and funding is a very critical plan design consideration. Sometimes an "affordable" plan in the context of minimum funding standards becomes an "unaffordable" plan on the financial statements. Same thing can happen in reverse, as well, especially in the case of a conservative management group and an aggressive employee representative.

[SoCalActuary]

Thanks for the kind thoughts. Nice way to start the week.