Past Service to generate PPA 06 Funding Cushion

[JAY21]

Looking for a concept check/correction, know points discussed before. Assume DB plan new for 2008 (1 man plan w/225k comp) with EOY valuation and would have target normal cost of say $100,000 at EOY if accruals based upon participation. It's been discussed that in this situation the first year of plan that min=max funding since cushion (max funding) based upon target liability at BOY which is zero (0).

It's been further discussed that switching accruals to past service would give you a target liability at BOY that is not zero, and could therefore create a funding range in the first year. If we take this approach, and given 415 apparently has special rule for funding as of 1st day of plan year (can assume a 1/10th 415 limit accrual), would the mechanics of putting in a rich unit credit formula of say 10% for each YOS (maybe limited to 1 year past service credit) produce a funding approach like the following:

Target Liability @BOY: $100,000 (might be discounted back 1 year for interest adj.)

Cushion Amount: $100,000 * 1.5 = $150,000

Target Normal Cost: $ 0 (since 1/10th of 415 limit is max accrual and it's been applied as of 1st day of plan year to past service accruals).

Shortfall Base/Pmt: ($100,000)/TAF (based on appropriate segment rates), assume payment is maybe $16,000.

DB Funding Range: $16,000 to $150,000 (or whatever the exact number produce).

Does this work ? Corrections ? The lack of normal cost seems weird but you wouldn't have 2/10ths of the 415 limit at EOY so I don't see how you'd have an accrual for normal cost.

[Blinky the 3-eyed Fish]

I haven't come across anything that says this isn't correct.

[mwyatt]

Larry Deutsch did have an observation at the EA meeting that you wouldn't want to put the entire benefit at the beginning of the year; actually would want 1/4 at inception, 3/4 accruing during the year (or vice versa, going on memory) so you don't run into a violation of the 133 1/3 accrual rule.

[ak2ary]

The 133 1/3 rule is only an issue for plans that use it, such as cash balance plans. If you have a one person 415 limit plan, there is no reason to use a cash balance design. A traditional design that meets the fractional rule will work fine. Also IRS has promised additional guidance on the 133 1/3 rd rule that, they say will allow most greater of formulas to meet 133 1/3. Further, technical corrections will apply the cushion to the target normal cost

So while this was, in theory, a problem for April 1 AFTAPs...I don't expect it to be a big deal

Also BTW in a plan that pays immediate lump sums, the plan will have an at-risk liability equal to the PV of immediate lump sums...so you can fund at least for the lump sums...

[david rigby]

I like Blinky's phrasing.

I recall a discussion in one session at the EA meeting that proposed (almost) exactly what JAY21 decribes, and the panel responded with "Yep".

BTW, does the individual have a fiscal year other than the CY?

[Blinky the 3-eyed Fish]

Ak2, I am assuming your last sentence relates to a plan who actually is subject to the at-risk rules and not smaller plans.

[ak2ary]

All plans can deduct unfunded (at-risk target liability + at-risk TNC) regardless of size

[Blinky the 3-eyed Fish]

Good to know. I hadn't gotten into the details far enough to know that.

[flosfur]

............. Further, technical corrections will apply the cushion to the target normal cost

...........

How definite is it that that this is going to happen? Can one quote new plan funding numbers with 50% cusion?

[ak2ary]

One can quote that way as long as the one is not me and doesn't work for me. Actually, you're dealing with 404 and not 430 or 436. It seems to me that I would quote the 404 number as being based on current law and note that, if tech corrections pass, it will blossom to (insert higher number).

So you could let the client know that the higher limit is possible, even likely, but don't let the client fund it quite yet

[JAY21]

I wonder if the at risk assumptions that apply to all plans for 404 will practically result in much in any difference for a very small plan if the first year of the plan is say 2008 (i.e., doesn't seem it would qualify for the load factor under at risk rules).

If I understand the at risk rules, and maybe I don't, it's (A) primarily assuming the earliest ERA/NRA will be taken (but not before plan year end) for participants expected to be eligible for either in the next 10 years, and (B) further assuming the most valuable benefit option will be taken.

These "special assumptions" just sound like typical small plan design to me that would already be part of the minimum funding under IRC 430, wouldn't it ? What enhanced value/add'l contribution would the 404 likely produce for a 1st year plan in 2008 for someone funding at 1/10 of their 415 limit ? (assume no past service for ease of discussion).

The only thing I can think of is possibly under 404 being able to fund the 415 limit as a subsidized J&S annuity under these at-risk assumptions (assuming plan docs subsidizes the J&S), whereas maybe minimum funding might be based upon the expectation of a lump sum distribution and be limited to 415 single life assumptions.

Thoughts ? Could you get a little higher 404 deduction for the J&S subsidy under 404 at-risk rules ?

[ak2ary]

In a typical small plan that pays immediate lump sums, everyone is at Earliest Retirement age, because its the earliest age at which you can terminate employment and commence your benefit.

So under at risk assumptions you would assume everyone gets a lump sum at the end of the year.

Further 430 allows you to adjust your assumptions for lump sums to take into account the phase in of GATT/PPA rates for benefits expected to commence before 2012, so, in determining your at-risk liability its essentially the lump sum payable on the last day of the year discounted to the val date and, if the val date is the last day of the year, at-risk liability is the total plan lump sum..and it's deductible

[JAY21]

ak2, since the at-risk assumptions say to assume the most valuable form of benefit, can you fund for a subsidized J&S annuity benefit even if the participant is at the 415 limit and the expected form of benefit election is a lump sum ? Normally I would think no since you are assuming a lump sum distribution election, not an annuity distribution, but the at risk assumption say....

"All employees shall be assumed to elect the retirement benefit available under the plan at the assumed retirement age which would result in the highest present value of benefits."

Since the 415 limit can be paid on a J&S annuity basis without reduction could this subsidy be funded for under the 404 at-risk rules ?

[ak2ary]

If the plan provides for 415 limt in J&S form, that would be valued for at-risk. This, that plan, which has potentially higher benefits than a plan that does not provide a subsidized J&S, would have a higher at risk liability and, hence a higher potential deduction limit

[JAY21]

Has anyone written out conceptually what happens if you do use past service and assuming no technical correction bill to allow 150% of first year target normal cost (assuming a 1 person NEW plan at 415 limit w/past service).

I think it might be just a a rob Peter-to-pay-Paul approach. If you give the 1/10th of 415 limit as on first day of the 1st year (say 2008) for target liability purposes with a plan with rich past service formula, then I believe you essentially create the 150% cushion for 404 purposes for the first year (no target normal cost due to 1/10 of 415 limit), but in year 2 your beginning of the year target liability is still just 1/10th of 415 limit, yet you already funded for 150% of 1/10th of 415 limit in past year, so you're essentially left ONLY with the target normal cost in year 2 I believe (i.e., you've shifted the otherwise low contribution for the first year if plan does not credit past service, to the 2nd year), so I'm not sure we've gained much looking at the 2 years collectively. For year 3 and thereafter it looks like we're fine and back to having a consistent 150% cushion of Unfunded Target Liability (ignoring gains/losses).

[Blinky the 3-eyed Fish]

In a typical small plan that pays immediate lump sums, everyone is at Earliest Retirement age, because its the earliest age at which you can terminate employment and commence your benefit.

So under at risk assumptions you would assume everyone gets a lump sum at the end of the year.

Further 430 allows you to adjust your assumptions for lump sums to take into account the phase in of GATT/PPA rates for benefits expected to commence before 2012, so, in determining your at-risk liability its essentially the lump sum payable on the last day of the year discounted to the val date and, if the val date is the last day of the year, at-risk liability is the total plan lump sum..and it's deductible

Ak2, can you help fill in the blanks because I am not following? My goal is just to figure out how to fund the full cash balance in the first year of the plan in a situation where the interest crediting rate is less than the effective yield curve. Ignore the cushion amount since technical corrections haven't passed yet.

The way I read 404(o)(2)(B) (special at-risk rules) is that the target normal cost is determined as you would for any other purpose. In other words, the special 430(i) loads or assumptions do not apply. (The funding target is determined as if 430(i) applies but of course there is no funding target in my little example.)

So, can you explain in more detail how the funding can equal the cash balance?

[ak2ary]

The target normal cost is the increase in the funding target expected for the year..thus it is apples and oranges to mix the at risk funding target and the non-at-risk TNC. Makes no sense..that doesn't mean it isnt exactly what it says but it makles no sense...I will look at it

[Blinky the 3-eyed Fish]

Ak2, I am bumping this back to the top to see if you have looked at it further.

[Guest merlin]

At the Northeast Area Benefits Conference last Friday Jim Holland expressed some reservations about applying the at-risk funding that are not subject to the at-risk rules. It was just a brief comment, no further explanation.