Accrued Benefit - Cash Balance Plan

[Guest skc]

I understand the accrued benefit is calculated by taking the account balance and projecting out at the accumulation rate and dividing by an annuity rate at NRA.

If the accumulation rate is the 30 treasury rate so as of 12/31/2006 we would use 4.65% to determine accrued benefit as of 12/31/06. However for 2007 the rate is 4.68%. When determining Normal Cost for 2007 using unit credit method and for determining increase in accrued benefit for 401(a)(4) do I recalculate the 1/1/07 accrued benefit using the 4.68 accumulation rate or do I still use the 12/31/06 accrued benefit and Normal Cost does not equal hypothetical contribution assuming funding assumption is 30year treasury rate.

[Mike Preston]

The latter for 401(a)(4). Otherwise, you could potentially have benefits accruing which are never subject to testing.

[SoCalActuary]

The latter for 401(a)(4). Otherwise, you could potentially have benefits accruing which are never subject to testing.

Mike:

The consequence of your suggestion is that accrued benefits have changed for reasons that have nothing to do with the employer's action nor the employee's service credit, and you suggest that this external influence should affect testing. Since I disagree, could you explain why the current year accrual method should be based on anything else but the current hypothetical contribution?

Now, I should note that some CB plan designs have gimmicked the interest rates so they are not a market rate, as when the sponsor used different interest credits for actives vs terminated. Some also have excessive guaranteed rates. But those plans that use a market rate of interest will have inherent fluctuations in the benefit to be tested. I don't see that this random walk should have any influence on proper compliance with 401(a)(4) discrimination rules.

[Mike Preston]

What you describe as a random walk is nothing more than a change in the accrued benefit brought about by continued age/service. That change is reflected in the a4 accrual for testing purposes. I just don't see how it can be any other way.

There are ample precedents in the a4 regs, me thinks. I just don't have time to look them up today.

The annual testing method is not "what have you accrued this year". Instead it is "what are you accrued in now less what have you tested in the past". At least that is always the way I've done it.

[tymesup]

What you describe as a random walk is nothing more than a change in the accrued benefit brought about by continued age/service. That change is reflected in the a4 accrual for testing purposes. I just don't see how it can be any other way.

There are ample precedents in the a4 regs, me thinks. I just don't have time to look them up today.

The annual testing method is not "what have you accrued this year". Instead it is "what are you accrued in now less what have you tested in the past". At least that is always the way I've done it.

I had a plain vanilla unit formula that was giving me a variety of accrual rates because average comps were changing. We took the view that a 1% plan was a 1% plan, regardless of the difference in the accruals. This seemed to be consistent with the language in the a4 regs.

If only I could have hit the curveball, I wouldn't have to deal with these curveballs.

[Mike Preston]

Your view is dangerous in my opinion. 415 increases are tested in the current year, as you indicated (but you also indicated that you ignored it), changes due to salary changes are tested in the current year, why wouldn't changes due to interest rates be tested in the current year?

[SoCalActuary]

Under the methodology of translating the account balance to a monthly benefit, the employer has control over the salary, benefit accrual rates/hypothetical contribution, and the choice of interest rate for accumulating past balances. But the employer has no control over the financial markets that can make interest rates change yearly.

For CB plans that use the 417(e) rates for actuarial equivalence, this has a dramatic effect on the benefit derived from prior service. So testing done in June 03 at 4.37%, in 04 at 5.41%, in 05 at 4.29%, and in 06 at 5.16% would show that a terminated employee in 03 had a benefit accrual in 04, a reduction in benefits in 05, and a benefit accrual in 06. Is that the type of testing you described, or am I mis-understanding you?

[Guest skc]

I'm more confused now than before.

Mike you are saying do not make the adjustment therefore:

1. 401(a)(4) testing should take into account both accumulation rate change and additional hypothetical contribution. And for some particiants accrued benefit increase can actually be negative?

2. What about funding under unit credit? Is Normal cost not just the value of Hypothetical Contribution but also adjustment for accumulation rate change.

[AndyH]

So am I.

I thought the AB is the prior account projected at the crediting rate to NRA, then converted to an AB using actuarial equivalence. And you test that AB using the standard (7.5-8.5) rates. And you fund the AB using the segment rates.

No question that the use of 417(e) rates produce both a disconnect to funding, 415, and testing rates to the extent that they differ, and to the extent that the rates change with interest conditions. But I see that as a problem with the decision to use the 417(e) rates (not that I have a better idea).

I thought that using 5.5% for all, which the IRS does not like but some advocate, minimizes the problem.

But, these disconnects are why we need the 150% cushion on the NC, IMHO, to bridge these gaps. But maybe I'm way off because I don't pretend to be a CB expert and don't disagree with Mike lightly.