In-Service Distribution Adjustments

[Andy the Actuary]

A plan provides for lump sum distributions. The plan has a COLA and for purposes of lump sum distributions, 3% is assumed. The regular actuarial equivalence is 71GA and 7% interest. The plan has been amended to allow for inservice retirement on or after age 65. Upon the employee's later termination of employment, the plan stipulates to calculate the accrued benefit and offset it by the actuarial equivalent of the distribution received. The obvious question is what is that? My recommendation is to have the plan define how the adjustment is made rather than simply saying "the actuarial equivalent."

Assume an employee takes a lump sum at 65 and later terminates employment at 70, it would appear that an appropriate way to handle this is to calculate the accrued pension at age 70 and offset it by the age 65 pension increased by 3%.

Now, assume the employee takes a monthly pension at age 65 and later terminates employment at 70, it would appear that an appropriate way to handle this is to accumulate the monthly payments with 7% interest and determine the offset by dividing this acculation by an annuity factor at age 70 computed using 71GA, 7% interest, and the assumed 3% COLA. Clearly, if the employee elects a lump sum, there is a whipsaw effect.

Any suggestions?

[Effen]

Andy, There are some old threads dealing with offsets due to prior distribuitons, mostly related to 415 adjustments.

That said, if a longer service person takes a lump sum, and if the plan offsets for prior distributions, the chance that the participant will ever see another $ from the plan is pretty small. They would need to accrue a pretty large benefit in order to offset the "value" of what they already received.

I don't really see it as "whip saw", I just see it as a choice. They didn't have to take the distribution, the plan could have given them a suspension notice and their lump sum might have declined with their life expectency. The participant chooses $ today and therefore doesn't get $ tomorrow (in most cases).

[david rigby]

I agree with Effen. Almost certainly, the "residual" benefit at age 70 (your example) is zero, assuming the age 65 distribution is a lump sum. The only reasonable exception is a significant plan improvement (via amendment) between ages 65 and 70.

But that is not exactly what you asked. My document preference would be to have the plan use "actuarial equivalent" phrasing, but make sure that refers to a particular definition.

[David MacLennan]

OK, here is my 2 cents:

The principles for adjusting a plan benefit due to a prior distribution are identical to the principles for adjustment of a 415 benefit limit for a prior distribution, but they are different calculations. The benefit adjustment methods offered above could be appropriate methods for that plan participant in that plan, but not appropriate for another participant in the same plan under different circumstances, and altogether wrong for another plan. The commonly used offset calc methods might seem reasonable but if you tweak the facts a little you will see that they are not based on any general principles and lead to nonsense under certain conditions.

Tread carefully with these offset calculations. I recommend you don't make any calculation decisions on your own, and that every offset calculation be explicitly approved by the Plan Administrator. This doesn't mean that you shouldn't make suggested calculations - just let them know that there is no standard of practice in our actuarial profession (shame on our professional bodies - this is an essentially simple mathematical problem). I have written several papers on the topic of offsets and I would be happy to email copies to anyone who requests them.

Re the offset calc, the first question one should ask is how accrued benefits are adjusted for late retirement, in your case 65 to 70. In other words, what are the late retirement factors, or is it just A.E. adjustment? That would be a starting point - again I would refer you to my papers for details.