PPA Valuation of Lump Sums

[Guest Not Amused]

I need help setting up my PPA valuation for a plan that pays lump sums based on the accrued benefit payable at NRD.

Assuming x% of the TV’s will defer payment until NRD and elect a lump sum at that time, my reading of the rules would have me value a deferred annuity commencing at NRD using the valuation segment rates, with PPA mortality before NRD and the 417(e) mortality after NRD. But since my plan provides for a death benefit equal to the present value of the vested benefit, it seems appropriate to assume no mortality during the deferral period.

If y% of the TV’s are assumed to elect an immediate lump sum benefit, my reading of the rules would have me value a deferred annuity commencing at NRD using the valuation segment rates and the 417(e) mortality both before and after NRD. In this case, it makes sense to apply a mortality decrement prior to deferral age since that is consistent with the actual 417 lump sum basis.

For a given employee terminating at age z, this would make the liability for the immediate lump sum lower than that for a deferred lump sum. This doesn’t seem right, so maybe I'm missing something. Or maybe it just illustrates the fact that the immediate 417 lump sum is a bad deal under this plan because of the death benefit?

[Mike Preston]

I agree with the bad deal comment. This is one of the reasons that I've generally considered it inappropriate to apply a pre-retirement mortality charge to the 417(e) lump sum determination. I recognize that the IRS considers the normal course of action to be the exact opposite: pre-retirement mortality is considered the norm.

In general, if there is a death benefit I just find it a bit weird to assume in a calculation that a death results in a forfeiture.

There are some who might say that the "bad deal" you are referring to is a misapplication of how the calculation should be done under the terms of the document.

[Andy the Actuary]

I agree with the bad deal comment. This is one of the reasons that I've generally considered it inappropriate to apply a pre-retirement mortality charge to the 417(e) lump sum determination. I recognize that the IRS considers the normal course of action to be the exact opposite: Prue-retirement mortality is considered the norm.

In general, if there is a death benefit I just find it a bit weird to assume in a calculation that a death results in a forfeiture.

There are some who might say that the "bad deal" you are referring to is a misapplication of how the calculation should be done under the terms of the document.

RE: Pre-retirement Mortality in lump sum calculations: Is it a matter of the least you must do versus what the Plan Sponsor agrees that the Plan will do (i.e., what the Plan says)? Clearly, words in the law and the Plan do not cover every nuance (or is that nuisance?). Often, it is a matter of recommending doing what is reasonable so long it is done in a uniform and consistent manner.

[Mike Preston]

Not sure what you are getting at, Andy. Clearly, the IRS has stated that plans which provide for a pre-retirement mortality decrement in the determination of the 417(e) minimum are within their rights to do so. I don't think anybody is suggesting that one would be able to apply a pre-retirement mortality decrement to any benefit, whether referencing the 417(e) minimum benefit or the "regular" plan benefit without the document being in lock step.

In the case that was posited, I think I might have missed something. In the "y%" cases, the OP indicated that both pre- and post- mortality would be at 417e mortality. I don't think that is correct. I think post needs to be at 417e mortality, but pre- follows the terms of the valuation.

[Guest Not Amused]

Not sure what you are getting at, Andy. Clearly, the IRS has stated that plans which provide for a pre-retirement mortality decrement in the determination of the 417(e) minimum are within their rights to do so. I don't think anybody is suggesting that one would be able to apply a pre-retirement mortality decrement to any benefit, whether referencing the 417(e) minimum benefit or the "regular" plan benefit without the document being in lock step.

In the case that was posited, I think I might have missed something. In the "y%" cases, the OP indicated that both pre- and post- mortality would be at 417e mortality. I don't think that is correct. I think post needs to be at 417e mortality, but pre- follows the terms of the valuation.

Maybe. But my thinking was that that the proposed rules for valuing lump sums were intended to be an estimate of the benefits payable under 417(e), and since the applicable rates are not known, the valuation segment rates are substituted. Therefore, using a pre-retirement mortality decrement is consistent with the way the benefit would be determined. I would clarify that no pre-retirement mortality decrement is being applied before exit age, only between assumed exit and NRD.

[Andy the Actuary]

I agree with the bad deal comment. This is one of the reasons that I've generally considered it inappropriate to apply a pre-retirement mortality charge to the 417(e) lump sum determination. I recognize that the IRS considers the normal course of action to be the exact opposite: Prue-retirement mortality is considered the norm.

In general, if there is a death benefit I just find it a bit weird to assume in a calculation that a death results in a forfeiture.

There are some who might say that the "bad deal" you are referring to is a misapplication of how the calculation should be done under the terms of the document.

RE: Pre-retirement Mortality in lump sum calculations: Is it a matter of the least you must do versus what the Plan Sponsor agrees that the Plan will do (i.e., what the Plan says)? Clearly, words in the law and the Plan do not cover every nuance (or is that nuisance?). Often, it is a matter of recommending doing what is reasonable so long it is done in a uniform and consistent manner.

Heck, I don't know what I was getting at. I'll try to find out and bring it to ya.

Okay, only about feeling weird about calculating in accordance with the law that does not particularly make sense. Attempting to incorporate market rates in your lump sum calculation and then allowing that your interest rate could be 16 months old (e.g.. Aug '07 interest rates for December '08 distribution) not only seems weird but frustrates the purpose. But, so what?