So, what is paid?

[Andy the Actuary]

Plan provides for unreduced retirement at age 62. Participant retirees at 62 with 2,000/month ab payable at age 65, so may elect life only of 2,000/month. Plan's AFTAP=70% and participant elects lump sum of $300,000 and participant elects to receive $150,000 and defers election of remainder. It just so happens that at 65, AFTAP=80% so restriction is removed. So, what does Plan pay?

(a) 1,000 x a₆₅ using interest/mortality at 65

(b) 1,000 x a₆₅ using interest/mortality at 62

© 150,000 x (1+i)³, where "i" is first segment intrest rate at 62

(d) 150,000

(e) Something else

I vote for © as being most reasonable and equitable and preserves the notion that the participant actually elected a lump sum.

Any thoughts or suggestions?

[Effen]

Personally I think it will be a document issue. The attorney's we work with are basically telling us to pick something, document it, and then when appropriate they will amend the plans to fit what we have decided.

My thinking is that this participant is still entitled to $1000/ month at 65 and an unreduced at 62. (I assume he would also be entitled to some immediate annuity since you offered him a lump sum.) Either way, once restrictions are lifted why wouldn't you just determine the lump sum value of the $1,000 based on your normal procedures?

If the plan's lump sum provisions include the value of the subsidy then (b) {using a62}, if not, probably (a). I don't like © or (d) because they could potentially violate 417(e). I guess I wouldn't look at it like he received 50% of his lump sum. I would look at it like he received the value of 50% of his annuity as a lump sum and therefore he is still entitled to 50% as an annuity. The lump sum value of that would be determined if and when it becomes payable in that form.

[Andy the Actuary]

Mr. E, thank you. In reading your answer, it is clear my facts were unclear. There are two choices:

(1) Participant elects lump sum in a "pay me as you" can mode, and

(2) Participant elects lump sum of 50% and defers election on remainder.

In (1), I would stick with my © answer. [i wrote this post thinking (1) and failed to note (2)]

In (2), I would go with (a), which is consistent with your response.

© is consistent with how we would develop the undistributed amount to an HCE (with a subtraction of distributed amounts) if the 110% restriction of 401(a)(4) applied.

[Andy the Actuary]

Peripheral questions:

Is each leg of the 50% distribution eligible for IRA rollover?

Is the availability to rollover different under scenario (1) from scenario (2)?

[Effen]

I think the difference between (1) & (2) would be a document issue. The document would need to define what options are available to the participant and would need to define how each is determined.

I think I would recommend that only option (2) would be available, with the added option of an immediate annuity w/ no lump sum conversion. Basically defer the option on the annuity piece or take the annuity, but if you take the annuity, you won't be able to convert it to a lump sum later.

Again, I'm not saying this is the only way, it just seems to make the most sense to me and would be the easiest to work with in the future.

[Andy the Actuary]

I think the difference between (1) & (2) would be a document issue. The document would need to define what options are available to the participant and would need to define how each is determined.

I think I would recommend that only option (2) would be available, with the added option of an immediate annuity w/ no lump sum conversion. Basically defer the option on the annuity piece or take the annuity, but if you take the annuity, you won't be able to convert it to a lump sum later.

Again, I'm not saying this is the only way, it just seems to make the most sense to me and would be the easiest to work with in the future.

The issue with option (2) in my example is you taken away the value of the e.r. subsidy if the person elects a lump sum. I know, so don't elect a lump sum!

[Effen]

"Yarp"

[Andy the Actuary]

At 2009 EA meeting, conclusion from session that involved Mr. Holland echoed Mr. Effen's position that how you handle the distribution of the restricted portion is a plan design issue and that the IRS is not entertaining (which doesn't mean they won't) issuing any guidance.

[Effen]

Interesting that you would say that Andy. I was at an "inconvenient truth" session with Tonya Manning (AON) and Don Segal. There was a fairly long discussion regarding bifurcation and the problems created. Don's opinion was the participant elected the lump sum, but the law wouldn't pay it. Therefore the question is how to pay it later? Tonya and many in the audience looked at it my way that it was two separate elections. I think Don wanted to apply a restricted benefit approach similar to a top 25 distribution.

If there is one election then how do I determine the value of the lump sum if it is paid later?

If it is new election, is it a new annuity starting date? If so, how does the J&S waiver effect things. Does the spouse need to waive again? What if there was a divorce, does new spouse have to waive? What about a death?

I think everyone agreed that there should be no 2nd bite at the apple, but there was a lot of confusion about valuing the 2nd lump when it becomes payable.

I agree it is a document issue, but it isn't an easy question - there are lots of things that should be specified in the document.

[Andy the Actuary]

Mr. E., I'm acquiescing a lot in my old age!

The conclusion was not that this discombobulation wasn't replete with problems but rather that the IRS wasn't going to solve them for us. Here is what I put before an attorney recently as food for thought:

(1) Could the Plan include an option that pays 1/2 the lump sum and then an annual amount. When the restriction is removed, the remaining balance is paid.

For example, suppose the participant has an annual pension of $24,000 payable at age 62 with resulting lump sum of $300,000 and distributes a lump sum of $150,000. If the special option is elected, the Plan would pay $12,000 (the other $1,000/month) annually until the lump sum has been totally distributed. I.e., we start with a lump sum of $150,000 and distribute $24,000. The balance is increased with interest to year 2 when the restriction still applies. The Plan again distributes $12,000, increases with interest and carries the balance forward to year 3. At such time, no restriction applies, so the remaining amount is released. If the interest rate is 5%, we have:

Year Amount Distribution Balance Interest

1 $150,000 $12,000 $138,000 $ 6,900

2 144,900 12,000 132,900 6,645

3 139,545 139,545 0

The difference between this approach and an election of a life only annuity are (1) if the participant dies, the remaining balance is not forfeited and would be distributed to the beneficiary and (2) there will be a finite period after which the total lump sum has been distributed.

This approach is similar to how the Plan might administer the lump sum provision for an HCE if the funded percentage was less than 110%.

(2) If the Plan cannot offer such option or the employer does not want to amend the Plan to provide such option and a participant elects lump sum payment, at some point the remaining lump sum is paid. What is such amount??? I would say we have two cases:

(a) The participant elects full lump sum payment on a "pay me as you can basis." In such case, I would suggest that once the restriction is removed, the Plan pay the remaining 50% increased with interest from the original election date to the final distribution date. (We can discuss the mechanics later.)

(b) The participant elects 50% lump sum and defers making an election of the remaining 50%. At the time the restriction is removed, we offer the participant the full array of elections and the chips fall where they may as far as the lump sum calculation.

(3) Do you have any feel for whether the first 50% and/or the second 50% are eligible for IRA rollover?

(4) Suppose the participant elects 50% lump sum and reaches age 65 and the AFTAP is still less than 80%, then what? The Plan provides the participant must start his pension so the lump sum option goes away and the person is forced into taking a monthly pension?