1st year Cash Balance Plan

[jkdoll2]

Cash Balance Plans

Target Normal Costs generally will not tie out to the hypothetical allocations anymore.

For instance NHCE’s getting 2.5% of compensation. The target normal cost does not equal that amount for each participant. The hypothetical allocations are converted to target normal costs by

1. Being projected to retirement age using a single interest crediting rate, converted to an annuity amount at retirement using the actuarial equivalence assumptions

2. Then the conversion and discounting goes from the retirement age back to current age using the three segment rates and funding mortality assumptions.

So – going forward is using plan actuarial equivalence, discounting back is using the segment rates.

In past years cash balance plans used the 30 year treasury rate for all portions of the calculation, so the normal cost came out the same as the hypothetical allocation. PPA doesn’t allow that any more.

Client put in $139,356.93 into the cash balance plan – which is the 2.5% for NHCE’s and 36% for owners.

When the 2.5% and the 36% were converted to a target normal cost – the amount is lower ($115,061.31).

Even though the vested accrued benefit is each participants account equals the right percentage

On the first year of a cash balance plan there is no room for extra contributions. The minimum due and the maximum due is $115,061.31. The amount to meet termination liability is $139,366.00.

The actuary is saying that the rules that are in place right now does not allow for the company to fund the termination liability amount of $139,366.00 – only up to the maximum contribution amount of $115,061.31.

The actuary suggests that the tax return be amended and the extra $24,304.69 be used for the 2009 plan year.

What do you suggest? If the plan were to close today and they only funded $115.061.31 – they would not have enough to pay everyone out. If they funded the $139,366.00 – then they would. But new PPA rules do not allow for funding that amount.

My question - can you use the termination liability amount for funding the first year? Has there been final regulations?

[Effen]

No final regs, no real guidance. It's really all "good faith" compliance for 2008 & much of 2009. I think your actuary is taking a valid, but conservative approach. In fact, we were taking a similar approach earlier last year.

However, I think that many actuaries now take the position that the "at-risk" liability in a cash balance plan that pays lump sums equal to the hypothetic balance when a participant terminates, should be equal to the sum of the hypothetical accounts. Therefore, the "at-risk" liability would equal your "termination liability" and since the maximum deductable contribution is based on the "at-risk" liability and not the funding target, a first year contribution equal to the sum of the hypothetical accounts would be fully deductible.

This approach isn't 100% guaranteed, but it seems to be a very common interpretation.

[carrots]

If the interest crediting rate is based on an index (say, the 30 year treasury rate), and you chose to make your projected interest crediting assumptions equal to the segment rates. Then the TNC = Contribution Credits, and FT = Hypothetical Account Balances.

[mwyatt]

This was touched on at the EA Meeting, but you project to NRD using your most recent actual crediting rate, not the segment rates, so that won't work. Think that for first year anyway, you can use the "at risk" approach for EOY vals. If you're doing it BOY, at risk is EOY payment, then discounted back at the segment rate so there will be a discrepancy.

[Effen]

I agree. Carrots answer does not work in the post PPA world because of the requirement to use segment rates / yield curves.

[carrots]

This was touched on at the EA Meeting, but you project to NRD using your most recent actual crediting rate, not the segment rates, so that won't work. Think that for first year anyway, you can use the "at risk" approach for EOY vals. If you're doing it BOY, at risk is EOY payment, then discounted back at the segment rate so there will be a discrepancy.

Why do you have to project to NRD using your most recent crediting rate? Is there a reg on that?

[Guest Deflector]

Why do you have to project to NRD using your most recent crediting rate? Is there a reg on that?

I believe you project forward using the assumed interest rates that you expect to credit on the hypothetical balances. As was mentioned before.

One other thing is the crediting interest rates should be a reasonable market interest rate. The funding 3 segment rates are around 6%+, which may be a little high for a reasonable market rate.

I have heard of people using the at risk method for the maximum and defending it as a "reasonable interpretation". It was also mentioned at the EA conference last week in one of the session and I do not believe that anything was said against it. However I do not believe there were government speakers at that session.

[carrots]

So, if the projected crediting rates are equal to the segment rates, the projection and discount exactly offset!

[Effen]

So, if the projected crediting rates are equal to the segment rates, the projection and discount exactly offset!

That would work, IF you were permitted to do it. Then again, you might be permitted to do it, but it wouldn't satisify the "market rate of return" requirements and therefore you would be open to age discrimination and whipsaw type lawsuits.

For CCH:

Interest credits. An applicable defined benefit plan violates the age discrimination prohibition unless the plan provides that the interest credit for any plan year shall be calculated at a rate that is not greater than the market rate of return. The plan may provide for a reasonable minimum guaranteed rate of return, or for a rate of return equal to the greater of a fixed or variable rate of return as long as the rate is not greater than the market rate of return. If an interest credit is less than zero, it cannot reduce the account balance to less than the aggregate amount of contributions credited to the account . The Secretary of the Treasury may provide regulations governing the calculation of a market rate of return and permissible methods of crediting interest to the account.

CCH POINTER:

Proposed IRS regulations provide that an interest crediting rate for a plan year is not in excess of a market rate of return if it is based on specified indices. These include the safe harbor rates described in Notice 96-8, the interest rates on 30-year Treasury securities, and the rate of interest on long-term investment grade corporate bonds (as described in Code Sec. 412(b)(5)(B)(ii)(II) prior to amendment by PPA for plan years beginning before January 1, 2008, and the third-segment bond rate used under Code Sec. 430 for subsequent plan years). For this purpose, the third-segment bond rate is permitted to be determined with or without regard to the transition rules of Code Sec. 430(h)(2)(G).

[carrots]

Effen: I appreciate your comments. However, I think we are talking about two different things:

1. I don't think that there are any age discrimination or whipsaw type problems because the actual interest credits are based on an acceptable market index, such as 30 year treasury + 1%.

2. For funding calculations, only, if the Actuary's best estimate assumption for future crediting rates is that they will exactly match the segment rates, then we get TNC = Contribution Credit, and FT = Hypothetical Account Balance.

[Effen]

But I would argue that those two statements are mutually exclusive.

If the crediting rate is based on the 30-yr Treasury, how can the actuary argue that the segment rates (high grade corp bonds) are his/her best estimate of future crediting rates? Treasury rates and corporate bond rates are certainly not equivalent.

I would argue that if that is your assumption, you are outside of the box of acceptable.

[carrots]

In September, 2007 the 30 Year Treasury plus 1% (for example) = 5.79%, and the Actuary assumes that will generally increase somewhat in the future.

The September, 2007 Transitional Segment Rates for funding were 5.66%, 5.85%, and 6.03%. For funding, the Actuary chooses these rates as the best estimate of future crediting rates.

In September, 2008 the 30 Year Treasury plus 1% = 5.27%, and again the Actuary assumes that will generally increase in the future.

The September, 2008 Transitional Segment Rates for funding were 5.41%, 6.09% and 6.41%. The Actuary chooses these rates as the best estimate for future crediting rates.

The method of choosing the projected crediting rates is the same each year (segment rates).

How could those projections of future crediting rates possibly be considered unreasonable?

[Guest Deflector]

How could those projections of future crediting rates possibly be considered unreasonable?

My concern would be that they "could be" considered unreasonable. If you are talking about an employee who is within 5 years from retirement, and the rates are close, it may not be viewed as unreasonable.

However, if you look at the current plan rates (or happen to hit the december 08 rates), you are looking at the 30 yr treasury plus around 3% for an employee that is in the 2nd or 3rd segment range. A 3% difference could be viewed as a large difference, especially when the rates have been under 4%.

[JAY21]

Carrot, personally I think you are allowing too much of a disconnect between distribution and funding. Yes, we all know the concepts and rules are a bit different but the "best" (i.e,. most accurate forcast) assumptions should be used to keep the values under funding and distributions as close as possible.

Your interest crediting rate under the plan document is part of the Accrued Benefit itself. While you certainly don't know future rates under the chosen plan doc benchmark you do know the actual interest rate for the current plan year which is used to develop part of the current year's accrual (interest on theoretical contributions).

To me it would be hard to justify segment rates in the 5.5-6.25% range if you current accrual was using say 4.0% at least to bring it from the prior year to end of current year for theoretical account.

Maybe the best bet is to amend the plan doc benchmark to tie into a corporate bond benchmark and get an IRS letter (since it's not a safe-harbor benchmark under current regs) to have a better argument for using segment rates. Of course, then the plan sponsor has to make sure they go out and get that kind of rate to avoid shortfall contributions.

[carrots]

Deflector and Jay21;

Thanks for your comments. Just a couple of responses:

1. All of the cash balance plans I deal with have end of year valuations, so the TNC and FT are being calculated only with regard to the unknown, projected interest credits. The most recent crediting rate is merely history.

2. If, as the Actuary, you believe that the 30 year treasury (+1%) is going to increase, then you should reflect that in your projected interest crediting assumptions.

3. Again, all of the CB plans I work with, provide for and assume 100% lump sum (Hypothetical Account) distributions. So, it is very important, as you said, Jay21, that the funding be close to the distributions. A good way to get that result would be if the FT = Hypothetical Accounts.

Thanks, again for your input.

[Blinky the 3-eyed Fish]

My two cents:

If the interest crediting rate is a fixed rate, say 4%, that better be your assumed interest crediting rate. To assume otherwise would be to assume an amendment to the plan in violation of 412©(8) now known as XXXX (I can't remember..... 412(d)(2) maybe).

If the interest crediting rate is variable, the assumed future crediting rate should be something reasonable. IMHO, to assume that the interest rate is exactly the segment rates each and every year is not something I would do, especially if the basis for the variable rate is different from the determination of the segment rates.

I understand the willingness to match liabilities versus assets and the sillyness of this funding whipsaw results. But it's only a first year problem and only possibly a small problem if you consider the at-risk liabilities. Worst case is they fully fund the plan early the second year and are one-year late on the deduction.