Proper way to calculate present value of TNC and FT under PPA

[Guest Doogie61]

Here is my last question for today...lol

I was looking at some of our take over valuations from other actuaries and saw calculations done two different ways...

Let's say you have a calendar year DB ....Valuation date 1/1/08. Using 5.31, 5.92 and 6.43 segment rates. Participant had a NRA of 65 and is currently 45 years old as of the valuation date. When calculating his TNC and Funding Target, you take the present value of the aforementioned benefits as of the valuation date. When discounting back to current age (e.g present value) would you discount back using 5.31 for the first 5 years, then 5.92 for the next 15 or just use 5.92 for the entire period since he is 20 years from retirement and no benefits are assumed to be paid before retirement?

I say you use just 5.92 ..what do you say???

[Blinky the 3-eyed Fish]

Doogie, are you assuming a lump sum will be paid or an annuity?

[Guest Doogie61]

Doogie, are you assuming a lump sum will be paid or an annuity?

Hey Blinky!

A lump sum!

Death benefit is the PVAB.

I think that some vendors have the calculation all wrong!

[Blinky the 3-eyed Fish]

If assuming a lump sum you should determine the PVAB using the valuation segment rates (5.31%, 5.92% and 6.43%) and the '08 Applicable Mortality Table and also the PVAB using actuarial equivalents. Take the greater of the two. Compare that result versus the 415 lump sum limit (let me know if you want more details on that) and take the lesser of those two. That is your PVAB at retirement age.

Discount that PVAB at the appropriate segment rate. If the person is age 45 and retirement is age 65, it would be exactly 20 years, which is the 3rd segment rate of 6.43%, not 5.92%. If the person was age 46 it would be the 2nd segment rate.

[Mike Preston]

Just for clarification purposes, how do you superimpose the segment rates when using the 417 safe harbor? Assume, for illustration that you have been given permission to use a special mortality table for this calculation (I know this can't be done, but humor me). The mortality table says that the individual you are valuing will live to retirement age plus one year and 1 day and that there is no mortality prior to that. (Humor me some more.) Retirement age is 7 years away from the valuation date. Assume that this plan pays an annual retirement benefit, not a monthly one. The annual retirement benefit (which will be paid twice, once at the person's retirement age and once one year later - he is then assumed to die one day after the second payment) is $1,000. Assume that this $1,000 is fully accrued during the plan year and that there was no accrual at the beginning of the year. Hence, whatever we come up with as the present value will be part of the Target Normal Cost.

Are you saying that the Target Normal Cost for this individual is:

[$1,000 * (1.0531 ^ -0) + $1,000 * (1.0531 ^ -1)] * 1.0592 ^ - 7 = $1,303.45

or are you saying that the Target Normal Cost for this individual is:

[$1,000 * (1.0592 ^ -7) + $1,000 * (1.0592 ^ -8)] = $1,299.79

[Blinky the 3-eyed Fish]

$1,303.45 is my answer.

[Mike Preston]

Well, based on your answer, which I admit was a bit of a surprise to me, I went back to the proposed regulations and tore apart Examples 6 and 7 under 1.430(d)-1f7. I think the math implied there is fundamentally inconsistent with using two separate first segment rates. Sorry I didn't do that *before* posting the example, otherwise I would have said that I think the lower number is the proper result based on those examples.

If you get a chance to look at those examples, let me know if you think they support a different answer than the one you just game.

In general, I think "restarting" the segment rates (or the yield curve if using the yield curve) is inconsistent with the general theory under which they are developed. Not that that would stop the IRS from doing so if it felt like doing so.

[mwyatt]

Mike, we do have to keep in mind that prior to 2008, the funding method proscribed under IRC 430 was explicitly labeled as not valid for salaried based plans. Have you tried to wrap your head around how you do an end of year valuation yet for a sole proprietor where Schedule C Income is a factor? There are infinite answers as to the contribution range. What do you solve for?

[SoCalActuary]

Mike, we do have to keep in mind that prior to 2008, the funding method proscribed under IRC 430 was explicitly labeled as not valid for salaried based plans. Have you tried to wrap your head around how you do an end of year valuation yet for a sole proprietor where Schedule C Income is a factor? There are infinite answers as to the contribution range. What do you solve for?

But you can look at the standards set by Academy committees, and find that Congress did not see it that way. So it does not matter that the old rules required funding for a benefit which has not yet been earned.

The sole proprietor earned income factor now requires a more linear equation approach than in the past, optimizing the earned income so that it justifies a deduction range that surrounds the actual deposit made. Said another way, you find the contribution desired, compute the earned income that results, and determine if that earned income justifies the deduction desired. If you fall outside that range of deductible amounts, then you must modify the contribution and redo the process.

[Guest RBlaine]

Just for clarification purposes, how do you superimpose the segment rates when using the 417 safe harbor? Assume, for illustration that you have been given permission to use a special mortality table for this calculation (I know this can't be done, but humor me). The mortality table says that the individual you are valuing will live to retirement age plus one year and 1 day and that there is no mortality prior to that. (Humor me some more.) Retirement age is 7 years away from the valuation date. Assume that this plan pays an annual retirement benefit, not a monthly one. The annual retirement benefit (which will be paid twice, once at the person's retirement age and once one year later - he is then assumed to die one day after the second payment) is $1,000. Assume that this $1,000 is fully accrued during the plan year and that there was no accrual at the beginning of the year. Hence, whatever we come up with as the present value will be part of the Target Normal Cost.

Are you saying that the Target Normal Cost for this individual is:

[$1,000 * (1.0531 ^ -0) + $1,000 * (1.0531 ^ -1)] * 1.0592 ^ - 7 = $1,303.45

or are you saying that the Target Normal Cost for this individual is:

[$1,000 * (1.0592 ^ -7) + $1,000 * (1.0592 ^ -8)] = $1,299.79

I would use 1,299.79

[Blinky the 3-eyed Fish]

Mike, I forgot I meant to get back to you on this. I reverse my answer, my reason -- brain cramp. Maybe I was thinking, even though the entire discussion was on segment rates, that in your question the factors were actuarial equivalents and not 417(e) factors.

I agree the proposed regs support the $1,299.79 methodology. It too is how I have been running the 2008 valuations. So my apologies for having you "tear apart" the proposed regs.

[Mike Preston]

No problem. Every once in a while it is good to run through the examples anyway. In this context I was looking for a specific issue, which is what I meant to imply with the "tear apart" reference.

[SoCalActuary]

Ignore the special mortality, etc. Just define your benefit as a 2 year certain only benefit. Then your example is not even twisted at all. Any, by the way, nice job of isolating the issue. I also go with the $1299 value.

Just for clarification purposes, how do you superimpose the segment rates when using the 417 safe harbor? Assume, for illustration that you have been given permission to use a special mortality table for this calculation (I know this can't be done, but humor me). The mortality table says that the individual you are valuing will live to retirement age plus one year and 1 day and that there is no mortality prior to that. (Humor me some more.) Retirement age is 7 years away from the valuation date. Assume that this plan pays an annual retirement benefit, not a monthly one. The annual retirement benefit (which will be paid twice, once at the person's retirement age and once one year later - he is then assumed to die one day after the second payment) is $1,000. Assume that this $1,000 is fully accrued during the plan year and that there was no accrual at the beginning of the year. Hence, whatever we come up with as the present value will be part of the Target Normal Cost.

Are you saying that the Target Normal Cost for this individual is:

[$1,000 * (1.0531 ^ -0) + $1,000 * (1.0531 ^ -1)] * 1.0592 ^ - 7 = $1,303.45

or are you saying that the Target Normal Cost for this individual is:

[$1,000 * (1.0592 ^ -7) + $1,000 * (1.0592 ^ -8)] = $1,299.79