100% J&S Annuity assumption under PPA funding

[YankeeFan]

Lets assume you have a one participant defined benefit plan sponsored by a sole proprietor. The plan's normal form of benefit is a 100% J&S annuity. Note that a single lump sum is one of the plan's optional forms of benefit. The actuarial valuation for the year prior to the enactment of the PPA funding rules was prepared on the basis the participant would receive a 100% J&S annuity from the plan which had the effect of increasing the funding obligation.

Is it reasonable to continue to fund for the 100% J&S annuity under the new PPA funding rules if the participant at this time indicates his intent is to indeed take a 100% J&S annuity from the plan? Therefore, we would fund for the annuity and use 0% as the probability of the lump sum. Is this approach too aggresive or can it be deemed unreasonable by the IRS upon audit?

[Andy the Actuary]

Although intents by Westchester County law are valid for no more than 11 days, on what basis (chapter, verse, stanza) are you envisioning the IRS might find the approach unreasonable? On the basis that you fund for a J&100% for nine years and then the client changes his intent in the last year?

Wouldn't you still be funding for a lump sum which would be the best estimate of the annuity purchase price? Otherwise, if you're not going to buy an annuity, (1) what would justify the expense of keeping the Plan alive in perpetuity when no contributions are being made? (2) How would you deal with the residual assets when the last to die has died? (3) What happens if the joint life cohort survives the money and/or contributions are needed?

If you are pushing the envelope to 415, you'd better buy the annuity lest you end up with about 120% give/take more money than if a lump sum were distributed. Then, your client will discover the true meaning of unreasonable when the excise tax man shows up at his front door. In this respect, what do you do if 20 seconds before you purchase the annuity the spouse dies and now you can only buy the actuarial equivalent of a life only annuity?

All of this sarcasm adds up to don't do it. It may be feasible but it seems replete with issues down the road.

[Blinky the 3-eyed Fish]

PPA changed nothing with regard to whether or not assuming a lump sum or an annuity is reasonable. It is or it isn't and you dang Yankee should be the one qualified to know the answer to that question.

[Belgarath]

I don't know about you guys, but the IRS made us take a Jt life annuity out of the new (to be approved shortly, presumably) EGTRRA DB prototype as a normal form of benefit. Single life annuity allowed, but not jt life. So I don't see how you could fund for a form of benefit that isn't allowed. Are we the only people who had this happen?

Of course, not being actuarially inclined, I'm probably misunderstanding the issue entirely.

[Andy the Actuary]

On what basis did the IRS indicate it would not approve the Plan document if the standard form for married participants was a J&100?

[mwyatt]

You can probably fund for the 100% J&S (but you're going to be using the funding interest assumptions and standard male and female tables), but the reality is that your client is going to want the lump sum as the end game. Do you want to be explaining to your client that yes, you deducted all of this money, but (barring another market collapse) you've actually generated excess assets that you're going to recoup 9 cents on the dollar?

Thought most small plans had moved away from the J&S subsidy a long time ago (say the 80s).

[Belgarath]

Andy - I can't answer that. I only know they did. Also required that the instructions in the adoption agreement election, where they have the option to choose "other" as a normal form of retirement benefit, had to specifically state that it could not include any form of joint life annuity.