Second Year Valuation

[JBones]

Am I correct that a plan that has a past service liability will never be able to use a prefunding balance in the second year to reduce their contribution because the prior funding percentage will always be less than 80%?

My client's plan used one year of past service to create a funding target, funded enough to cover the funding target and target normal cost for that year and elected to create a prefunding balance based on the contribution in excess of MRC. Now in year 2, they have a PFB, but can't use it. Is that correct or am I missing some sort of exemption that would apply here?

[Effen]

Since this question was lifted and posted on the ACOPA board, I felt it was only fair to lift their answer and post it here. I have nothing to do with the answer or question, just trying to provide a service....

We are actually setting up plans just this way, -- and it's working out as follows -- First of all, No, the plan sponsor may NOT use the PFB generated in year 1 to reduce the MRC in year 2, because of the 80% rule that you cited. However, if the minimum contribution calculated for year 2 is more than the employer wishes to pay, the employer can still waive the existing PFB generated by the year 1 contribution. This is not as effective as applying a balance (which, if allowed, might drop the year 2 MRC all the way to $0), but it can still reduce the contribution significantly (in actual plans, we see it about cutting the MRC in half versus leaving the full PFB in place).

Your other questions: 1. If the contribution is large enough, the assets (before adjustment downward by the existing PFB) at the start of year 2 could be larger than the year 2 FT, which includes the benefit attributable to past service plus the accrual in year 1 of the plan. If the assets without adjustment for PFB are large enough to create a FTAP greater than 100%, then there is no need to reduce the assets when determining the AFTAP (see Code §436(j)(3)(A)). If this is the case, the actual AFTAP is over 100%, there are no restrictions, and there is no deemed burn required. If the assets without adjustment are less than 100% of FT at the start of year 2, then you are required to burn some of that year 1 PFB to get the AFTAP up to 60% or 80% - if the plan allows for lump sum or other accelerated distributions.

2. Remember that in the first 5 years of the plan, the only restriction under Code §436 is the restriction on lump sum and other accelerated distributions. If a deemed burn is mandated at the start of year 2 of the plan (see above), it can only be due to the restrictions of IRC §436(d). The rules for making an additional contribution to avoid the funding restriction (IRC §436(f)) state that such a contribution can only be made to avoid the restrictions in §§436(b), 436©, and 436(e). So no, you may not make an additional contribution under 436 to avoid the deemed burn at the start of year 2 of a plan, if such a burn is required.

Hope this helps, -- as an aside, nothing in the above answer changes my opinion that this idea (recognizing past benefit service so that year one generates a FT and a cushion that allows the employer to establish a PFB in year one) is the best way to set up a new plan under PPA.

From:

Sent: Tuesday, May 04, 2010 8:11 AM

To: CollegeofPensionActuaries@yahoogroups.com

Subject: RE: [CollegeofPensionActuaries] Use of balances

There was an interesting question posted on BenefitsLink that I would like to get opinions on. A plan grants past service credit for the first year and therefore the FTAP / AFTAP is zero. The client proceeds to make a large contribution creating a prefunding balance.

They would like to use the prefunding balance to offset the minimum in the second year. I do not believe this could be done because the use of the balances requires looking at last years funded percentage and it is required to be at least 80%.

A couple of questions come to mind:

1 Does the plan have a required burn of the prefunding balance to get the percentage up to 60/80 (if possible) thereby eliminating some / all of the prefunding??

2 Could the client make a ‘special’ contribution under 436 which does not get counted towards the minimum (but presumably is deductible) and use it to increase the prior year funded percentage so that the prefunding balance could be used??

Thanks for any and all comments!!

[JBones]

Thanks for the help Effen. I thought that was the answer, but just wanted to confirm.