Funding Target in a Cash Balance Plan

[emmetttrudy]

If the lump sum in a Cash Balance Plan is set to be the vested hypothetical account balance, then why does the Funding Target, which I understand to be the present value of accrued benefits, for each participant not equal their vested hypothetical account balanace as of the valuation date?

[Effen]

Because Congress thought that would make pension funding too easy and they wanted to protect the jobs of all the actuaries. I think some claimed during the recent campaign that they saved 4,000 jobs just by making pension funding more complex....

The cash balance account is projected to expected retirement using the accumulation assumption, then discounted back to attained age using the segment rates or yield curve. Currently the segment rates are generally higher than the accumulation assumptions, so the funding targets are less (sometimes significantly) than the actual cash balance account.

However, most people are using the sum of the cash balance accounts as the "at risk" funding target and therefore would preserve the deductibility of a contribution sufficient to bring the plan to 100% funded based on the cash balance accounts.

[SoCalActuary]

But you might get an interest rate spike above the 24 month average, so your projection is more expensive than the current balance. It has happened before. Some smart-aleck mathematician said that half the time, you are above the average. Just not lately.

[JAY21]

Do you think it is necessary that the "accounts" all be 100% vested to have a strong argument to treat the 100% of the hypothetical account balances as the "at risk" funding target ? I'm inclined to use the hypothetical account balance as the Funding Target under the at risk rules, but it seems like in one or more seminars I thought I heard that if the "accounts" aren't yet fully vested then it wasn't entirely at risk. Thoughts/opinions ?

[Effen]

Carol Z confirmed that with me a while back. However, keep in mind that the person will be vested in no more than 2 years, therefore there is only a 2 year discount on the value, so the difference between the cash balance accounts and the real at-risk liability is relatively small. I'll let you decide if it is small enough to ignore.

[david rigby]

Carol Z confirmed that ...

Effen, which part of the prior post are you confirming?

[Effen]

That vesting needs to be considered when determining the at-risk liability.

[AndyH]

That vesting needs to be considered when determining the at-risk liability.

If I may ask, Why?

[Effen]

I believe the theory is that if the benefit isn't vested, it can't be paid. Since for the determination of the at-risk liability you look at the value of the benefit payable at its earliest eligibility, the participant isn't really eligible for a benefit until they are vested.

[AndyH]

Thanks.

Does that make any sense to you? I can see applying any withdrawal decrements, but if the funding assumptions contain no such decrements, how would the non-vested part be excluded? it would't be excluded from regular DB at-risk liabilities if there was no withdrawal decrement, right?

[SoCalActuary]

Thanks.

Does that make any sense to you? I can see applying any withdrawal decrements, but if the funding assumptions contain no such decrements, how would the non-vested part be excluded? it would't be excluded from regular DB at-risk liabilities if there was no withdrawal decrement, right?

Your problem is not about withdrawal decrements, because the at-risk liability assumes they will take the most valuable benefit when it is available. It's the interest whipsaw between crediting rates and valuation interest assumptions that causes the difference.

[Effen]

What really doesn't make sense to me is that apparently you can only use that logic on cash balance plans. It seems to me that you should be able to use that logic on ANY db plan that pays immediate lump sums upon termination. Apparently the IRS views the lump sums paid out of a cash balance plan to be different from lump sums paid out of a traditional plan.

[AndyH]

Thanks.

Does that make any sense to you? I can see applying any withdrawal decrements, but if the funding assumptions contain no such decrements, how would the non-vested part be excluded? it would't be excluded from regular DB at-risk liabilities if there was no withdrawal decrement, right?

Your problem is not about withdrawal decrements, because the at-risk liability assumes they will take the most valuable benefit when it is available. It's the interest whipsaw between crediting rates and valuation interest assumptions that causes the difference.

Maybe we're discussing two separate questions. I'm asking about the at-risk liability for 404 purposes, not 430. The original question seemed to be about 430, and your response correctly answer that question. I'm still not getthing this vesting issue for 404, which I think this thread drifted to. I think.

[FAPInJax]

The at-risk rules for 404 allow the immediate recognition of termination of employment (or whatever you wish to call it) at the earliest retirement age. The earliest retirement age is defined as the earliest age at which a participant can receive a distribution - they can not receive a distribution until they are vested and usually a cash balance plan is using 3 year cliff.

The calculation is the same for a regular DB plan with respect to the at-risk piece. There is allowed the presumption of termination for 404 purposes.

[Effen]

Are you suggesting that the PVAB based on current 417(e) rates can be used as the 404 at risk liability to determine the maximum deductible contribution in a traditional db plan that pays lump sums based soley on 417(e) rates?

That was really my point. That for a cash balance plan you can use the current lump sum value of the benefit for the 404 calculation, but I don't beleive the same is true for a traditional db plan. Do you agree?

[SoCalActuary]

Are you suggesting that the PVAB based on current 417(e) rates can be used as the 404 at risk liability to determine the maximum deductible contribution in a traditional db plan that pays lump sums based soley on 417(e) rates?

That was really my point. That for a cash balance plan you can use the current lump sum value of the benefit for the 404 calculation, but I don't beleive the same is true for a traditional db plan. Do you agree?

Well you have one major difference: CB plans don't measure the lump sum payout on 417(e), generally.

The equivalent treatment in a traditional DB plan is to look at the lump sum payable at date of first vesting, measured on the more valuable of two rates: plan assumptions or 430 funding assumptions. The IRS won't let you look to 417(e) lump sums for determining the most valuable benefit. So a traditional DB plan with a 7.5% actuarial equivalence will have a much lower at risk liability than a plan with the same benefits and a 4% actuarial equivalence, assuming the 430 assumptions fall somewhere in between the two extremes.

[AndyH]

That was really my point. That for a cash balance plan you can use the current lump sum value of the benefit for the 404 calculation, but I don't beleive the same is true for a traditional db plan. Do you agree?

Effen, you mean vested lump sum, is that correct? That was what I did not get. (my emphasis)

I'm also interested in the regular DB/417(e) question. I've never considered that, but why would it not be useable for at-risk? But it won't be much of an issue starting in 2012 anyways.

[Effen]

Yes, I understand the difference in determining the liability for cash balance plans vs. traditional db plan. I was just pointing out the lunacy of PPA once again. Two plans one cash balance, one traditional. Under both plans the participants are entitled to $10,000 payment if they terminate one because it is the current cash balance value and the other because it is the lump sum value of his deferred annuity. Yet simply because one is a cash balance plan the other is not, the at-risk (and not-at-risk funding targets) are significantly different. Just one more thing that makes no sense.

Ok, I think we are all on the same page. FAPinJax's post stated the "calculation is the same for a regular DB plan with respect to the at-risk piece". I just wanted to clarify that the result would be significantly different because of the issue you mentioned.

And yes, the benefit needs to be vested, but it isn't as simple as just taking the current vested benefit. If the person is currently non-vested, they still have an at-risk liability.

[SoCalActuary]

Yes, I understand the difference in determining the liability for cash balance plans vs. traditional db plan. I was just pointing out the lunacy of PPA once again. Two plans one cash balance, one traditional. Under both plans the participants are entitled to $10,000 payment if they terminate one because it is the current cash balance value and the other because it is the lump sum value of his deferred annuity. Yet simply because one is a cash balance plan the other is not, the at-risk (and not-at-risk funding targets) are significantly different. Just one more thing that makes no sense.

Ok, I think we are all on the same page. FAPinJax's post stated the "calculation is the same for a regular DB plan with respect to the at-risk piece". I just wanted to clarify that the result would be significantly different because of the issue you mentioned.

And yes, the benefit needs to be vested, but it isn't as simple as just taking the current vested benefit. If the person is currently non-vested, they still have an at-risk liability.

Yes. But it is not their current PVAB, nor their current CB account. It is the discounted value of their future to-be-vested benefit payment.

Further, if your traditional DB plan has a $10,000 pvab that is more valuable on plan assumptions than the rate on 417(e), then the CB account would be valued identically to the traditional design.

[Effen]

Further, if your traditional DB plan has a $10,000 pvab that is more valuable on plan assumptions than the rate on 417(e), then the CB account would be valued identically to the traditional design.

Are you saying this is true for at-risk as well? I agree the numbers could be the same for the not-at-risk funding target (that is significantly lower than the current actual value of the benefit in the present interest rate environment), but I didn't think that was true for the at-risk liability.

Are you saying the at-risk liability for a traditional db plan the guarantees a lump sum that is more valuable than the 417(e) rates would be the current lump sum value? (ignoring all 415 issues)

[SoCalActuary]

When you consider the mathematical model for the at-risk values, you look at the expected payments. If you assume that a $10,000 lump sum value is payable immediately, that is a simple application of the at-risk valuation model.

What makes this troublesome is that the IRS does not let you reflect the 417(e) rate structure, but you must use the 430 rates. If your plan has a more generous lump sum than 417(e), then you can make the actuarial assumption that it will be paid.

So the short answer is YES.

[FAPInJax]

I believe the at-risk calculations will use the lump sum payable in 3 years (2 if you count the current year). Now, most small plans have a definition of AE that provides a lump sum greater than 417e (especially with the phasing out of the grandfather).

[SoCalActuary]

I believe the at-risk calculations will use the lump sum payable in 3 years (2 if you count the current year). Now, most small plans have a definition of AE that provides a lump sum greater than 417e (especially with the phasing out of the grandfather).

That has been true of some plans with some assumption sets. No guarantee that your plan has those rates.