IRS Notice 87-20

[Guest algeis]

Does anyone know what the IRS Notice 87-20 is? We are possibly taking over a DB plan and the current actuary speaks of this notice. We cannot find any information as to what this notice is or where we can find it. Thanks

[Effen]

In what context does the actuary speak of it?

[AndyH]

From memory, it is the IRS Notice that first detailed how to apply "applicable interest rates" for determining lump sum benefits. I believe it first introduced PBGC interest rates as a second calculation to contrast with a lump sum based on fixed plan interest rates.

[Belgarath]

Pension Rulings and Other Documents,Notice 87-20, I.R.B. 1987-6, February 9, 1987 [Clarified by Notice 87-57 at ¶17,100Z].,Internal Revenue Service, (Feb. 9, 1987)

Defined benefit plans: Accrued benefits: Present value: Interest rates for computation of present value: Compliance with Tax Reform Act of 1986: Plan amendments.– The IRS has issued guidance for sponsors of defined benefit plans in complying with Tax Reform Act of 1986 changes to Code Secs. 411 and 417 which limit the interest rate(s) that may be used under a defined benefit plan for computing the present values and amounts of certain plan benefits. This guidance may be relied upon until further guidance is issued.

Back references: See "Finding Lists."

This notice provides guidance for sponsors of defined plans in complying with sections 411(a)(11)(B) and 417(e)(3) of the Internal Revenue Code, as amended by the Tax Reform Act of 1986 (Pub. L. 99-514) (Act). These sections limit the interest rate(s) that may be used under a defined benefit plan for computing the present values and amounts of certain plan benefits. Until further guidance is published by the Service, sponsors of defined benefit plans may rely on the guidance in this notice for plan years beginning after December 31, 1984. If further guidance is more restrictive than the guidance provided by this notice, such further guidance will not have retroactive effect.

Background

Sections 411(a)(11) and 417(e) of the Code, as added by the Retirement Equity Act of 1984 (Pub. L. 98-397) (REA), and the temporary Income Tax Regulations thereunder, provided with respect to a defined benefit plan that, for purposes of determining (1) the present value of any accrued benefit (including a qualified joint and survivor annuity) or of any qualified preretirement survivor annuity (QPSA), as those terms are defined in sections 411 and 417, and (2) the amount (subject to section 415) of a “section 411(a)(11)(B) or 417(e)(3) benefit”, the interest rate(s) used must not exceed the “PBGC immediate interest rate.” A “section 411(a)(11)(B) or 417(e)(3) benefit” is any plan benefit that is an alternative form of a plan benefit included in (1) above except a benefit described in section 1.417(e)-1T(e)(3) of the temporary regulations.

The “PBGC immediate interest rate” refers to the interest rate(s) used by the Pension Benefit Guaranty Corporation (PBGC), in accordance with section 2619 of the PBGC regulations (29 CFR Part 2619), to value immediate annuities under a trusteed, single-employer plan. An immediate annuity is an annuity under which benefits are to be paid immediately upon the date of plan termination. While section 2619 of the PBGC regulations spcifies the use of several interest rates to value various plan benefits under a PBGC trusteed, single-employer plan, the “PBGC immediate interest rate” for plans terminated as of any given date is and has been a single interest rate. For different plan termination dates, such single interest rate has varied as specified in Appendix B to section 2619 of the PBGC regulations. The PBGC has proposed amendments to section 2619 of the PBGC regulations (51 F.R. 10334 (1986)) that, if adopted, would replace the “PBGC immediate interest rate” with an interest rate structure providing for more than a single interest rate for PBGC trusteed, single-employer plans that terminate on any given date in the future.

To comply with sections 411(a)(11)(B) and 417(e)(3) of the Code, as added by REA, any defined benefit plan under which the interest rate(s) specified for determining the present value of accrued benefits and QPSA's and the amount of “section 411(a)(11)(B) or 417(e)(3) benefits” differed from the “PBGC immediate interest rate” had to be amended to provide that such determinations would be made using the “PBGC immediate interest rate” or that such other specified rate(s) would not exceed the “PBGC immediate interest rate”. However, section 1.417(e)-1T(e)(2) of the temporary regulations provided that if a defined benefit plan specified an interest rate other than the “PBGC immediate interest rate” for determining the amount of an accrued benefit, the interest rate providing the greater benefit, subject to the limits of section 415, must be used. Consequently, a defined benefit plan under which the interest rate(s) specified for determining the amount of “section 411(a)(11)(B) or 417(e)(3) benefits” differed from the maximum interest rate(s) permitted by sections 411(a)(11) and 417(e) could not be amended to increase or decrease the specified interest rate(s) if such amendment would decrease the amounts of existing accrued benefits. Such an amendment would violate section 411(d)(6) which provides generally that the amounts of accrued benefits may not be reduced or eliminated by a plan amendment adopted after such benefits have accrued.

Change in Interest Rate Limitation

Section 1139 of the Act amended sections 411(a)(11)(B) and 417(e)(3) of the Code to change the maximum interest rate(s) permitted thereunder from the “PBGC immediate interest rate” to the “section 1139 limits.” The “section 1139 limits” are (1) the rate(s) that would be used for a PBGC trusteed single-employer plan to value the particular plan participant's (or beneficiary's) benefit (“applicable interest rate”) if the present value of such benefit does not exceed $25,000 and (2) 120% of the “applicable interest rate” if such present value exceeds $25,000 (determined using the “applicable interest rate”), provided that the present value determined on the basis of 120% of the “applicable interest rate” is not less than $25,000.

Currently, section 2619 of the PBGC regulations provides that, for purposes of determining the present value of an immediate annuity benefit, the “PBGC immediate interest rate” and the “applicable interest rate” are the same single interest rate for any given date. However, even under current section 2619 of the PBGC regulations, the “PBGC immediate interest rate” and the “applicable interest rate” are not the same for purposes of valuing a benefit under which the date payment commences is deferred until a date in the future.

If the currently proposed amendments to section 2619 of the PBGC regulations are adopted, the “applicable interest rate” will generally be more than one interest rate for valuing any immediate or deferred benefit. For example, the “applicable interest rate” to value a benefit could be:

X% for the first 5 years over which the benefits are valued

Y% for the next 10 years over which the benefits are valued

Z% for the following years over which the benefits are valued

and 120% of the “applicable interest rate” would be:

1.2X% for the first 5 years over which the benefits are valued

1.2Y% for the next 10 years over which the benefits are valued

1.2Z% for the following years over which the benefits are valued

Because the interest rates comprising the “applicable interest rate” are variable and not subject to any upper or lower limits, all defined benefit plans will have to provide that the interest rate(s) used to determine present values of accrued benefits or QPSA's or amounts of “section 411(a)(11)(B) or 417(e)(3) benefits” shall never exceed the “section 1139 limits” (subject to the limits of section 415 of the Code).

Pursuant to section 1140 of the Act, the sponsor of a plan that must be amended in order to comply with section 1139 of the Act must amend the plan before the close of the first plan year beginning after December 31, 1988, or a later date in the case of certain collectively bargained plans. Prior to amendment, the plan shall be operated in accordance with the amendments made by section 1139 of the Act. Such amendment must be given retroactive effect to the first day of the first plan year beginning after December 31, 1984. Accordingly, the amendment will apply to benefit payments commencing in plan years beginning after such date except for those benefit payments that commenced in plan years beginning before January 1, 1987, and were made in accordance with the requirements of REA and the temporary regulations thereunder. Also, pursuant to section 1140 of the Act, the Service has prescribed a model amendment for plan sponsors to adopt that will satisfy the plan qualification requirements as amended by the Act. See Notice 87-2, 1987-2 I.R.B. 17. Such model includes language to satisfy the requirements of section 1139 of the Act.

Compliance with Code Section 411(d)(6)

A plan amendment to incorporate the “applicable interest rate” or a function of the “applicable interest rate” into plan provisions must comply with section 411(d)(6) of the Code. Accordingly, any such plan amendment must preserve the amounts of existing accrued benefits. However, section 1139 of the Act provides that, to the extent an amendment of a defined benefit plan before the close of the first plan year beginning after December 31, 1988, reduces accrued benefits in accordance with these amendments to sections 411(a)(11)(B) and 417(e)(3) of the Code under the Act, such reduction will not be a violation of section 411(d)(6). Section 1139 of the Act applies to benefit payments that commence in plan years beginning after December 31, 1984, except for benefit payments that (1) commence in plan years beginning before January 1, 1987, and (2) were made in accordance with the requirements of REA and the temporary regulations thereunder. Consequently, if a plan contains language that was adopted on or before October 22, 1986, providing for the use of the “PBGC immediate interest rate” (or function thereof) for purposes of determining the present vaues of accrued benefits or QPSA's or the amounts of “section 411(a)(11)(B) or 417(e)(3) benefits,” a reduction of accrued benefits will not be treated as a violation of section 411(d)(6) if the reduction is caused solely by the “timely” amendment (see below) to replace existing plan language providing for the “PBGC immediate interest rate” with plan language providing for either the “applicable interest rate” or the “section 1139 limits.” Although a plan amendment described in the previous sentence will not fail to satisfy section 411(d)(6), such a plan amendment must, of course, satisfy the other requirements of section 401(a) (e.g., 401(a)(4)) for the plan to satisfy 401(a).

A “timely” plan amendment for this purpose is one that is adopted before the end of the first year beginning after December 31, 1988. Because the Act does not provide a different date for “timely” amending a collectively bargained plan for this purpose, even in the case of a collectively bargained plan for which section 1140 of the Act provides a later date for making required amendments, the above-described relief from section 411(d)(6) of the Code is available only if the plan is amended for this change before the end of the first plan year beginning after December 31, 1988.

This limited exception from the requirements of section 411(d)(6) of the Code applies only if the amendment to replace plan language providing for the “PBGC immediate interest rate” with plan language providing for either the “applicable interest rate” or the “section 1139 limits” further provides that the “applicable interest rate” shall be determined as of the same date provided under the plan for determining the “PBGC immediate interest rate.” For instance, if, under the plan, the “PBGC immediate interest rate” was determined as of the date benefits commenced, the “applicable interest rate” must be determined as of the same date; and, if the “PBGC immediate interest rate” was determined as of the first day of the plan year during which benefits commenced, the “applicable interest rate” must be determined as of the same date.

Example:

A qualified plan that was adopted and effective in 1980 had originally provided that the amounts of “section 411(a)(11)(B) or 417(e)(3) benefits” were determined using 5% interest. In 1985 a plan amendment was adopted effective as of January 1, 1985, that provided for the amounts of “section 411(a)(11)(B) or 417(e)(3) benefits” to be determined using either 5% interest or the “PBGC immediate interest rate” determined as of the first day of the plan year during which benefit distribution commences whichever produces the greater benefit. If an amendment to the plan is to be effective January 1, 1987, with respect to existing accrued benefits so that the amounts of “section 411(a)(11)(B) or 417(e)(3) benefits” are determined using only the “section 1139 limits” in place of both 5% interest and the “PBGC immediate interest rate”, the amendment would violate section 411(d)(6) of the Code.

Retroactive Correction

Section 1139 of the Act and amended sections 411(a)(11)(B) and 417(e)(3) of the Code apply to distributions of benefits under defined benefit plans that commenced in plan years beginning after December 31, 1984, if such distributions were not made in accordance with REA and the temporary regulations thereunder (“subject distributions”). Pursuant to section 1139 of the Act, a plan will not fail to satisfy section 411(a)(11)(B) or section 417(e)(3), as amended under the Act, for “subject distributions” commencing before August 10, 1987, if before August 10, 1987, such “subject distributions” are retroactively corrected to comply with amended sections 411(a)(11)(B) and 417(e)(3) by adjusting participants' and beneficiaries' rights and benefits.

Retroactive correction of the amount of a “subject distribution” shall mean recalculation of the increased amount of the benefit and distribution of the cumulative underpayment(s). For purposes of recalculating the amount of the benefit, if the date the benefits commenced precedes the first day of the first plan year beginning after December 31, 1986, the date for the determination of the “applicable interest rate” (and 120% of that rate, as appropriate) shall be the date the benefits commenced.

A plan will not be treated as retroactively correcting a “subject distribution” unless the cumulative underpayment(s) has (have) been credited with interest from the date(s) of the underpayment(s) until the distribution of the cumulative underpayment(s). Such interest shall be at a rate no less than the greater of (i) the interest rate otherwise provided under the plan for recomputing benefits that have been paid late or have been underpaid, or (ii) the interest rate used (or the highest interest rate if more than one interest rate is used) to recalculate the correct benefit amount. For example, a “subject distribution” in the form of a single sum distribution of $20,000 was made on October 1, 1985, to a participant, but the interest rate used exceeded the “applicable interest rate.” The benefit is retroactively adjusted to $22,000 as of October 1, 1985, using the “applicable interest rate” which is 9%. Under the terms of the plan, an 8% annual interest rate is applied to all underpayments. If the excess is to be paid to the participant on January 1, 1987, the $2,000 recalculated excess must be credited with 9% annual interest from October 1, 1985 to January 1, 1987.