Explaining actuarial increase

[newguy2012]

Can someone tell me if I am thinking fully and corrrectly about the concept of the mortality table and interest rates as they relate to actuarial equivalence and/or actuarial increase? I know that you would use these to determine actuarial equivalence when optional forms are involved. I just don't know exactly how they work. Well, I know how the interest rate plays into this, I think. That is, if the normal form of benefit is a single life annuity (and the interest rate is high (8%)) that means you will get less is a lump sum distribution than you would have if the interest rate were lower--because the the assumption is that you will invest that lump sum at 8% a year or something like that.

And, I understand that the mortality table predicts the age of death and how that would affect funding; I guess I don't see how a certain table is chosen or if I need to know anything else about the concept.

I guess the better question relates to actuarial increase: I have read that:

An "actuarial increase must be provided under a defined benefit plan for an employee who retires after age 70 1/2."

What is the difference between accrued benefit and actuarial increase of accrued benefit? I have seen language concerning late retirement that reads somehting like this: "a P's who continues employment after attaining NRA his benefit shall be the greater of continued accruals or act. eq. of acc. benefit." I can't wrap my mind around it. The I read that the late retirement benefit could be "paid as though the P had actually retired on the NRD." That seems weird to me. Can that be done?

Please understand that I have plenty of people in my office who can tell me if I am right or wrong on something; I am just trying to learn this DB stuff to the point of really understanding it and being able to explain it to a novice--understanding at a fundamental level.

[david rigby]

Accrued Benefit. See IRC 411(a)(7). Note the reference to Normal Retirement Age, which means that must be defined first.

BTW, you might benefit from general background reading (if not alread) such as "Fundamentals of Private Pensions" (my copy is published by the Pension Research Council) or "Pension Planning" (published by Irwin).

[newguy2012]

Accrued Benefit. See IRC 411(a)(7). Note the reference to Normal Retirement Age, which means that must be defined first.

BTW, you might benefit from general background reading (if not alread) such as "Fundamentals of Private Pensions" (my copy is published by the Pension Research Council) or "Pension Planning" (published by Irwin).

Thanks. I will read the rule and see if I get what you are saying. It just so happens that I have the first book on my desk and have read a little. I hope to read the DB chapters over the weekend. I don't know if I heard about the other one. I will look in our library. Thanks.

[frizzyguy]

You might want to do some research about ASPPA. It may be beneficial for you. It won't get you the depth that you are going to need but it will give an accelarated base of knowledge. They also do a great job of keeping you current with law changes.

[newguy2012]

You might want to do some research about ASPPA. It may be beneficial for you. It won't get you the depth that you are going to need but it will give an accelarated base of knowledge. They also do a great job of keeping you current with law changes.

Thanks, Frizzy. I just ordered their Retirement Plan Fundamentals I book. They have a new "RPF" designation if you complete volumes I and II and take the open book tests. I will finish those this year since there are no experience requirements and then move on to QPA/QKA/CPC designations over the next three years.

Any recommendations on learning the purpose behind each rule relating to qualified plans? I find that if I know the purpose behind a rule and/or how it works in practice, I understand it better.

And, anytime you think of anything that would be useful for me to know, feel very free to e-mail me. I'm hoping you guys on here will be let me benefit from your wisdom and experience.

[david rigby]

Any recommendations on learning the purpose behind each rule relating to qualified plans? I find that if I know the purpose behind a rule and/or how it works in practice, I understand it better.

Well............ this is Congress and the IRS/DOL, so "purpose" might be in the eye of the beholder.

In general, there are a few purposes behind most statutes and regulations:

- set a minimum level of "reporting" (ie, from the plan/employer to the government)

- set a minimum level of "disclosure" (ie, from the plan/employer to the participants)

- set minimum fiduciary standards

- set standards for "non-discrimination" (usually objective, but not always)

- set standards for eligibility (getting in the plan), vesting (getting a right to the benefit), and funding (paying for the plan)

Others may add to this list.

Other rules were changed or added with a specific eye on money: Congress wanted more tax revenue, so they tightened certain things. Not good design, just a different purpose. There are some rules that were added in response to a situation that had previously been overlooked, such as IRC 416 and IRC 401(a)(26).

BTW, keep in mind the big-picture historical information that you find in your reading: the Studebaker situation and other pre-ERISA lack of standards, as many of the original parts of ERISA grew out of those experiences.

[FAPInJax]

Your original question was an explanation of an AE increase. The AE increase is design to make a participant not lose or gain from deferring retirement - ie making benefits at different ages equivalent.

The old fashioned formula is as follows:

Ben65 * N(12)65 / D65 = Ben66 * N(12)66 / D66 * (D66 / D65)

producing

Ben66 = Ben65 * (a65 / a66) * (D65 / D66)

Now most of the time actuaries will eliminate the mortality from the last term and just have a (1+i) adjustment.

[david rigby]

Now most of the time actuaries will eliminate the mortality from the last term and just have a (1+i) adjustment.

Clarity needed:

- The AE adjustment is not determined by the actuary, but by the plan document.

- "most of the time" is in the eye of the beholder. Many plans do not define the AE adjustment as interest only, but also include mortality. And the plan's death benefit design might be a relevant factor in this distinction.