Actuarial equivalency

[Guest ABC]

I understand the function of the interest rate is to provide an assumed level of return on assets over an assumed period of time to produce the annuity payments over that same period.

For example, disregarding the 417(e) minimum assumptions, if a plan provides for a 7% interest rate and specifies a mortality table for calculating actuarial equivalency, is it accurate to say that a participant is "earning" 7% per year on his benefit, disregarding any actuarial adjustments for early/late commencement ? This does not seem accurate, but I'm not familiar enough with the mechanics to understand the reason.

[david rigby]

Some might use the word "earning", but not I. That word implies an investment account, and an accrued benefit is not an account.

Instead, I describe the actuarial increase as adjusting the payment to reflect the payments not received between NRD and actual retirement, or some such nonsense.

[Guest ABC]

That's how I'm thinking about it as well. But is it accurate to say that the lump sum value as of NRA is increased by approximately 7% each year if that's the plan's interest rate assumption for actuarial equivalency? I suspect it's close but not exact. The interest rate assumption merely assumes a rate of growth on plan assets to produce the life annuity payments over the individual's actuarial life expectancy. That is not the same thing as saying the lump sum value grows each year by 7%.

[FAPInJax]

True. A 7% interest rate and 2011 Applicable mortality will actually cause the lump sum to grow by over 9% from 65 to 66 and get progressively larger increases each year.

[david rigby]

BTW, I not aware of any requirement that the plan definition of AE must include both interest and mortality.

For example, the plan could define the AE for post-NRA as "8% per year".

[Mike Preston]

If you are going to throw 417(e) out of the equation, I think it is perfectly fair to reference the lump sum increase from one year to the next as being "earned through the passage of time". Technically, it is "earned" by the fact that at the later measurement date there is one less year available between said later measurement date and the benchmark date (typically the normal retirement age).

It is hard to go to a 45 year old who has a lump sum due at age 45 of $1,000 and, if the plan allows the option of waiting until 46 to take his lump sum, has a $1,070 lump sum available at age 46 and deny that his lump sum benefit is increasing at 7% per year. As has already been pointed out, some plans increase for both interest and mortality and in such a case the lump sum might increase to $1,090.

I think it is perfectly reasonable for the participant to interpret the above as if his "account" is earning either 7% or approximately 9% per year.

[Guest KBSimpson]

It is clear that ignoring mortality, the value of the benefit is increasing from one date to the next at the plan's AE interest rate. In a recent plan termination I actually had to explain to participants why manager X, who has been at the company longer and makes more money was receiving a "smaller" benefit than manager Y. Manager Y was about 20 years older than manager X, so I had to equate discouting back from NRA to today in terms of earning interest from today to NRA.