IRC 436 restrictions or 110% test restrictions. Which come first?

[dmb]

A plan's AFTAP is less than 80% but more than 60% and therefore subject to 50% restriction on lump sums. An HCE is restricted because the plan fails the 110% test. Which restriciton is applied first? Does the 110% test get performed after bifurcation pursuant to IRC 436 or is the 110% test performed based on the entire lump sum before bifurcation? Thanks.

[Hojo]

The 110% is based on the full value of the benefit. The bifurcation technically happens after the benefit is elected.

[dmb]

I guess my question is which restriction takes precedence? This plan pays lump sums and purchases annuities for monthly benefits. For someone electing a lump sum, do you look at the AFTAP, bifurcate and then perform the 110% test assuming the 50% lump sum and the annuity purchase for the rest of the benefit, or do you perform the 110% test on the whole lump sum then bifurcate?

[Andy the Actuary]

Whoa. An annuity purchase (i.e., irrevocable commitment) is treated like a lump sum distribution. Forget about HCEs. If restrictions apply, then you could not purchase the entire pension.

[SoCalActuary]

Both rules apply. If the plan is below 80% aftap, then you also fail the 110% test. But the 110% test applies on the remaining amounts after the distribution. If a participant is eligible for the 50% lump sum, but they are a restricted HCE, then I would look at the effect of the 50% LS on the 110% test. If you would fail the 110% test after the partial lump sum, then you can pay a life annuity benefit, or you can have an escrowed part of the 50% lump sum, subject to reclaiming it by the trust.

[dmb]

Andy, understood that can't purchase annuity under restriction.

SoCal, thanks. We are thinking that the 436 restriction takes precedence and then perform the 110% test on the 50% lump sum plus the cost of purchasing the annuity for the balance. But until the plan passes the 110% test, the benefit will be treated as two separate benefits, the draw down monthly benefit of 50% of the restricted lump sum and the monthly benefit from 50% of the 436 restriction. If and when the plan passes the 110% test, the balance of the 50% lump sum will be paid and an annuity will be purchased for the other restricted portion. All that assuming when they pass the 110% test they will also have AFTAP at least 80%. Does that sound reasonable and correct. Thanks again.

[SoCalActuary]

dmb, you can pay a 50% lump sum with a 60% aftap and failing the 110% test. You just have to comply with the rules for keeping that separate account in escrow. If you are not interested in that solution, then the only choice left is an annuity option that pays a life annuity or lower payment. So your understanding is reasonable and correct.