Funding for a Single Life Annuity

[Pension RC]

I am checking a 2011 valuation of a one-man DB plan that was effective 1/1/2011. The assumed form of payment is a single life annuity. Since there is no accrued benefit, at 1/1/2011, the funding target is zero. I would have expected the target normal cost to be the greater of 1) the present value of the 2011 increase in the accrued benefit using plan assumptions and 2) the present value of the 2011 increase in the accrued benefit using the IRS mandated assumptions. However, my valuation software is ignoring the option using plan assumptions (which would have been greater). Does anyone have an idea of why the valuation software would be doing this?

Thanks!

[Andy the Actuary]

Seems as if you changed assumed payment form to lump sum that you'd get desired result. Q: Is it reasonable to assume that a one-person DB Plan will keep going after retirement to make periodic payments?

[Pension RC]

Thanks for your response. I agree that it isn't reasonable to assume a single life annuity form of payment in a one-person DB plan and think that I'll change that in the 2012 valuation. I was just trying to match the 2011 results and was wondering why the valuation system seemed to ignore the present value based upon plan assumptions. Do you have any thoughts?

[Andy the Actuary]

Thoughts are plan factors apply for lump sums. Since no lump sum assumed, no lump sum valued.

[My 2 cents]

It is my understanding that in calculating expected lump sums for funding purposes, one can never reflect the actual 417(e) segment rates, that the IRS "annuity substitution" rule requires that one replace the mandated sex-distinct mortality with the 417(e) mandated unisex mortality table but otherwise calculate the expected lump sums using the funding segment rates.

Perhaps the plan in question defines lump sums in terms of the 417(e) basis or the plan's regular equivalence basis, whichever produces the higher lump sum (and uses extremely conservative rates for regular equivalence). The former value, for funding purposes, will be more or less equal to the funding target for the life annuity (perhaps just a touch higher if the one-person plan covers a male).

Have you made sure you are coding your valuation system correctly? Perhaps special coding is needed to get it to make such a comparison. Do you have anyone you can ask about the coding?

[david rigby]

It is my understanding that in calculating expected lump sums for funding purposes, one can never reflect the actual 417(e) segment rates, that the IRS "annuity substitution" rule requires that one replace the mandated sex-distinct mortality with the 417(e) mandated unisex mortality table but otherwise calculate the expected lump sums using the funding segment rates.

I would not use that phrasing. See regulation 1.430(d)-1(f)(4)(iii).

[My 2 cents]

Perhaps I did not make myself clear. Suppose one is dealing with a plan that specifies that lump sums will be the greater of the value based on Section 417(e) or the value based on the plan's definition of actuarial equivalence (although plans may define actuarial equivalence for purposes of benefits subject to 417(e) to be the value determined in accordance with 417(e), in which case there would be no comparison made to the present value under the actuarial equivalence basis used for annuities but presume that we are not talking about such plans here).

The actual amount payable as a lump sum would then be the greater of the present value based on 417(e) interest and mortality or the present value based on the plan's actuarial equivalence basis. The funding target, however, would be based on the greater of the present value based on the plan's actuarial equivalence basis or what the 417(e) present value would be if the funding segment rates were used instead of the 417(e) segment rates. There would be no funding calculations looking at the actual amount payable under 417(e). This is buttressed by the explicit indication in the MAP-21 guidance that specifies that if the funding target is being determined using MAP-21 segment rates and the funding target reflects assumed lump sum payments, then expected lump sums for funding target deteminations would be calculated using the MAP-21 segment rates instead of the segment rates actually required under 417(e) for benefit payment purposes. If the plan specifies an alternative minimum basis for lump sums, that alternative minimum basis would be reflected in the calculation of the funding target. My point was that in calculating the funding target, the actual 417(e) segment rates would not be utilized.

[Draper55]

in reviewing the responses to this post, i am wondering has anyone ever heard the IRS

opine that it is flatly unreasonable to assume other than a lump sum payment

in a one person(including with spouse plans)plan. further, suppose one makes

such an assumption, is it then even more unreasonable to switch back??

under the MAP-21 scheme annuity funding could produce much smaller contributions depending

on plan lump sum factors...would the IRS actually have a problem with smaller deductions for mr. owner(and mrs. or vice versa)? On audit, are the going to say you underfunded the plan?