Accrued Benefit comparisons

[Guest CuriousEmployee]

Forgive my ignorance--I'm an employee/plan participant, not an actuary.

Accrued benefit is defined under my plan by the fractional method. Suppose accrued benefit (defined as the normal Age 65 benefit) is $1000/mo. Suppose retiring at Age 55 yields $700/mo. Suppose retiring at Age 56 yields $650/mo. (I pulled these numbers out of thin air so don't pay much attention to them specifically). If I'm reading the IRS code right, you are entitled at Age 65 to the higher of the Age 65 accrued benefit or the early retirement benefit at any earlier age. Thus, the benefit in this example would be $1000 if you retired at Age 65.

But, suppose you want to retire at Age 56. Why should you receive a lower benefit than if you had retired at Age 55? Yet, the plan administrator says that because the Accrued Benefit--defined as the normal retirement benefit at Age 65 by the fractional method--is the same for both of these, there is no cutback of accrued benefits between Age 55 and Age 56. Is this correct? It just seems wrong to me that you should receive less after another year of work!

Beyond the fact that there is an absolute dollar reduction from Age 55 to Age 56, you also have one less year of receiving the benefit. Why shouldn't you at receive the actuarially equivalent benefit? i.e., why wouldn't you be entitled to the greater of either (a) the actuarial equivalent of the Age 65 Accrued Benefit at your early retirement age, or (b) the actuarial equivalent of the highest early retirement benefit? (In this example, then, if you retired at Age 56 you would be entitled to the actuarial equivalent of the Age 55 benefit. Or if it was higher, the actuarial equivalent of the Age 65 benefit. But you wouldn't get stuck with the low-ball Age 56 benefit).

Is the law/plan just stupid, or is it me? I'd be grateful if you could clarify/explain the rationale for this to me.

Thanks for the help!

[Effen]

As you suspect, what you described would not be legal. IRC 411(d)(6) states the accrued benefit can never go down. However, there are situations where bad communication can lead to misunderstandings. We would need more information to answer your question. Also, plan administers don't always understand their own plans, so it might not be as they describe either.

In general, under fractional rule, if you were hired at age 30, and retirement age was 65 and your projected benefit was $1,000. At age 55 your accrued benefit would be $714 (25/35*1000). At age 56, it should be $743 (26/35*1000). Both of these numbers represent monthly benefits payable at Normal Retirement. Early Retirement benefits may be significantly lower.

A few question:

- how is the projected benefit of 1000 determined? Is it a fraction of your compensation? Did your compensation go down?

- Could this be a "cash balance" plan, or some sort of "retirement equity" plan?

- Are you sure you are calculating the age 55 benefit and age 56 benefit correctly? Are they your calculations or are you looking at a benefit statement?

- Has your employer changed the way the projected benefit is determined?

Also, your concept of "actuarial equivalent" is a little off. Generally actuarial equivalents only come into play if the person defers receipt of their benefit to after their Normal Retirement Age.

Also, keep in mind that your accrued benefit is payable at your normal retirement date. If you are eligible for an Early Retirement Benefit, it may be significantly lower than your stated accrued benefit because it would be payable at an earlier date.

Ask for a copy of the "Summary Plan Description" and a detailed calculation of your accrued benefit. You have a legal right to both of these items.

Keep asking questions until you are satisfied. Just because the employer says it "just is", doesn't mean that it really "is", but it could be.

[Effen]

Curious- I just reviewed some of your older posts. Are you still talking about a PEP plan? That is a bit of a different animal and may require that you actually hire someone to review all the documents. It might be difficult to get specific advise off this board with out really digging into your specific situation.

Good luck!

[Guest CuriousEmployee]

Effen,

Thanks for your response. I'm afraid my question wasn't clear. The $1000 would be the Age 65 benefit. The $700 at Age 55 and $650 at Age 56 are the benefits commencing at those ages, i.e., early retirement. (And again, these are made up numbers). So, what is bothering me is that the Age 56 benefit is less than the Age 55 benefit. I asked the plan administrator why, and they said that the Accrued Benefit defined by the plan (defined as Age 65 normal retirement benefit prorated by the fractional method) doesn't decrease with age so therefore it is OK.

The plan I'm talking about is not the PEP, but a grandfathered traditional defined benefit plan. 1.6% x HC3A x service minus an offset that is based on Social Security income. From examination of the formulas, the reason the benefit decreases with age is because (a) compensation and credited service were frozen a few years ago (as part of the transition to PEP) so the first part of the formula doesn't increase; (b) the social security offset increases with age and is subtracted from the initial calculated value, so that as you get older, the total benefit by this formula decreases. Since the SS offset is not frozen, it increases with age, while the number it is subtracted from does not (since compensation and service were frozen). The plan administrator says the SS offset is allowed under an IRS safe harbor method Treas. Reg. section 1.401(l)-3(e(2). I can't help but wonder if the regulation foresees the effect of a freeze like this and how it results in a lower benefit with increasing age. Just doesn't seem right to me. Life ain't always fair, but I want to know if this is one of those instances where it ain't, or if the administrator is mistaken!

My concern is threefold: (1) can an early retirement benefit go down with age like this and yet the plan be compliant just because a defined Age 65 accrued benefit does not decrease with earlier retirement age? (2) Can an early retirement benefit decrease with age, in absolute dollars ($700 vs. $650, for example), due to a SS offset even when a service/compensation freeze is distorting the formula? (3) Should actuarial equivalence be taken into account when making comparisons between benefits at two different ages?

My terminology may be off w/r/t actuarial equivalence. What I'm trying to get at is that even if the early retirement benefit was the same at Age 55 and Age 56, in absolute dollar terms (for example, $700), the net present value of the income stream over the expected life of the employee would be greater for an employee retiring at Age 55 with $700/mo than for the same employee retiring at Age 56 at $700/mo. Thus, I would expect that a plan should give a lower benefit to the one retiring earlier, i.e., maybe $650 to the Age 55 employee and $700 to the Age 56 employee. Instead, it is the other way around. The one retiring later is getting the smaller benefit in absolute dollars and even more so on an NPV basis.

Appreciate your comments on this.

[Effen]

Obviously you are much deeper into this and closer to the issue than me. You sound like you have a pretty good grasp of the situation, so without specific details, I can't offer much.

However, a few things sound a little strange - not that they might not be correct, but someone would need to dig deeper.

- it seems strange that a frozen benefit can decrease due to a increasing offset. I would have thought once the plan was frozen, it was frozen and future COLA changes to SS bens would not impact it. But, I don't work on any plans that use an offset, so I am certaianly no expert.

- What does it mean that "ss offsets increases with age"? SS bens are not payable at 55, so how could your benefit at 55 be offset with a SS ben at that age? The SS bens do increase for COLA each year at age SSRA, which could decrease the projected, and therefore the accrued, but not to the scale you mentioned.

(1) can an early retirement benefit go down with age like this and yet the plan be compliant just because a defined Age 65 accrued benefit does not decrease with earlier retirement age? Maybe, but it would be a VERY rare situation. Generally ER reductions decrease with age, therefore, the relative benefit increases.

(2) Can an early retirement benefit decrease with age, in absolute dollars ($700 vs. $650, for example), due to a SS offset even when a service/compensation freeze is distorting the formula? Maybe, I would need to see the actual formula to see how it works. It would not be a typical situation.

(3) Should actuarial equivalence be taken into account when making comparisons between benefits at two different ages? I would say not until after NRA has been attained..

Early Retirement benefits are often "subsidized", which means they are worth more than the straight actuarially reduced benefit from NRA to ERA. They are subsidize to provide an incentive to retire. If you don't retire, you are entitled to the subsidy and it goes away. Normally the benefit at 55 has more subsidy than the benefit at 56, and so on, but it typically doesn't actually decrease in absolute dollars without something else happening.

[Guest CuriousEmployee]

From what I've read, SS offsets are a way of recognizing the contribution the company made to your future SS benefit through their taxes (their 50% of FICA). I believe the term for it is "pension integration." Not sure what it has to do with COLA, unless by that you mean the annual increase in the SS wage base, on which this formula is calculated, in which case I guess it is a COLA.

Formula is this:

Normal Retirement Benefit (i.e., Age 65) = A - B

A = 1.6% x HC3A x Credited Service in years

Credited Service and HC3A were frozen a few years ago.

B = Basic Offset Factor x ASSB3 x Credited Service x SSRF

Basic Offset Factor is obtained from a lookup table based on the ratio of ASSB3 / (ASSB - YOB), where ASSB3 is as defined below, ASSB-YOB is the "covered compensation" which is the annual average of the SS wage base for each year of the 35 years ending with the year before employee reaches SS retirement age.

ASSB3 is the "average offset compensation" and is the lesser of (a) SS taxable wage base for each plan year, or (b) employee's annualized compensation for each plan year, both determined over the last 3 years of employment. [Note that in my case, the first term "a" is used, i.e., ASSB3 is based on the SS taxable wage base. Since the SS taxable wage base increases annually, and wasn't frozen by the plan, ASSB3 continues to increase throughout employment, causing term B to increase as well, and thus the benefit = A - B to decrease.

SSRF is the Social Security Reduction Factor and = 1 - (0.555% x N1 + 0.278% x N2), where N1 = number of months, not exceeding 60, that date of the first benefit payment precedes the last day of the month in which a Participant attains SS retirement age, and N2 is the number of such months above 60. Obviously, SSRF decreases the earlier you retire, reducing B and raising your benefit.

Early Retirement Benefit = Normal Retirement Benefit x early retirement factor

(early retirement factor is equal to 1 in this case because I have 85 points)

So, the crux of the matter is that ASSB3, based on the taxable SS wage base, is increasing even though Term A is frozen; the effect of this is greater than the reduction in SSRF with earlier retirement, so the net effect is that B increases and the benefit A-B decreases with time. Does this look correct to you, or is there some regulation or court decision that prevents the plan from freezing A without also adjusting B to compensate, such as by freezing ASSB3 when the compensation and service were frozen?

And, if actuarial equivalence is not required before Age 65, then a company could pay a similarly situated employee retiring at Age 55 the same as an employee retiring at Age 56 without discriminating against the 56 year-old? Still seems unfair to me.

[Hojo]

When were the Age 55 and Age 56 benefits calculated? Meaning, did someone do the Age 55 benefit calculation in 2010 and is doing the Age 56 calculation in 2013? If so, then yes, the offsets would be different and the two benefits are not entirley comparable because they are payable at different times.

[Guest CuriousEmployee]

Hojo,

The Age 56 benefit is calculated at the date of early retirement. The Age 55 benefit is calculated as if retirement had taken place 1 year earlier. Thus, in effect the Age 55 calculation was done in 2010 and the Age 56 calculation done in 2011 (for example). i.e., the same employee would have received a higher benefit if they'd retired a year earlier.

[david rigby]

Terminology is important.

"Accrued benefit" refers to the benefit earned at any point in time, but payable at NRD.

The "early retirement benefit" generally reflects any applicable reduction in the AB, due to payment commencing at ERD.

Is it possible the $700 is the age 55 AB, but the $650 is the age 56 ERB?

[Guest CuriousEmployee]

David,

No. Both calculated identically. Both are ERBs. (which is why the company says it is OK, because they say that the AB at Age 65 is not smaller for the employee retiring at Age 56 than when he retires at Age 55).

[david rigby]

Might be relevant.

Gray Book Q&A 2008-42. Other DB Plan Issues: Declining Accrued Benefits

May an accrued benefit decrease during continued employment due to any of the following:

a) Increases in a Social Security offset?

b) Increases in covered compensation?

c) Reductions in average compensation?

d) Reductions in the maximum benefit limitations under 415 (other than legislation or changes in response to a variable index)?

e) Investment performance underlying a variable annuity?

RESPONSE

a) Yes, but only to the extent that the offset meets the restrictions specified in Rev. Rule 84-45 and is in keeping with the qualification rule stated in IRC §401(a)(15).

b) and c) No. In this situation, the reduction would be on account of increasing service since the reduction would not occur if the participant terminated employment. A reduction in benefits due to increases in age or service would violate IRC §411(b)(1)(G). This was the rationale behind the answer to Question 33 from the 2003 Gray Book which dealt with situation c) above.

d) Where a post age 65 actuarial increase would be limited by the compensation limit as capped by IRC §401(a)(17), the benefits must be started, or “suspended”, to avoid an impermissible forfeiture. Benefits accrued prior to the IRC §415 regulatory effective date would be insulated from having to make this change and could continue to provide actuarial increases in spite of the 401(a)(17) limit. In addition, note that for benefits accrued after the regulatory effective date and prior to adoption of plan amendments, regulation §1.411(d)-3 would limit the ability to add a suspension of benefits approach. Moreover, for participants who have attained age 70-1/2, suspension of benefits would generally not be permitted.

e) Yes. In this case the reduction is not on account of age, service or plan amendment.

[Guest CuriousEmployee]

David, thank-you. I looked up Rule 84-45 and it makes it pretty clear. Offsets can increase with time, and thus make the pension benefit decrease.

Too bad for me... :-(

[david rigby]

Formula is this:

Normal Retirement Benefit (i.e., Age 65) = A - B

A = 1.6% x HC3A x Credited Service in years

Credited Service and HC3A were frozen a few years ago.

B = Basic Offset Factor x ASSB3 x Credited Service x SSRF

Perhaps another approach? We've used the term "frozen plan" but your description is that only part of the plan is frozen. Let me suggest that (particularly since your Post #4 indicates "transition to PEP") that all parts of the plan were frozen, or intended to be frozen. Not throwing stones, just wondering if (a) your description is accurate, or (b) the freeze amendment drafted incorrectly.

As Effen implied above, it would be unusual to have a "partially frozen" benefit formula.

[Guest CuriousEmployee]

You are correct that the entire plan was not frozen. Would be more accurate for me to say the plan was amended. A grandfathered formula benefit was maintained for eligible employees, while all others were converted to a PEP. After 10 years, the grandfathered benefit formula's HC3A and service were frozen at 12/31/2005 levels. You are entitled to the greater of the grandfathered formula benefit or the PEP benefit.