Interest added when a lump sum payout is corrected

[Gary]

Say somenone receives a lump sum of 50,000 at 1/1/99. and on 1/1/2000 they discover they s/ have received 70,000. As a result the person is given an extra 20,000 plus interest from the original time of payment. What is a reasonable interest to credit the makeup payment from 1/1/99 to 1/1/2000 (i.e. the date the makeup payment is made)? Since lump sums can be computed using variable rates of interest.

[richard]

Take your pick. I've seen the following, all of which would be reasonable.

T-Bill rate used to calculate 1/1/1999 lump sum.

T-Bill rate used to calculate 1/1/2000 lump sum.

Average of the above.

Money market rate.

Money market rate plus 1% or 2% (depending on the client)

[AndyH]

I would do it differently, by backing into the accrued benefit initially paid, i.e. the actual lump sum divided by the correct pv factor. Therefore, the person may have been paid 5/7 of his accrued benefit. Then, apply the lump sum factors in effect at the time of the final payment, based upon the 2/7 remaining accrued benefit, current age, etc. This seems to me to be the best way of assuring that you've satisfied 417.

[Lorraine Dorsa]

A plan I was working on a few years ago discovered that they had systematically underpaid a number of participants over a several year period and decided to seek IRS approval under the VCR program re the method of correction.

We considered all of the methods/interest rates above plus the plan's actuarial equivalent (which for late retirement lump sums was greater of the late retirement AB or the lump sum at NRD increased with 7.5% interest to date of payment).

(I as an actuary felt I could best justify AndyH's method, but the client and attorney preferred the unpaid amount + interest method.)

We finally settled on the unpaid amount increased with 7.5% interest to date of payment and applied for approval of this method in our VCR submission.

IRS approved this method and we made the corrections accordingly.

I don't think I'd apply under VCR for a single error (APRSC should be sufficient), but with the large number of corrections to be made, our client wanted the assurance of an IRS letter since there are, as noted above, several ways to look at it.

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[richard]

As an actuary, I too like AndyH's method.

If GATT or Treasury Bill interest rates increase in the interim, it would be hard to explain why the $20,000 actually decreased. (Actually, it would be easy for me as an actuary to explain, it would just be unpalatable to the employee.)

And AndyH is right, the 417(e) could be a problem if interest rates decreased in the interim.