Rate of Return for Credit Balances Adjustment

[Calavera]

Assuming the following:

1/1/13 trust statement asset - 100

1/1/14 trust statement asset - 200

7/1/13 contribution made for 2012 plan years – 100

2012 effective rate – 5%

What is the rate of return during the 2013 year for the purpose of the credit balances adjustment:

Option A: Since the contribution was made for the prior plan year, include it in the beginning of the year value discounted with the 2012 effective rate. Therefore the rate of return is

200 / (100 + 100 / (1.05^0.5)) = 1.22%

Option B: Account for the timing of the contribution disregarding the fact that it was made for the prior plan year as: 100 * (1+i) + 100 * (1+i)^0.5 = 200 . Which gives you 0%.

Other - ?

[Andy the Actuary]

Option B, cash basis for SB accounting. On the contrary, accrual basis when determining AVA using smoothing method.

[FAPInJax]

^{Actual rate of return is zero.}

[Calavera]

Definetely accrual basis for AVA, but some people think that it also should be used for adjusting the credit balances. The 1.430(f)-1(b)(3)(i) says that for the credit balances adjustment for investment experience, the actual rate of return on plan assets is determined on the basis of fair market value and must include the amount and timing of all contributions. The fair market value is not clearly defined and some people think that it should include the accrued contributions (i.e.Option A).

I like Option B myself, since it makes more sense to me, and trying to argue that since it said "must include amount and timing of all contributions", this should be the actual amount and the actual timing of all contributions whether it is for the prior plan year or not and not the discounted amount as of the end of the prior plan year.

Thanks to both of you for the support of common sense and 0% asset return.

[david rigby]

Note that IRC 430(f)(8) includes the phrase, "...in accordance with regulations prescribed by the Secretary..."

The IRS has stated (informally) their opinion that no regulations are needed or desired. That position is very sensible.

Yes, a cash basis calculation of ROR is the best approach here.

[My 2 cents]

A cash basis calculation of ROR when there are receivables for the preceding year would produce an investment return figure different from the actuarial valuation, even if the actuarial valuation uses market value and not a smoothed value.

Is a cash basis calculation of ROR better than an accrual basis calculation, with both being considered reasonable and acceptable, or is the use of a cash basis more or less required?

[david rigby]

IMHO, if accrued items (whether BOY or EOY) are included, then they will be included with an improper time-weighting. I believe that a plain reading of the statute supports this position and I see no reason to be concerned that the cash basis assets do not equal the valuation assets.

[My 2 cents]

Not just the assets. The actual investment earnings on a cash basis calculation will not equal the investment earnings in the actuarial valuation. See the original example above - the cash basis ROR calculation will show $0 investment earnings and the actuarial valuation will show earnings during the period of $2.41 (accrual of discount on prior year's receivable contribution. Using accrual basis assets for the calculation, both the ROR calculation and the actuarial valuation show earnings during the year of $2.41. Seems to be the consensus here that that is not reason enough to calculate the ROR on an accrual basis.

[Calavera]

Is a cash basis calculation of ROR better than an accrual basis calculation, with both being considered reasonable and acceptable, or is the use of a cash basis more or less required?

Yes, that was another thing I was trying to figure out by starting this discussion. The 1.430(f)-1(b)(3)(i) says that the actual rate of return on plan assets is determined on the basis of fair market value and must include the amount and timing of all contributions. In absence of the IRS regulations, I guess if you read it as cash basis or if you read it as accrual basis, you may say it is respectfully required, but if you read it as it is not clear, both methods could be considered reasonable and acceptable. It is just hard for me mentally to accept that the "actual rate of return on plan assets" is not 0% in my example above.