Is monthly benefit due to failed 110% test eligible for rollover?

[dmb]

HCE elects a lump sum option, but plan fails 110% test, participant receives monthly draw down of LS amount. Is the monthly benefit eligible for rollover? Thanks.

[dmb]

_{What am I missing? What's the DQ event? The HCE elected a lump sum. Since plan fails 110% test, he is receiving a monthly annuity from plan instead of the lump sum. Wouldn't that monthly draw down of the lump sum still be considered part of the lump sum which otherwise would have been eligible for rollover?}

[Andy the Actuary]

Apologies. Misread your post and have deleted mine.

My non-tax-accountant, non-legal understanding is that series of payments not eligible for rollover. However, if restriction ever lifted, balance of lump sum would be.

[My 2 cents]

These questions all deal with a 25-high HCE electing a lump sum and declining to provide any security, forcing a limited payout approach.

I have thought about such issues and some of the resulting questions (example: Irrespective of the survival or marital status of the participant, is it not clear that, absent a clawback situation, there can be no circumstances in which value can be lost? While the limited payout may look like a straight life annuity, there can be no risk of loss due to death.)

One of the things I had thought about concerned the question in this discussion thread, and my opinion is that even though circumstances could result in the lump sum being parcelled out in identical periodic amounts over 12-14 years, it should all be eligible for rollover because in any future year, circumstances could arise permitting the entire remaining amount to be paid, so the payout stream is not technically a series of substantially equal amounts payable for a period in excess of 10 years. It would be nice, however, to know what the regulatory agencies think of that.

[Andy the Actuary]

Here's the wording from the boiler plate "Your Rollover Options"

How much may I roll over?

If you wish to do a rollover, you may roll over all or part of the amount eligible for rollover. Any payment from the Plan is eligible for rollover, except:

• Certain payments spread over a period of at least 10 years or over your life or life expectancy (or the lives or joint life expectancy of you and your beneficiary)

Does this help?

[dmb]

Thanks for the responses. So it doesn't seem to me that the draw down of the lump sum is "over your life or life expectancy", it's over the life of the lump sum (with or without interest). But it could be, and usually is at least 10 years. Not sure what i'm getting at, but just thinking out loud.

[dmb]

Just to amend my last post, I guess the period of payment is usually scheduled to be at least 10 years, but as mentioned, the balance of the lump sum could be paid at any time, if and when the plan comes out of restrictive status (or terminates).

[dmb]

Found a Gray Book question, 2003 #24, which says the payment are not eligible for rollover. No details in the answer, just "No".

[Andy the Actuary]

Maybe IRS read "Your Rollover Options!" (which I believe it was called "Special Tax Notice . . ." in 2003)

[My 2 cents]

Well, for lack of a more formal bit of guidance to the contrary, and recognizing that a 2003 Gray Book answer is not necessarily binding, perhaps one should only attempt to roll such amounts over if one can find an ERISA attorney ready, willing and able to defend doing so!

Also note that the answer included a statement that it would be appropriate to grow the unpaid balance using the same interest rate used to calculate the amount of lump sum (although that is not as unambiguous as it used to be, given the fact that PPA requires the use of segment rates to calculate lump sums).

[Andy the Actuary]

FYI, with blessings from ERISA attorney, Plans determine equivalent constant interest rate and create exhibit similar to an amortization schedule.

BC0011a.pdf

[My 2 cents]

I would go with an "equivalent interest rate" yielding, as of the benefit start date and using the 417(e) mortality table applicable on that date, the same present value as the 417(e) segment rates and mortality applicable then. Once the lump sum amount has been calculated, all future accumulations would be interest only, since forfeiture due to death is impossible. I agree that, pending the potential ability to cash the remaining balance out, the timing can thus be predetermined and a specific schedule can be created.

Assuming yearly payments, does anybody see a problem with paying 12 times what the monthly life annuity would be every year on the anniversary of the benefit start date (including the calendar year of the benefit start date)? That would mean that if someone has a $2,000 monthly accrued benefit and the benefit start date is December 1, 2014, then the limited payment to be made on that date is $24,000, with a further payment of $24,000 every December 1 (starting with December 1, 2015) until the total value is exhausted (or the balance can be paid without restriction). Would one be able to pay $24,000 on December 1, 2014 and then $24,000 every January 1 thereafter (starting with January 1, 2015) until all paid out?

Is it agreed that if it ever comes to pass that the restrictions are lifted (as opposed to actually exhausting the balance through limited payments), the payment of the remainder (after subtraction of any RMD for the year, if applicable) would be eligible for rollover?

If it would take 12 more years of restricted payments to exhaust the balance on the date when the participant dies and it had been arranged that the remaining restricted amounts (or, when applicable, the unpaid balance) would go to the participant's estate, would there be any possible minimum distribution issues? If it comes down to 401(a)(9) versus the 1.401(a)(4) restrictions on payments to 25-high HCEs, which rule prevails? Is it not certain that those circumstances could never jeopardize the plan's qualification or result in any excise taxes being imposed for failure to meet the minimum distribution rules?

Any thoughts concerning the correct handling of the unpaid balance for minimum funding purposes? Recognize the scheduled future payments and the respective durations for each such payment (discounting at the current year's funding segment rates) or treat the entire unpaid balance as part of the Funding Target with a 0 duration (as though it were to be paid on the first day of the current plan year, assuming that to be the valuation date for the plan)?

It should be clear that, however infrequently this sort of thing arises, I have spent way too much time thinking about it!

[dmb]

I don't know about the annual payments, but with regard to interest and funding target, we think the interest should be decided by the employer. We discuss and provide some options, most go with the effective interest rate of the lump sum calculation. As for the funding target, we use the remaining balance of the lump sum on the valuation date.

[Effen]

Keep in mind that whatever you do needs to be specified in the plan document. If the lump sum cannot be paid because of the 110% rule, and the plan is silent about optional forms of payment when this occurs, then the lump sum simply cannot be paid and he need to elect some other form of payment that is available.

Discussing these other options is interesting, but if they aren't in your plan document, they aren't really options you can use.

[Andy the Actuary]

Agree with Effen subject to IMHO participant can elect lump sum and Plan would start paying no more than annual life only actuarial equivalent. Issue is that some plans don't state actuarial equivalence basis. E.g., early retirement is 1/15, 1/30, table of factors for conversion to other forms (e.g., J&50%). Plan would need to be amended to stipulate how but would challenge that participant cannot start receiving distributions, especially since Effen's Pirates came back to beat my Cardinals late in last night's game.

[My 2 cents]

If the plan's AFTAP is below 80%, restrictions would apply to all participants with respect to election of the lump sum option. Otherwise (and this is my understanding of the IRS position), barring an explicit plan provision to the contrary (and, as many times as I have seen the usual 25-high payment restrictions, I have never seen a plan provision to the contrary), the plan MUST allow a participant subject to the 25-high restrictions to elect a lump sum if the plan offers a lump sum. What is true is that if the participant makes such an election, either the participant must establish sufficient security to permit clawback efforts to succeed OR the plan must parcel the lump sum out bit by bit.

The limitation would be based on the immediate straight life annuity offered by the plan. All qualified defined benefit plans, as a condition of qualification, must provide a sufficiently detailed actuarial equivalence basis to make all necessary determinations concerning actuarial equivalence unambiguous. If the plan allows election of lump sums prior to early retirement age, it must specify what the basis is for an immediate QJSA (no spousal waiver in favor of an immediate lump sum being valid unless there is the opportunity to elect an immediate QJSA).

If a 25-high participant elects a lump sum, and does not set up security himself or herself, then the plan holds his or her lump sum proceeds as a form of security. The money, on or after the benefit start date, belongs to that participant until and unless there is a bona fide clawback situation (which can only occur if the plan is terminated without sufficient funds for the non-HCEs, and not always even then). The participant, otherwise eligible to elect a lump sum, cannot be denied that choice.

Incidentally, my opinion (for what that is worth) is that all qualified defined benefit plans that allow participants eligible for a subsidized early retirement benefit to elect a lump sum should be forced to calculate that lump sum as the greater of the lump sum equivalent of the accrued benefit (i.e., the value of the deferred benefit payable at normal retirement age) and the lump sum equivalent of the immediate normal form benefit otherwise payable (i.e., whatever the life annuity payable immediately would be, the lump sum should never be allowed to have a lower value based on 417(e) interest and mortality factors). I cannot see there being any legitimate justification for paying any less than the full value of the annuity benefit otherwise payable, given that the participant has met all requirements for receipt of the plan's subsidy (including separation from service and election of an immediate benefit).

[Andy the Actuary]

Concur with your last paragraph from an ethical position. However, law requires only that the lump sum provide for the Pv of the NRB so excluding the subsidy is not illegal (I don't think). Your point is precisely the reason the relative values regs were born. My treatment has always been to value the lump sum both ways and give the greater. Normally no big difference unless early retirement is unreduced. Otherwise, there's no way the lump sum could purchase the equivalent annuity under the same assumptions.

[My 2 cents]

Of course, whether to just value the accrued benefit or compare the accrued benefit value to the otherwise payable benefit value requires that the plan provisions call for it. My point is that the plan provisions should have to call for it. Based, however, on the fact that tightening up the non-discrimination rules and the integration rules did not relieve us of having to deal with top-heavy rules, I would not hold my breath waiting for such a requirement to eliminate the relative value rules!

[Effen]

2 Cents - I generally disagree with your position, I don't see any problem in plan's not including the value of the early retirement subsidies in the lump sum values. If I am providing you with an incentive to retire, why should I be forced to pay you that value up front in one lump sum. Maybe the value of the incentive is not worth as much as you thought, because you can't get it in a lump sum, but that should be part of the analysis, not forced upon the employer to pay. If you want the subsidy, take the annuity, if you don't, take the lump sum. Why is that "wrong"?

I think the relative value requirements do a nice job explaining the value of the options so participants can make informed decisions. However, I also think the rules are often misinterpreted by practitioners, or simply ignored, which is a problem with our profession and not the regulation. If practitioners provide proper disclosures, participants can make informed decisions.

[Andy the Actuary]

Agree with Effen with the qualifier "that the participants must have scored in the top ten percentile on the verbal skills SAT."

[My 2 cents]

...and be able to defer the gratification that comes from receiving an immediate lump sum in favor of a slower but more valuable payout. Smart, to understand the difference in value, and at the same time wise, to be able to choose the more valuable option despite the strong tug of human nature.

That said, if someone has worked the 25 or 30 years it takes to qualify for the subsidized benefit, why shouldn't they be entitled, if they take a lump sum, to the present value of the subsidy? They earned it. We aren't talking about having to pay the value of the subsidy to anyone who has not qualified for it.

Perhaps you should be forced to pay the value of the subsidy because otherwise you are shortchanging the person electing the lump sum. On some reasonable basis, all benefit options ought to have roughly the same value, and clearly, the full value of the subsidy is passed along to anyone receiving a straight life annuity or any sort of joint annuity.

If there is much of a subsidy, isn't the enrolled actuary most of the time going to be making sure that it is suitably reflected in the Funding Target in any event (i.e., assuming that 80% will retire immediately upon satisfaction of the 30-and-out provision)? So the employer is "paying for it" whatever option the participant winds up electing.

[Effen]

You did "earn it", you earned it as a benefit payable as an annuity. You did not earn it as a lump sum because the plan does not offer that benefit.

Yes, the Funding Target should include the assumption that a benefit is payable as a lump sum, however, it is generally not a problem for valuation software to assume a certain percentage elect a lump sum without the value of the subsidy, and a different percentage will elect an annuity, which would include the subsidy.

Sure the plan can pay the lump sum value of the subsidy, but that extra payment comes at a price of a lower overall benefit, or a higher employer contribution. The reality is the plan benefits are set by how much the employer/employee wants to contribute. If the plan pays out higher lump sums, it just means someone else gets less somewhere else.

[My 2 cents]

I was saying that the Funding Target, in any event, would reflect the assumption that X% of the people who are expected to grow into eligibility for the early retirement subsidy will elect to retire early and take the subsidy, certainly to the extent that it was being assumed that the participant would take a life annuity or a QJSA. The handling of any assumed lump sums would depend on the plan provisions (i.e., whether it would be based on the subsidized early retirement benefit or just on the deferred accrued benefit).

Valuation software would presumably be able to value the anticipated lump sums in accordance with the plan provisions either way, as needed.