Late retirement and cash balance plans

[AndyH]

Plan says that the late retirement benefit is the greater of the actuarial equivalent of the normal retirement benefit or the accrued benefit based upon comp and service through the distribution date.

Interest credit is 5%. Actuarial equivalency is defined as the applicable mortality table for 417(e) purposes and 7% interest.

The death benefit is defined as the present value of the accrued benefit.

Participant retires at age 65 with cash balance of $100,000 but does not start payment until age 66, at which time he selects a lump sum.

Is his lump sum:

A. $105,000

B. The present value of a monthly benefit increased from age 65 to age 66 calculated based upon interest and decrease in life expectancy (or $105,000 if greater), or

C. The present value of a monthly benefit increased from age 65 to age 66 calculated using interest and mortality and decrease in life expectancy (or $105,000 if greater).

Opinions please.

[Mike Preston]

It depends on the document language, but if the provisions are "normal" the lump sum is the hypothetical account, which is $105,000. However, the annuity the participant is entitled to receive at age 66 would typically be calculated as described in B, unless it is a PBGC plan in which case it appears to be C.

[AndyH]

Thanks for the feedback Mike. I'm with you except I wonder if there needs to be a direct relationship between the monthly benefit payable at age 66 and the lump sum payable at age 66, so one is "actuarially equivalent" to the other.

[Mike Preston]

It has to be one or the other, it can't be both.

[Effen]

Just as an FYI, the IRS has started to rattle their saber around this issue. They have said the post retirement actuarial adjustment on the cash balance account must be "reasonable", and they have implied that simply giving an interest credit equal to the 30 year treasury is most likely NOT reasonable. In your example your crediting rate is 5% - is that reasonable? I don't know, but since you are crediting the annuity with 7%, you might want to consider using the same rate for the cash balance plan.

[ak2ary]

I disagree with Mike. I believe that the account balance should be increased to the extent necessary to be the actuarial equivalent of the normal retirement benefit. There is no exception to the post retirement accrual rules that says it doesn't apply to lump sums. The final regs are clear that crediting sufficient interest to make this happen will not cause the plan to have a greater than market interest credit rate. If the plan is written to provide enough interest post NRA to ensure at least the actuarial equivalent one some reasonable basis is provided, then the entire plan remains a cash balance plan and the lump sum is the account balance

There may be an argument that this could be looked on as a " greater of" benefit where one part of the greater of benefit is the cash balance account and the other part is the actuarial equivalent of the normal retirement annuity (which is not a cash balance benefit)

In that case, the minimum lump sum is the greater of 417(e) value of the annuity or the cash balance account.. This is what happens when you have a top heavy min in a cash balance plan.

Based on the plan provisions you described, this second concept could apply to what you have and would cause a lump sum considerably higher than the account balance, as the actuarially increased benefit might not be considered a lump-sum based benefit and thus would be subject to 417(e)

[FAPInJax]

I was also under the impression that attainment of normal retirement age 'established' the normal retirement benefit. This then, according to your document, may receive an AE increase and the lump sum is now subject to 417(e) (Basically, the cash balance account balance no longer automatically provides 417(e) coverage)

[My 2 cents]

Should we expect guidance concerning this issue?

[Effen]

FWIW, there is a very similar and much longer discussion currently going on about this topic on the ACOPPA Board.

I think what is comes down to is the meaning of 1.411(a)(13). From the preamble of the final hybrid regs it states: "Under these final regulations, a cash balance formula or PEP formula is treated as a lump sum-based benefit formula to which the relief of section 411(a)(13)(A) applies if the portion of the participant's accrued benefit that is determined under that formula is actuarially equivalent (using reasonable actuarial assumptions) to the cash balance account or PEP accumulation either upon attainment of normal retirement age or at the annuity starting date for a distribution with respect to that portion."

The question is, what is reasonable. I don't think we need to go as far as FAP suggests, although that would certainly be safe, but I do think you may need to give more than a standard interest credit.

Is more guidance expected? Doubtful, considering how understaffed the IRS is and the fact that it took them how many years to give us these final regs? They will wait for an egregious test case, then bang them on audit.

[My 2 cents]

A standard interest credit (if not particularly low, say 4% - 5%) together with annuity conversion factors that decline with age might together result in the equivalent annuity going up somewhere around 7- 8% per year after 65, even without any pay credits. Might that be enough to avoid there being a problem?

[ak2ary]

It's a plan language issue. The way the plan is written, the benefit post NRA is the greater of the actuarial equivalent of the annuity payable at NRA or the benefit provided by the account balance. This appears to be a greater of benefit formula where one of the benefits is a lump sum based formula and the other is not lump sum based. The final regs are clear that, if this is such a formula, the lump sum value of it is the greater of the account balance or the annuity benefit valued at 417e rates.

There may be an argument that this doesn't apply if the account balance is at least the PV of the actuarially increased annuity, but it falls dead flat if the account is not sufficient to provide the benefit. Certainly if the account is sufficient for the annuity, the plan can be written to avoid the problem

Consider the example above and take it forward five years... do you really think the IRS would be ok with the account being credited with interest at 5% (or even 0% depending on the plan interest credit rate) while the annuity climbs at 7%?

[Effen]

The final regs are clear that, if this is such a formula, the lump sum value of it is the greater of the account balance or the annuity benefit valued at 417e rates.

Can you provide a site for this?

I think your final paragraph accurately describes the problem. There is no clear guidance what you need to do post NRD on a hybrid plan. All they have said is it must be a reasonable adjustment.

[ak2ary]

1.411(a)(13)-1(b)(4)(ii)(A) - "Greater of" formulas

[Effen]

Thank you. The "greater of" formula in this site only applies if your plan has a split benefit, where one piece is based on a traditional db and the other piece is based on a hybrid formula. This provision specifically mentions that the piece of the accrued benefit based on the hypothetical account is not subject to 417(e), whereas the piece based on the traditional db is subject to 417(e). These provisions are the reason you can't "set it and forget it" when you convert a traditional plan to a hybrid plan.

The whole point of (b)(1) is to state that hybrid plans are not subject to 417(e). Section 1(b)(4) provides exceptions to that rule when the current hypothetical account was created by converting a traditional db into a hybrid.

[AndyH]

"IRS .......will wait for an egregious test case, then bang them on audit."

I think the PBGC's post termination audit program is a significant concern on these types of issues.

[ak2ary]

Look at the original example and the proposed answer...The proposed answer was that the lump sum would stay at $105,000 and the annuity would be the full actuarial equivalent at 7% of the NRB which is greater than the benefit that can be provided by the $105,000.

This means that the account balance is NOT providing the benefit in the plan and the plan's terms provide the greater of 'the actuarial equivalent of the NRA annuity' (this is a traditional benefit) and the 'benefit that can be provided by the account balance'.(this is a lump sum based benefit). This leads you directly into the "greater of" section I mentioned

If the interest credits were increased, in this case to $107,000, you could argue that the entire benefit is provided by the account balance and arguably avoid 417(e)

[Effen]

I think we will just need to disagree on this.

I agree there could be a disconnect between the lump sum ($105,000) and the "value" of the actuarially increased annuity benefit. However, I don't believe this is necessarily a problem, and I don't believe 417(e) has any place in this discussion, assuming the plan has always been an account based benefit formula.

There is nothing wrong with your interpretation, and a document could be written to require it, and it would certainly be the conservative approach, but I don't believe it is only acceptable method.

[FAPInJax]

I believe the cite should have been 1.411(a)(13)-1(b)(2)

This section specifically refers to lump sum based benefit formulas (cash balance plans for instance). It says that the relief of 411(a)(13) (which I believe is the ability to say the PVAB = Account balance) does not override the requirements for post-retirement adjustments (absent a suspension of benefits)

It appears we will need to ensure the language is appropriate in our documents.

[My 2 cents]

It seems to say that. If this requires more for people working after Normal Retirement Date than just continuing to add pay credits (if applicable) and interest credits and then converting to an annuity using a factor that goes down as age goes up in a cash balance plan with no other adjustments specified and no language calling for the issuance of suspension notices, how long will plan sponsors have to bring administration and plan provisions into compliance? I had thought that the law specified that the account balance provides whatever is payable and that's it. Is this regulation consistent with the requirements of the law?

[ak2ary]

Frank

I agree that your cite brings you to the section that says you cannot have an interest credit rate so low that it fails to provide an actuarial increase without making some other adjustment.

ALOT of standard documents, including the Relius standard document , have language guaranteeing that this requirement is met by providing that post NRA the benefit is the greater of the actuarial equivalent of the NRB and the accrued benefit taking into account salary and service through actual retirement

It is this language that sets up a comparison between the account balance-provided benefit and the actuarial equivalent of the NRA annuity and seems to invoke the "greater of " language I cited.

My 2 cents

The reg is specific that, in the opinion of the IRS, the requirement to provide actuarial increases post-NRA trumps the ability to simply pay the account balance. Now you can still pay the account balance if you have suspension provisions in your plan and you can still pay the account balance if you provide an interest credit sufficient to provide an actuarial increase and your document doesn't provide some other measurement such as the one described in the original post.

[AndyH]

"Now you can still pay the account balance if you have suspension provisions in your plan.."

True for an active, but not a vested term as in this particular example.

[ak2ary]

good point