interim valuation

[Jim Chad]

Profit sharing plan has annual valuation. The market is up quite a lot since 12-31-15. What rules do other people use to decide whether or not to do an interim valuation? Or I should say when to recommend it to the trustee?

[Bird]

We did some interim vals earlier this year because the market was down. I don't have a hard and fast rule but if the assets leaving are more than 10% of total assets I'd think about it. When assets are down, ballpark the cost of the val (if paid by the plan, or even if not, just for a point of reference) and compare it to the savings (to the other participants) of not making the terminee share in the losses).

We rarely if ever to an interim val when the market is up. I'll tell the participant - it's your choice: take the money now based on 12/31 values last year, or take your chances on the market continuing to go up or at least staying where it is.

In an ideal world, you anticipate the large distributions and raise cash before the end of the year so that it doesn't matter. But the world is not ideal and sometimes they come out of nowhere.

[Tom Poje]

if it involves a distribution of an HCE then it just smells bad, especially if you have paid out some NHCEs earlier in the year

[Peter Gulia]

In at least one case, the court found that the trustee's selection of valuation dates was not an honest exercise of discretion, but rather was a disloyal effort to shift an allocation of investment losses from his account to those of former partners and employees.

Janeiro v. Urological Surgery Prof'l Ass'n, 457 F.3d 130 (1st Cir. 2006).

What do BenefitsLink mavens think about specifying in advance the conditions under which a plan will use an interim valuation?

[hr for me]

I think it is a prudent idea to consider consistent conditions under which there would be an interim valuation performed that could be shown to be done without discrimination. I think a plan could get into very big trouble making the decision based on specific individuals or specific market events/conditions unless those are put forth before they happen. Because instead the trustee/plan admin are going to make the decision based on a specific current set of events and may not be consistent with that at other times.

That said and kind of off-tangent, I am kind of surprised that there are any DC plans out there that still have an annual valuation with all the access to other choices. Even back when daily valuation first came out in the 90s, we didn't have that many annual valuations, most were either monthly or quarterly. I suppose it is a plan cost issue. But have to wonder if it is a prudent one these days with all the access to other choices.

[GMK]

^-- agreed.

One case where annual valuations will likely continue is for ESOP's that hold company stock that is not publicly traded. Valuation of the stock requires audited financial statements, which take a month or two, so the stock price from the valuation is generally 2 to 3 months old by the time it is determined ... not to mention the costs of the full company audit and the valuation. The Plan Administrator can do an interim valuation, but unless the circumstances are very unusual, there is reluctance all around to go through this process more than once a year.

[Mike Preston]

There is still a group of folks and plans (miscreants?) that believe in professionally managed plans. I have several. Many of them are annually valued. Two of them were recently "attacked" by those seeking to implement individually directed accounts. The participants wanted no part of individual direction.

[ESOP Guy]

The real issue in my mind is fair = consistent. Sure the market could be up a bunch this year but a few years back it was down a bunch at this point. If you are consistent about it then in the long run it seems reasonable to figure it will all balance out in the long run. That was the basic thinking back in the '90s when I did work on a good number of annual balance forward plans.

The thing you need to avoid is allowing people to game the system.

Back in 2008 I worked on an annual valued PS plan. Most distributions happened shortly after the annual work was done. However, without thinking they had allowed for in-service distributions years prior for anyone over 59.5 at request. These payments were based on the prior 12/31

So in 2008 a bunch of the 59.5 people figured out in Oct of '08 they could get their money out based on their 12/31/2007 balance. There was a "run on the bank" if you will of these people getting their money out without having to take the '08 losses. This was millions of dollars and the loses were in effect being picked up by the people stuck in the plan.

The problem was they were inconsistent. There was only one group that could in effect wait all year to see how the market was doing and then decide to take their money.

The provision was quickly changed.

So to me the way to do this is make the rules and give as little discretion to anyone as possible Then be as consistent as possible with those rules. In the long run it ought to be fair as it should wash out in the end. Also no one can be accused of gaming the discretion in their or someone's favor.

Maybe I just stated the obvious and what was basically said the same as above but that is my 2 cents worth.

[Bird]

That said and kind of off-tangent, I am kind of surprised that there are any DC plans out there that still have an annual valuation with all the access to other choices. Even back when daily valuation first came out in the 90s, we didn't have that many annual valuations, most were either monthly or quarterly. I suppose it is a plan cost issue. But have to wonder if it is a prudent one these days with all the access to other choices.

There is a theoretical case to be made for having a single pooled account. Practically speaking, I don't think I've seen it net out to be "better" than self-direction. But in no way would I call it imprudent.

[My 2 cents]

Assuming that all of the investments can be readily valued, if one does not value them more or less on a daily basis, what happens to the misfit between the old, presumably out of date value and the amount of assets that need to be sold to raise the amount payable? Example: Value of person's account at the annual valuation date is $20,000. So (I presume) you are going to pay out $20,000. What happens to the extra money if you only need to sell 3/4 of that person's investments to raise $20,000? What happens if you have to sell 120% of that person's investments to raise $20,000 because of a market drop. Where does the extra 20% come from?

[Mike Preston]

I am confused by your question. It seems like you are pre-supposing individually directed accounts and then assuming something other than daily valuation. Curious combination.

[My 2 cents]

I had assumed that they are not invested in something without an established value and that distributions can occur throughout the year. I don't normally work with defined contribution plans and am accustomed to only seeing daily-valued assets. Perhaps the standard for annually valued plans is that all distributions are delayed until the end of year valuation, in which case there ought to be no misfit between actual value and amounts distributable.

[Bird]

(I think) we are talking about a pooled account that is not self directed, annually valued. In theory each participant owns a proportionate share of each investment, but in reality, they are paid from cash. If there is not enough cash to pay them, you sell something; it does not have to be proportionate.

If you have a $1 million plan, and a person with $5000 needs to be paid out, they get $5000. If the market is up or down by 10% after the latest val, that's a $500 gain or loss that is absorbed by other participants (.05% of the total; basically a rounding error). Not enough to worry about. If a person with $100,000 needs to be paid out, that's a different story - a 10% change is $10,000. (Still "only" 1.1% of the remaining assets but significant dollars.) And that's the crux of the discussion; when is it "enough" to justify doing an interim val?

[My 2 cents]

Unless the amount to be paid is in balance with the value of the underlying assets as of the time the distribution is to be paid, someone is being shortchanged and someone is being overpaid. Good reason to only allow distributions coincident (or nearly so) with proper valuations. If you are going to only value the assets once a year, only allow distributions once a year.

Still hard to understand why, in 2016, daily valuation is not standard. Not being able to value the assets based on the market each day either points towards inadequate technical capabilities on the part of the asset holder or towards the holding of investments not suitable for a defined contribution plan covering more than one person (assuming, as someone who does not handle such plans, that hard to value/illiquid assets make more sense in one person plans than they do in plans covering more than one participant).

[Mike Preston]

My 2 cents is showing his lack of understanding as to how many DC plans work. There still are thousands of DC plans that are pooled and valued annually. Maybe not all of them, but certainly most of them are that way intentionally. There are still many advisors who fundamentally disagree with individually directed accounts and believe that pooled, professionally managed investments are best for participants. And contrary to My 2 cents' make believe world, due to cost considerations, annually valued plans rarely process distributions independent of annual administrative work and therefore you will find that distributions take place not on or near the valuation date, but after the 5500 has been prepared, which can be as late as 9 and 1/2 months after the valuation date. The characterization of "shortchanged/overpaid" is pejorative. While an annually valued plan does have to consider when it is appropriate to perform an interim valuation, that minor issue doesn't justify throwing out an administrative framework that has withstood the test of time.

[jpod]

This is a serious question because in my line of work I don't get down that deep into the record-keeping trenches, plus I am not sure we have any clients with DC plans that are not self-directed. Can a pooled plan be daily valued, given the technology available in this day and age (assuming no "hard to value" investments), with distributions processed at any old time during the year? Seems to me that is the most ideal scenario for participants generally.

[Bird]

Like Mike said, it works well for a significant number of plans. As I tried to point out above, the dollars and percents involved are usually not that significant, and it evens out for the plan. Apples to apples, a non-daily valued plan is or should be less expensive to run, since recordkeeping costs something. (I've seen plenty of poorly run/managed pooled plans that were indeed better off daily val'd, but that is often a function of the management fees (too high).

Another benefit is the sponsor can just "throw" money at the plan - if they have $1000 one month, and $10000 another, they/we can figure out the details later. Daily val'd requires you to allocate it when deposited.

I'm not saying I'm setting up many new plans this way but there is definitely nothing "wrong" with it.

[K2retire]

This is a serious question because in my line of work I don't get down that deep into the record-keeping trenches, plus I am not sure we have any clients with DC plans that are not self-directed. Can a pooled plan be daily valued, given the technology available in this day and age (assuming no "hard to value" investments), with distributions processed at any old time during the year? Seems to me that is the most ideal scenario for participants generally.

I believe the actual assets likely are valued daily.

The manual calculation of what proportion of of the income, loss, expenses, etc. are allocated to each participant is the piece that is only done annually. As a practical matter, by the time you gather the necessary data to do that calculation, the values have moved on. In many cases, the participant can choose when to request a distribution if he or she is concerned about the impact of changes in the market.

[jpod]

I don't understand why the allocations can't be done daily automatically, and not manually, shortly after 4pm EST.

[Mike Preston]

jpod, you are kidding, right?

[jpod]

I am seriously not kidding (somehow mutual funds do something very similar), but if the consensus is that it is impossible or near impossible you don't have to bother giving me the reasons. They are probably staring me in the face but I can't see them, and while you can fit what I know about computer technology in a thimble it seems to me that this is something which shouldn't be a great technological challenge.

[Bird]

You'd have to do it to see how it works. We literally work from paper brokerage statements, or, for the really advance, pdfs...wow. There is no system linking the account to the plan. There is "investment management" and there is "administration" but there is no "recordkeeping."

I guess if you have never worked anywhere but the daily val world it is unfathomable but it exists and works ok.

[hr for me]

And it's how it worked before dailies were available. We usually did monthly or quarterly valuations (reconciling the trust to the plan/participant accounts) and distributions happened either during (and they got NO earnings positive or negative) or they waited until right after the valuation (which was usually 4-6 weeks after the end of the quarter) to receive that valuation depending on the plan rules.

That said any increase/decrease in the "funds" was allocated using a basis (that generally included taking out 100% of the distributions and loans and crediting 1/2 the contributions and loan payments although some plans could be different basis calculations) over the rest of the participants and did generally work itself out, but we had pretty steady investment funds and the participants/plans generally only had 3-4 choices to go between. And the market was pretty steadily increasing. Now that the markets and investments are all over the place, I think the liability has increased as to the change in assets over time. That's why it surprises me that there are still annual plans personally unless the funds are 100% from non-publicly traded stocks/funds.