Regs 1.417(e)-(1)(d) - please check it out

[Gary]

Reg 1.417(e)-1(d)(1) says that the PVAB of any optional form of benefit must be at least equal to the PVAB of the normal retirment benefit determined under the app interest rate and app mortality table.

Reg 1.417(e)-1(d)(6) seems to imply that d(1) does not apply to say a life annuity pension form for eg.

My original thought was that say a reduced early ret. benefit must be at least equal to the PVAB of the normal ret benefit under the app. factors, but based on the above it appears that this may not be the case.

Any thoughts about this one?

Gary

[Guest]

An reduced ERB must be actuarially equivalent to the NRB. Otherwise there is a forfeiture of the employees NRB. See Reg. 1.411(a)-4(a). The determination of actuarial equivalency for this purpose can be made without regard to the section 417(e) interest and mortality assumptions.

I believe that the purpose of Reg. 1.417(e)-1(d)(6) is to simply state that you are not required to use the section 417(e) assumptions when you convert an annuity into another optional form of benefit AS LONG AS THE OPTIONAL FORM IS NONDECREASING (as described in the regulations).

[Gary]

So Harry, what I am gathering from you is that an early retirement benefit must be at least the act. equiv. of the normal ret ben, othw. there is a forfeiture under 411. However, the act equiv would be based on plan act equiv rates as opposed to 417(e) rates. I will refer to the reg you mentioned.

Curious to get your input, Gary

[Guest]

I agree with your summary! But make sure the ERB qualifies as a nondecreasing annuity. The IRS has its own ideas here. For example, the IRS believes that a level income early retirement benefit (higher before age 62 because employee not eligible for social security and lower beginning at 62 when the employee is eligible to receive social security) is not a nondecreasing annuity and must be converted using section 417(e) assumptions (or plan assumptions if that produces a more valuable benefit).

[Gary]

Harry, what you described, sounds like a SS Supp on top of the benefit. So I would think the base benefit (exclusive of the Supp) is a non decreasing annuity. Please let me know of any regs that support your point.

gary

[Guest]

No, it is not a vanilla social security supplement but a social security leveling option. Two different animals. The IRS position has not been, I believe, formally published anywhere. It has been put forth on the rubber chicken circuit and in informal conversations with National Office personnel.

[Gary]

I would have always thought that a SS leveling option would have to be the act equiv of the normal form of benefit, under the plan act equiv assumptions. I would not have perceived that 417(e) assumptions would be relevant in this situation.

[MGB]

I'll add one more comment on the regulation.

Recently, one of the cash balance court decisions concerned whether or not 411(B)(1)(H) applies. In that paragraph, it says the rate of benefit accrual cannot be reduced because of the attainment of any age. A similar statement is under the EEOC and ERISA. The question is whether a cash balance plan violates this because the rate of benefit accrual does decrease with advancing age. The court found that this paragraph does not apply because the title of the paragraph is "Continued accrual beyond normal retirement age." The court felt that the title of the paragraph carried as much weight as the language itself.

Applying that logic to 417(e): The title of that subsection is "Restrictions on cash-outs." So, the question is whether or not the IRS has the authority to change it from "cash-outs" to "nondecreasing annuities" in their regulation.

Besides the courts giving credence to the title, there is a separate issue as to whether the regulation is a reasonable interpretretation of the statute. That may be correct in this case, and therefore that may override the concern of the subsection title only referring to cash-outs.

For example, could someone game the system so as to avoid the cash-out restrictions by calling a distribution a SS leveling option, or a two-time payment instead of a single payment? I just reviewed such a calculation. The person is near NRA and requested the SS leveling option. The accrued benefit is so low in comparison to the PIA that the leveling option creates a term-certain annuity for a very short period of time until NRA and no continuing life annuity after NRA. From a policy standpoint, shouldn't this fall under 417(e) cash-out rules?

(By the way, this client is not using 417(e) rates on the conversion.)

[Gary]

The question is "should the SS leveling option be considered a non-decreasing annuity in this case"?

I don't know, but my impression is that it is a form of benefit that is typically a non-decreasing annuity (as far as I can recall), so my feeling is that this would not be subject to 417(e) rates even though coincidentally the benefit acts and looks like a term certain benefit.

[Guest]

MGB -

I think your example is similar to that described informally by the IRS -- the leveling option can produce these results in certain cases. However, the IRS position is overkill, especially in garden variety leveling option cases.

Question -- Help a lawyer here . . . when does using the 417(e) assumptions work to the advantage of the participant? I thought it was if the 30-year treasury rate exceeds the plan's interest rate for actuarial equivalence (I'm ignoring different mortality assumptions for the moment). Is this right?

[MGB]

Gary,

I believe the SS leveling is considered a decreasing annuity because it is level until SS elig., and then "decreases" to the lifetime amount. It is that one step-down that causes it to be thrown out of the nondecreasing camp. If this is not true, then the discussion is moot.

Harry,

The higher the interest rate, the better off the participant is in going to a lump sum or other type that puts more of the cash flow into earlier years. A higher interest rate hurts the participant when going from life annuity to a J&S, because it is spreading it out further.

When I referred to "someone game the system" I was referring to the plan sponsor, not the participant. I.e., this rule is to override the plan sponsor's natural intentions in using a more reasonable assumption than the one the IRS wants you to use.

[MGB]

My last paragraph was twisted around...the higher the rate, the worse off the participant is.

Sorry

[Guest]

So let me see if I follow:

The lower the interest rate the better for the participant when converting a life annuity to a lump sum (I think even lawyers know that!); and

The higher the interest rate the better for the participant when converting a life annuity to another form of annuity.

If so, then the only time a participant is "helped" when using 417(e) factors for converting a single life annuity to a leveling option is when the 417(e) interest rate is higher than the plan's rate (again, ignoring mortality).

Hmmm . . . how does the requirement that the QJSA be the most valuable form interact with this requirement? Does the QJSA have to be actuarially equivalent to this "subsidized" level income benefit?

[MGB]

Harry,

Your second statement of converting to another form of annuity is not exactly right. It is not a clean categorizing of annuities versus lump sum.

With a low interest rate:

Participant is helped if the new form (annuity or otherwise) has a weighted-average length of payout that is less than the original form. So, going from a deferred life annuity to an immediate SS leveling option is helped by a low interest rate. Also, going from a deferred life annuity to an immediate life annuity is helped by a low interest rate. The shortest payout period is a lump sum which is, of course, helped by a low interest rate.

Participant is hurt if the new form has a weighted-average length of payout longer than the original form. So, converting from a life annuity to a J&S is hurt by a low interest rate. In the reverse situation, assume the normal form is J&S and they convert to a life annuity. They will be helped by a low interest rate.

On the mandatory provision that the J&S be the most valuable form, it is my understanding that this is deemed to pass by virtue of using the plan's actuarial equivalence if they are a "reasonable" actuarial equivalence. The fact that 417(e) rates are greater or less than this is not part of the analysis.

This has always troubled me with "simple" actuarial equivalencies (e.g., a stated percentage to switch from one form or another). I have always said they must be checked against some other reasonable actuarial equivalence (undefined in the Code) to make sure that any combination of ages will still produce the desired results. These desired results are two: The QJ&S must be the most valuable, and all alternative forms must be at least the actuarial equivalent of the normal form (using a reasonable actuarial equivalence to calculate this, not necessarily the plan's factors or any Code factors).

Mark