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Section 415 ACOPA Advanced Actuarial Conference June 2009

Section 415 ACOPA Advanced Actuarial Conference June 2009. Tom Finnegan The Savitz Organization Philadelphia / Atlanta / Boston. Section 415. Application of 401(a)(17) limit 417(e) Benefits– PPA WRERA Multiple Annuity Starting Dates Basic Calculation Partial QJSA Distributions

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Section 415 ACOPA Advanced Actuarial Conference June 2009

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  1. Section 415 ACOPA Advanced Actuarial ConferenceJune 2009 Tom Finnegan The Savitz Organization Philadelphia / Atlanta / Boston

  2. Section 415 • Application of 401(a)(17) limit • 417(e) Benefits– PPA • WRERA • Multiple Annuity Starting Dates • Basic Calculation • Partial QJSA Distributions • $10,000 De minimis Benefit • Transfer/ Aggregation of benefits

  3. Section 415 • Timing of COLA adjustments • Monthly vs Annual • Restorative Payments • Yrs of Participation • Post-Severance Compensation Issues • Average Compensation

  4. § 401(a)(17) Application

  5. § 401(a)(17) Application • Current Law • The compensation limit under Section 401(a)(17) of the Code applies for purposes of nondiscrimination and benefit determination • It does not apply for purposes of determining the 100% of pay 415 limit • The 100% of pay limit applies at any age to any form, it is NOT increased for delayed commencement

  6. § 401(a)(17) Application • Final Regulation • The compensation limit under Section 401(a)(17) of the Code would apply for purposes of determining the 100% of pay 415 limit

  7. § 401(a)(17) Application • Impact on small business • Income is generally more volatile in small businesses than in large • This especially true when you compare the income of the owner of a small business with the income of a corporate executive • The application of 401(a)(17) in benefit determination and testing is the cost of this volatility

  8. § 401(a)(17) Application • Impact on small business • (Assume a $200,000 pay limit) • Consider a corporate executive earning $200,000 and a business owner whose high three year income is $100,000; $350,000 and $150,000 • Under current law, for discrimination testing, the owner must use a compensation of $150,000; while the executive will be considered to have a $200,000 average pay • To provide the same benefit to the owner/exec, the small business must provide a greater benefit to staff

  9. § 401(a)(17) Application • Impact on small business • Under the proposed regulation, the small business owner must pay twice for his/her income volatility • First the benefit must be on the lower average • Now the maximum benefit could not exceed the lower $150,000 average pay

  10. § 401(a)(17) Application • Impact on older employees • The primary impact of the application of the 401(a)(17) limit for 415 purposes will be the elimination of most of the adjustment to 415 for deferral of benefit commencement past age 65 • Under current law the 415(b) limitation is adjusted if benefit commencement is beyond age 65 • The adjustment is made using the lesser of the plan’s interest rate or 5% • Because the 415 and 401(a)(17) limits are so close, the elimination of the deferred commencement adjustment occurs at age 68

  11. § 401(a)(17) Application-2009(** 233,333 is the average of 225,000; 230,000 and 245,000)

  12. § 401(a)(17) Application • Effective Date • Limitation years beginning on or after 7/01/07 • Accrued benefits as of last day of limitation year prior to effective date, based on the plan as of 4/5/07, are grandfathered • Calendar year plan grandfathers 12/31/07 accrued benefit based on plan as of 4/5/07 • Can continue to accrue til 12/31 under current law • What about actuarial increases to existing accrued benefits? • Are covered by grandfather

  13. § 401(a)(17) Application • Effective Date – Example • Bob, 69, has AB of 244,013 as of 12/31/07 • Bob’s average pay is 400,000 • 401(a)(17) average pay is 218,333 • 244,013 is grandfathered • At age 70, act. equiv. benefit is 264,109 • Is the actuarial increase grandfathered? • 411 would say its part of the accrued benefit • Broad implications if answer is yes

  14. § 401(a)(17) Application • Effective Date – Example 2 • Bill, 69, has AB of 210,000 as of 12/31/07 • 401(a)(17) average pay is 218,333 • AB is less than both old and new 415 • No grandfather? • At age 70, act. equiv. benefit is 254,029 • Is the actuarial increase grandfathered? • If yes, anyone near the 415 limit may have a grandfathered benefit to track

  15. 401(a)(17)/ Suspension of Bfts • Beginning at age 68, participants at the 415 limit will have their benefits catch the 401(a)(17) limit • Cannot actuarially increase benefits • Must give Suspension of benefits notice or commence distributions • At age 70.5, can no longer suspend benefits • Must commence distributions • Even if participant is not a 5% owner

  16. 417(e) Benefits

  17. PPA Changes to 417(e) Max • Prior to PFEA (2004) • to calculate the max benefit payable in a form subject to Section 417(e) [ lump sums, installments etc] • Calculate the maximum single life annuity payable at the ASD • Convert maximum SLA to the 417(e) form using the lesser result of • Plan interest and mortality and • Applicable (GATT) interest and mortality

  18. PPA Changes to 417(e) Max • PFEA Changes 2004,2005 (Temporary) • Calculate the maximum single life annuity payable at the ASD in exactly the same manner as before • Convert maximum SLA to the 417(e) form using the lesser result of • Plan interest and mortality and • 5.5% interest and applicable mortality

  19. PPA Changes to 417(e) Max • PFEA Expiration 1/1/2006 • Reverts back to pre PFEA rules • Determine max SLA payable at ASD • Convert max to 417(e) form using lesser result • Plan interest and mortality • Applicable (GATT) interest and mortality

  20. PPA Changes to 417(e) Max • PPA Changes • Retroactively effective to 1/1/2006 • Determine max SLA payable at ASD • Same as always (well... post SBJPA) • 417(e) maximum is the least of • 417e benefit with Plan interest and mortality • 417e benefit with 5.5% interest and applicable mortality • 105% of the 417e benefit with applicable (GATT) interest and mortality

  21. PPA Changes to 417(e) Max • PPA Changes • SO WHAT’S THE PROBLEM? • The problem is that GATT interest rates early in 2006 were below 5.5% • At the lapse of PFEA it became the law that the maximum benefit was calculated on the lesser result of plan or GATT rates • Thus, perfectly legal lump sums were paid early in 2006 that, apparently, are retroactively illegal

  22. Basic Calculation

  23. Basic Calculation – Pre 62 • Calculation is essentially unchanged • Simplified method is provided for “plan rates” for non 417(e) benefits by taking the ratio of the benefit payable at 62 to the benefit payable at determination date • Examples raised a few eyebrows, but appear to generate the same (perhaps unexpected) results as current law

  24. Basic Calculation – Pre 62 • Calculation is essentially unchanged • The limit at any age prior to 62 is the lesser of the age 62 limit reduced with the applicable mortality table and 5% interest or the age 62 limit reduced with plan rates • No mortality adjustment necessary if QPSA or greater death benefit

  25. Basic Calculation – Pre 62 • Example • 415(b) limit = 185,000 • NRA = 65 • Normal Form = Single life annuity • ERA = 60 • Early retirement reduction = 4% per year • Death benefit = QPSA • Participant M (age 60 with 30 years service) has an accrued benefit of $100,000 • WHAT IS M’s 415 LIMIT AT AGE 60?

  26. Basic Calculation – Pre 62 • Example • M’s Benefit at 62 = $88,000 • 100,000 x (1-(3 x 4%)) • M’s Benefit at 60 = $80,000 • 100,000 x (1-(5 x 4%)) • Plan rate reduced 415 limit = 168,182 • 185,000 x (80,000 / 88,000)

  27. Basic Calculation – Pre 62 • Example • Single Life Annuity Rates (5% Applic. Mortality) • Age 60 = 13.2508 • Age 62 = 12.6798 • Statutory rate reduced 415 limit = $160,569 • (185,000 / (1.05^2)) x (12.6798 / 13.2508)

  28. Basic Calculation – Pre 62 • Example • Age 60 415 limit is the lesser of • Plan rate reduced 415 limit = 168,182 • Statutory rate reduced 415 limit = 160,569 • $160,569

  29. 415 Lump Sum • The maximum lump sum payable is the least of • Maximum life annuity valued using plan rates • Maximum life annuity valued using applicable mortality table and 5.5% interest • 105% of the value of the maximum life annuity valued with 417(e) rates

  30. 415 Lump Sum • Example • Plan Act Equiv 83 IAM(f) 5.75% • Segment rates • First Segment 5.25% • Second Segment 5.75% • Third Segment 6.50% • Assume GATT mortality

  31. 415 Lump Sum • Example • Plan Act Equiv • 83 IAM(f) 5.75% APR = 13.1323 • Applicable Mortality 5.5% APR = 12.6409 • 1st Segment (5.25%) • N60=566762; N65=376279; D60=43800 • 2nd Segment (5.75%) • N65=265413; N80=47521; D60=32960 • Third Segment (6.50%) • N80=26052; D60=21569

  32. 415 Lump Sum • Example • Value of maximum benefit • Plan rates • 160569 x 13.1323= 2,108,640 • GATT mort and 5.5% • 160569 x 12.6409= 2,029,737

  33. 415 Lump Sum • Example • Value of maximum benefit • First segment piece • 160569 x (N60-N65) / D60 = • 160569 x (566762 – 376279) / 43800 = • 698307 • Second segment piece • 160569 x (N65-N80) / D60 = • 160569 x (265413-47521) / 32960 = • 1,061,490

  34. 415 Lump Sum • Example • Value of maximum benefit • Third segment piece • 160569 x N80 / D60 = • 160569 x 26052 / 21569 = • 193942

  35. 415 Lump Sum • Example • Value of maximum benefit • 417(e) max benefit value • 698,307 + 1,061,490 + 193942 = 1,953,739 • 105% of 417(e) value • 1,953,739 x 1.05 = 2,051,426

  36. 415 Lump Sum • Example • Max lump sum • Least of • Plan rates 2,108,640 • Applic Mortality 5.5% 2,029,737 • 105% of 417(e) result 2,051,426

  37. WRERA Changes • Confirms use of 417(e) mortality table effective 2009, optional 2006-2008 • Provides that plans with under 100 lives need not use the 105% of 417(e) rates calculation to determine maximum lump sum (eff. 2009) • Meant to allow a small employer to set actuarial equivalence at 5.5% or higher and not worry about fluctuations in 417(e) rates changing the max lump sum • It may have worked

  38. Plan Rates • What the heck are plan rates? • WE thought we knew • Plan provides a lump sum equal to the greater of the result using 5% or the result using PBGC/GATT/PPA rates has a 5% plan rate, correct? • Recently the IRS has been saying it depends • If PPA rates would yield the greater result for THIS distribution, PPA rates are the plan rate for this distribution

  39. Plan Rates • Interesting…no reg change to account for this • Apparently PBGC rates were plan rates for all those years…we just didn’t know it…EPCRS here we come

  40. Plan Rates- • Assuming new interpretation • If plan uses 5.5% as actuarial equiv, max lump sum is stable • When PPA rates yield greater lump sum than 5.5%; statutory 5.5% controls the max lump sum • When plan rate controls the LS, the plan rate and statutory 5.5% yield the same LS • If plan uses 6% as act equiv max LS will fluctuate based on PPA rates

  41. Multiple Annuity Starting Dates

  42. Multiple Annuity Starting Dates • Applies when there are two separate distributions which count against the 415 limit • Prior plans • Change in distribution pattern for 401(a)(9) • 415 COLA adjustments to benefits in pay status • Rehires • Lump sums to retirees at plan termination • Many others

  43. Multiple Annuity Starting Dates • PROPOSED REGULATION • The remaining 415 limit is equal to the total 415 limit at the second (or later) Annuity Starting Date • reduced by • the actuarial equivalent of the prior payments and the remains of the existing stream of payments • Most controversial item in the proposed regulation • Did not work where the 415 limit plateaus • Dollar limit from 62 to 65 • 100% of pay limit • Especially now with 401(a)(17) application

  44. Multiple Annuity Starting Dates • 100% of pay limit • 5% owner has 415 pay of 50,000 • Takes MRD at age 71 of 50,000 • Takes second MRD of 50,000 at 72 • Wants lump sum at age 73 • Can he take a lump sum equal to the actuarial equivalent of 50,000 per year ???

  45. Multiple Annuity Starting Dates • 100% of pay limit • NOT UNDER PROPOSED REGS • Because he has separate elections at 71,72 and 73, the limit at 73 must be reduced by the actuarial equivalent of the prior distributions • The lump sum at 73 equals the lump sum value of a life annuity of 50,000 per year minus the life annuity that could have been provided by the two prior distributions

  46. Multiple Annuity Starting Dates • Age 62 to 65 dollar limit • Assume $180,000 limit • Assume no dollar limit COLAs • Participant age 62 commences 180,000 life annuity • Plan terminates at age 65 and offers lump sum • CAN HE HAVE IT ???

  47. Multiple Annuity Starting Dates • Age 62 to 65 dollar limit • NOT UNDER PROPOSED REGS • By same reasoning the 180,000 limit must be reduced by the actuarial equivalent of the three distributions he already received • The maximum lump sum will be less than the actuarial equivalent of a life annuity at 65 of 180,000 • This is less than his accrued benefit and would violate 411(a) to have an optional form of less than the accrued

  48. Multiple Annuity Starting Dates • Final Regulations reserve guidance on MASDs • Preamble and regs say… • The limitations of 415 must be satisfied as of each of the ASDs, • taking into account benefits that have been or will be provided at all of the ASDs… • The plan is required to actuarially adjust past and future distributions with respect to the benefit that commenced at the other annuity starting dates

  49. Multiple Annuity Starting Dates • Is this a new standard or rule for handling MASDs??? • Apparently not, IRS has made statements that a reasonable interpretation must be made and that you cannot ignore payments as of other annuity starting dates.

  50. Multiple Annuity Starting Dates • Example: • 415 limit is 180,000 • Bob commences a life annuity of 50,000 at 62 • At age 65, after an amendment and additional accruals, Bob attempts to commence a benefit of 180,000, plus the 390,000 he didn’t get at 62, 63 and 64 spread over his remaining life expectancy • UNREASONABLE AND FAILS 415 AT 2nd ASD

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