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Update on Defined Benefit Restrictions under Section 436 2010 Great Lakes Benefits Conference June 16, 2010 PowerPoint Presentation
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Update on Defined Benefit Restrictions under Section 436 2010 Great Lakes Benefits Conference June 16, 2010. Carolyn Zimmerman Internal Revenue Service Kathryn J. Kennedy, Esq. The John Marshall Law School Joan Gucciardi Summit Benefit & Actuarial Services, Inc. Benefit Restrictions Today.

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Update on Defined Benefit Restrictions under Section 4362010 Great Lakes Benefits ConferenceJune 16, 2010

Carolyn Zimmerman

Internal Revenue Service

Kathryn J. Kennedy, Esq.

The John Marshall Law School

Joan Gucciardi

Summit Benefit & Actuarial Services, Inc.

benefit restrictions today
Benefit Restrictions Today
  • Still applicable: Treasury Reg. § 1.401(a)(4)-5(b)
  • PPA restrictions under IRC § 436
what we are covering
What We are Covering
  • Limitation on plan shutdown benefits and other unpredictable contingent benefits
  • Limitations on amendments increasing benefits
  • Limits on accelerated benefit payments
  • Required benefit freezes
  • Participant communication
ppa benefit restrictions
PPA Benefit Restrictions
  • Coordination with §401(a)(4) restrictions on accelerated distributions for HCEs
    • Restrictions still apply under Treas. Reg. §1.401(a)(4)-5(b)
    • Look at different purposes of rules:
      • §401(a)(4): Prevent discrimination in favor of HCEs
      • PPA restrictions: Improve funding of the plan by restricting lump sums and prohibiting benefit increases for certain underfunded plans
ppa benefit restrictions6
PPA Benefit Restrictions

PPA restricts distributions to plan participants from plans that are not fully funded to the amount of the participant’s monthly life annuity

Generally effective for plan years beginning after 2007

ppa benefit restrictions7
PPA Benefit Restrictions
  • PPA also requires the freezing of benefits under certain circumstances
  • The degree of restriction depends on the level of funding for the defined benefit plan
  • Applicable to:
    • Benefit increases
    • Available benefit forms
    • Benefit accruals
    • Shutdown benefits
restrictions based on aftap
Restrictions Based on AFTAP

Assets – COB –PFB

Funding Target

Adjustment to numerator and denominator for NHCE annuity purchases for prior 2 years

various types of restrictions
Various Types of Restrictions
  • 436(b) limits plant shutdown & other unpredictable contingent benefits for plans less than 60% funded
  • 436(c) limits the ability to amend a plan to increase benefits for plans less than 80% funded
  • 436(d) limits the ability to pay full or partial lump sum distributions depending on whether the plan is less than 60% or 80% funded
  • 436(e) freezes future benefit accruals for plans less than 60% funded
2 nd limit amendment increasing benefits
2nd Limit – Amendment Increasing Benefits

Any amendment increasing benefits, establishing new benefits, changing the existing accrual rate or changing vesting schedule

Exception for flat dollar plans

Exception for mandatory vesting changes: not subject to restrictions

IRS view is that COLA increases under 415(b) and 401(a)(17) are “benefit increases”

2 nd limit amendment increasing benefits11
2nd Limit – Amendment Increasing Benefits
  • Increase in 415 Limit is deemed to be a plan amendment
  • Assume benefits are in pay status
  • In 2009, if AFTAP < 80%, plan sponsor may elect not to make 436 contribution to cover cost of amendment
  • If AFTAP increases to 80% in 2010
    • Full benefits may be paid in 2010
    • 2009 adjustment cannot be made up

[2009 EA Meeting Gray Book, #20]

2 nd limit amendment increasing benefits12
2nd Limit – Amendment Increasing Benefits

What about an increase in lump sum benefit due to the annual update to the applicable mortality table?

Is it a deemed amendment for 436(c) purposes?

2 nd limit amendment increasing benefits13
2nd Limit – Amendment Increasing Benefits

Plan sponsor wants to provide an early retirement window

Current AFTAP is 70%

Increase in funding target is based on assumed utilization [2009 EA Meeting Gray Book, #22]

Increase in funding target must be based on actual valuation data for the current plan year [2010 EA Meeting Gray Book, #34]

2 nd limit amendment increasing benefits14
2nd Limit – Amendment Increasing Benefits

Cash Balance plan needed an amendment to get out of cash balance “jail”

Amendment is effective back to 2000

Amendment will reduce AFTAP below 80%

Amendment is needed for plan qualification

Plan sponsor must contribute enough to bring AFTAP up to 80%

[2010 EA Meeting Gray Book, Q&A #33]

2 nd limit amendment to g f frozen plan will it cause plan to lose exemption
2nd Limit – Amendment to G/F Frozen Plan: Will it Cause Plan to Lose Exemption?

Plan is amended to reflect PPA Applicable interest rate (AIR) and Applicable mortality table (AMT)? NO

Plan protects pre-PPA AIR and AMT? NO

Plan changes lookback month/stability period? NO

Plan is amended to provide in-service distributions at NRA or 62? NO

[2009 EA Meeting Gray Book, #23]

2 nd limit mid year amendment 3 possibilities
2nd Limit – Mid-Year Amendment: 3 Possibilities

1. AFTAP is > 80% after amendment

2. AFTAP is > 80% before amendment and < 80% after amendment AND plan sponsor makes a 436 contribution to bring AFTAP up to 80%

3. AFTAP is < 80% before amendment AND plan sponsor makes a 436 contribution to fully fund the amendment

Note: A 436 contribution cannot do double duty: if used to fund an amendment, then it cannot be used for 430 purposes

3 rd limit accelerated benefit payments
3rd Limit – Accelerated Benefit Payments
  • Plans less than 60% must not allow any “prohibited payments” for participants with an annuity starting date on or after the measurement date (exception for de minimis amounts)
  • “Prohibited payments” = any payment in excess of the monthly single life annuity, plus Social Security supplements
    • Possible exception for 2010 and 2011: SS leveling
  • Plans with funding between 60% and 79% may make “prohibited payments” but only to the extent the present value of the payments doesn’t exceed 50% of the total benefits (or the PBGC guaranteed amount if less)
  • Annuity starting date – regs require participant’s election
3 rd limit accelerated benefit payments18
3rd Limit – Accelerated Benefit Payments
  • Participants with restricted and unrestricted benefits MUST be offered the choice to:
    • Select an unrestricted form of benefit
    • Defer the entire benefit to a later date, or
    • Bifurcate the benefit
  • The sponsor MAY:
    • Allow the participant to take the partial distribution and defer the restricted portion to a later date
    • Make special optional forms of benefits available for ASDs when partial restrictions are in effect
slide19
Present Value of PBGC GuaranteeSample Values for 2010 based on $4,500/mo(Aug. 2009 segment rates: 3.60%, 5.31%, 5.47%)
3 rd limit 60 79 range aka no man s land options offered to plan participants
3rd Limit – 60% - 79% Rangeaka “No-Man’s Land”Options Offered to Plan Participants

Suppose that the participant takes the 50% lump sum and elects to defer the rest of the benefit until restrictions no longer apply

AFTAP now is >80%

Participant has a 2nd annuity starting date and must be offered the QJSA and QOSA

[2010 EA Meeting Gray Book, Q&A #43]

3 rd limit 60 79 range aka no man s land options offered to plan participants21
3rd Limit – 60% - 79% Rangeaka “No-Man’s Land”Options Offered to Plan Participants

What if the actuary does not issue an AFTAP?

Then AFTAP is deemed to be below 60%

No 50% lump sum option needs to be provided

Is this administrative discretion on the part of the actuary?

Might this ultimately violate the terms of the plan?

3 rd limit 60 79 range aka no man s land designing new db plans
3rd Limit – 60% - 79% Rangeaka “No-Man’s Land”Designing New DB Plans

What about drafting a new DB plan by limiting lump sum distributions?

Lump Sum is only available when AFTAP is 80% or above

Old PLRs: Conditioning a benefit on the funding level of the plan is discretion on the part of the employer

3 rd limit options when distribution restrictions cease
3rd Limit – Options when Distribution Restrictions Cease

If AFTAP was 60 – 79% and then certified to be 80% or more, plans must then offer lump sums for anyone with ASD occurring after the resumption

Restriction is not retroactive for anyone with ASD during the restricted period unless the plan so provides or is amended to so provide

3 rd limit options when distribution restrictions cease24
3rd Limit – Options when Distribution Restrictions Cease
  • Following options are available:
    • Plan can continue to pay benefits in the same form
    • Plan may automatically allow participants to change elections, triggering a new ASD
    • Plan sponsors may amend plan with a one-time opportunity for participants to change their elections
4 th limit freeze on future benefit accruals
4th Limit – Freeze on Future Benefit Accruals
  • Plans with less than 60% funding must freeze future benefit accruals
    • Once frozen, benefit accruals are not automatically retroactively restored if funding improves
    • Plan may provide or be amended to provide for retroactive accruals but this is deemed to be a plan amendment increasing benefits
    • Under a special rule, plans that automatically restore missed accruals when AFTAP improves to 60% do not have to fund to the 80% AFTAP level unless the accruals have been frozen for more than one year and resulting AFTAP is still over 60%
4 th limit freeze on future benefit accruals26
4th Limit – Freeze on Future Benefit Accruals

Worker, Retiree, and Employer Recovery Act of 2008 will not impose this restriction for plan years beginning 10/1/2008 – 9/30/2009

If the plan was at least 60% funded during the prior plan year

Funding relief would extend this through 2011

reflecting restrictions in mrc
Reflecting restrictions in MRC
  • Take into account restrictions from prior years
  • Ignore restrictions on benefits on or after the valuation date
  • Ignore restriction on benefit accruals
    • In target normal cost
    • In funding target, if plan provides for restoration of missed accruals and restoration still possible
material and immaterial changes
Material and Immaterial Changes
  • Automatically-approved change in asset method: Material change if it changes AFTAP range
  • AFTAP must be recertified
    • Even if it only affects next year’s presumed AFTAP
  • Can cause disqualification if it affects plan operation prior to recertification
can the plan pay lump sums
Can the Plan Pay Lump Sums?

Under PPA, a plan can pay full lump sum benefits only if its AFTAP is 80% or more

WRERA exception: can pay lump sum if PVAB is less than $5,000

wrera exception
WRERA Exception?

Lump sums are allowed despite 436(d) restrictions

Payment of a benefit under section 411(a)(11)

May be distributed without consent of the participant

Applicable to beneficiaries, alternate payees, and 401(a)(9)

various types of restrictions exception
Various Types of Restrictions:Exception
  • Exception to 436(d) limitation on lump sum distributions
  • Applicable to a plan frozen on or before 9/1/05
statutory presumptions
Statutory Presumptions
  • Intent: Obtain the actuarial certification ASAP during plan year
  • First Two Ranges are split into two halves
    • Range 1: 80% to 89% and 90% to 99%
    • Range 2: 60% to 69% and 70% to 79%
  • Jan. 1st – current year AFTAP same as prior year AFTAP
  • April 1st – if prior year AFTAP was in first half of either range, current year AFTAP = prior year AFTAP less 10%
  • Oct. 1st – current year AFTAP deemed to be < 60%
range certification
Range Certification
  • Actuary can certify that current year AFTAP is in one of 3 ranges:
    • 60% to 79%
    • 80% to 99%
    • 100% or higher
  • Advantage: ignore the first two statutory presumptions
  • Note that actual AFTAP must be certified by EOPY and actual AFTAP must fall within the range
range certification34
Range Certification
  • Final regulations changed the timing for certifying the actual AFTAP after a range certification
  • Actuary can certify by the last of the plan year if the AFTAP includes the cost of any plan amendments that take effect during the plan year
  • Even if such amendments are not included in the 430 valuation
  • Otherwise, AFTAP is deemed to be below 60%, retroactive to 1st day of the 10th month
range certification35
Range Certification
  • If actual AFTAP is not within the range, plan may have failed the qualification rules or not been administered in accordance with its terms
  • If the actuary makes a range certification, plan is treated as having a certified AFTAP at the smallest value within the range
    • For example, if range certification is 60% to 79%, then AFTAP is deemed to be 60%
what asset value is used
What Asset Value is Used?

Must be same value as used for §430 purposes

Fair market value on valuation date

Use FMV in calculating average value of assets

FMV do not necessarily have to be updated to match audited assets

If §430 asset value changes, then AFTAP must be updated

[2008 EA Meeting Gray Book, Q&A 20]

restrictions for new plans in existence less than 5 years
Restrictions: For New Plans(in existence less than 5 years)

New plans: only restriction in first five years is the inability to pay lump sums

But certification requirement still applies

new plans
New Plans
  • Final 436 regs provide that, if FT =0, then AFTAP = 100%
  • However, restrictions could still apply where a new plan provides prior service credit such that FT >0
plan terminations
Plan Terminations
  • No guidance in proposed regs regarding benefit payment restrictions as applied to a terminated plan
  • E.g., plan terminated and AFTAP < 80%
    • What to do if lump sums can’t be paid nor annuities purchased
    • Some argued that 436 no longer applied
  • Final regs provide some resolution
plan terminations40
Plan Terminations
  • Limitations in effect immediately before plan termination continue to apply thereafter
  • Limitations do not apply to prohibited payments that are made to carry out plan terminations “in accordance with applicable law”
plan terminations41
Plan Terminations
  • A plan sponsor’s purchase of an irrevocable commitment to pay benefit liabilities in connection with a standard termination is OK
  • Majority owner waivers should be OK
    • IRS view: nondiscriminatory allocation of assets
  • What about non-PBGC plans?
delay in issuing aftap certification
Delay in Issuing AFTAP Certification

Is it legitimate for employer to ask EA not to issue AFTAP certification until 10/1 to delay implementation of benefit restrictions?

Popular option: IRS is very uncomfortable with this

Employer can simply withhold data

Should actuary warn employer

Should actuary comply with employer’s instructions?

delay in issuing aftap certification ramifications
Delay in Issuing AFTAP Certification: Ramifications

Puts PBGC at risk

Harms participants who do not take lump sums

Violation of duty of impartiality

Actuary may be exercising fiduciary powers when making discretionary decisions

PPA does not require that certifications be made at any specific time

Problem comes to forefront when underfunded plan is terminated (distress or involuntary) and PBGC will not pay lump sums

participant communication
Participant Communication
  • Participants must be notified when any of the restrictions apply
  • Within 30 days after date restriction applies
  • Failure to provide notice could result in penalties of up to $1,000 per day