Transcript for Funding-Based Benefit Restrictions
Note -- Any federal tax advice contained in this transcript is intended to apply to the specific situation described and should not be considered official guidance independent of the presentation. The tax advice and statements contained herein should not be relied upon for retirement planning purposes without first consulting a tax or retirement planning professional. This transcript has been edited for technical accuracy and may differ slightly from the audio recording of the Funding-Based Benefit Restrictions Phone Forum. This information is current as of February 15, 2010. Since changes may have occurred, no guarantees are made concerning the technical accuracy after that date.
Moderator:
Ladies and gentlemen, thank you for standing by. Welcome to today’s Funding Based Benefit Restrictions phone forum. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session. Instructions will be given at that time. As a reminder, today’s conference is being recorded. I would now like to turn the conference over to your host, Mr. John Schmidt. Please go ahead, sir.
J. Schmidt:
Thank you and welcome, everyone. My name is John Schmidt. I am the Staff Assistant to the Director of Customer Education and Outreach for Employee Plans at the IRS. Thanks for dialing into our phone forum called Funding Based Benefit Restrictions. As you just heard, be advised that the following program, including questions and answers, will be recorded and maintained in accordance with federal record keeping laws. This recording is a work of the U.S. government and is in the public domain. A transcript and/or audio recording of this program may be made publicly available on our Web site, www.irs.gov.
Today we will hear from Carol Zimmerman, an IRS actuary. Carol has been working in the employment plan’s ruling and agreements division for approximately four years, following 25 years of pension consulting with national firms. In her current position, she is involved in a number of activities, including reviewing ruling requests, participating in several regulation projects and assisting practitioners and IRS personnel with technical questions. Carol currently serves as the Secretary of the Joint Board for the enrollment of actuaries. She is the fellow of the Society of Actuaries, an enrolled actuary, and a member of the American Academy of Actuaries. She has also been active in the actuarial profession serving on the Academy of Actuaries’ pension committee and speaking frequently at actuarial meetings.
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So without further ado, it’s my pleasure to turn the microphone over to Carol Zimmerman.
C. Zimmerman:
Thank you, John. For those of you who downloaded the PowerPoint, I will try to remember to tell you where we are on the pages. As John mentioned and Melody mentioned from AT&T, we will be presenting for about an hour and then we will have about 30 minutes of questions afterwards. Now I have to tell you that I put together the PowerPoint when I thought you were going to have to listen to me for 90 minutes straight. So I will be skipping over some of the slides, but if there are any things that I pass over, please feel to ask questions at the end.
We are going to cover today the funding rules for single employer plans and benefit restrictions, although I am going to cover them in the reverse order. This is a topic that could take a full day, so we will be hitting the highlights.
So first, let me deal with some of the background. Before PPA, there were a number of concerns about underfunded plans. The causes for the underfunding were ascribed to various reasons, some of which were because costs were amortized over long periods, sometimes as long as 30 years. And there could be up to 20% difference between the actuarial and market value of assets. It was also perceived that there could be some abuses in choosing assumptions and methods. And there was a lot of concern about using credit balances, advance funding over the minimum funding, for plans that would be underfunded without further funding. In addition, there were several cases where there were plan amendments or large distributions that would dilute the security of the plan for participants.
So Congress took a look at this -- now I’m on page five of the PowerPoint -- and did a number of things. We’re focusing here on single employer plans. So for one, all costs are amortized over 7 years instead of up to 30. There are some restrictions on the actuarial value of assets, funding methods, assumptions, etc. And in particular, we’ll see that there are some restrictions on the use of credit balances. On the other hand, there are some expansions on the deductible limits because the goal is to try to get as much money into the plans when people have it to contribute. And then we will be talking a great deal about some of the benefit restrictions that apply to these plans to avoid pulling money out of the plan and leaving the plan less secure for remaining participants.
Now one of the questions that was submitted prior to the sessions asked whether or not these restrictions would also apply to 403(b) plans. And the answer to that is no. These restrictions are for single employer defined benefit plans only. The key reason here, is that there’s no need for similar restrictions in a DC or savings type plan because in those plans, there are individual accounts and there are assets or annuities contracts to back those up. So you wouldn’t have a problem with paying out one person diluting the benefit for others. So this is strictly a single employer defined plan situation.
Now after PPA, and this is on to slide six, we’ve had some further developments. WRERA changed some of the provisions. Some of them were in the nature of technical corrections and some were funding relief. We have several proposals working their way through Congress that would expand temporary relief for funding purposes, recognizing the state of the economy and what that had done to pension plan funding. These proposals would take a number of forms -- generally would provide for an extension or time to amortize costs, ease some of the restrictions on the actuarial value of assets, provide some look-backs, to provide relief on credit balances and benefit restrictions, etc. So we’ll have to wait and see how that develops and see where things go with that.
On to slide seven then, we’ve been able to issue a fair amount of guidance, although I recognize there are still some areas where there are questions. We’ve issued some proposed and final regulations, notices, announcements and some of those are listed on the slide. What we’re working on currently per slide eight, we’re looking at final regulations for some of the sections that have only been proposed so far, 430(a), 430(j), some 4971 excise tax rules. But we’re also working on another round of proposed regulations for sections 430 and 436 of the code. These would incorporate WRERA changes and other changes that have not been exposed to practitioners and therefore practitioners have not had a chance to comment yet. We’re also working on guidance on the 101(j) notice, which is the notice that must be provided within 30 days after benefit restrictions take effect.
So with that, let’s dive into the benefit restrictions. Again, I’m going to try to hit the highlights here. Just as a quick overview looking at slide ten, 436 affects us all in a number of different ways. First of all, it’s first and foremost a qualification issue, but it also will be a fiduciary issue since these rules are affecting individuals’ benefits. The provisions eventually must be reflected in the plan and they’ll have to be done so in a way that is definitely determinable. And, just as a reminder, the high‑25 restrictions still apply and this is a restriction that would apply to the highest 25 highly compensated participants and those rules are found in the regulations under 401(a)(4).
Moving on to slide 11, a quick overview of the restrictions. I’m going to for the most part assume that people are familiar with the basic restrictions. But the restrictions are based on the AFTAP, which is measure of the funding of the plan. Some questions have arisen. First, the actuary must certify this AFTAP and it does need to be based on the same actuarial assumptions, methods, etc. as the valuation results that are reported on Schedule SB. As we will see as we walk through these rules, the AFTAP is based on assets that are reduced for credit balances with limited exceptions. So as we will discuss, there will be times where it’s advantageous or required to reduce those credit balances and therefore, raise the assets accounted for the AFTAP.
The AFTAP is based on the actual valuation results, but if there are subsequent changes, there are circumstances in which that needs to be recertified and we’ll talk about those later. One thing to point out is the final regulations expanded the information required in that actuarial certification, so you might want to take a look at that if you’re doing certifications and make sure that you have everything that is required.
I mentioned earlier that there is a 101(j) notice that must be provided within 30 days after a restriction applies. A question has arisen or a question was submitted as to whether the employer would need to notify participants when the restriction is lifted, but we are working on that guidance. At this point, we don’t have an answer for you yet. You do need to do something reasonable in the meantime, but it does occur to me that it is always good public relations if you would let your employees know that a restriction is lifted and that benefits can be paid again.
I’m going to go quickly over the next few slides. This is an overview of the restrictions. Some basic percentages-- over 100%, there would be no restrictions. Between 80% and 100%, generally no restrictions unless the employer is in bankruptcy; in which case, there is a restriction on accelerated benefits. Between 60% and 80%, there’s a partial restriction on accelerated benefits. This would primarily be lump sums, but also will affect things like Social Security leveling options, anything where the monthly benefit can be bigger than the benefit that would otherwise would be payable on a life basis. In between 60% and 80%, plan amendments cannot take effect.
Under 60%, moving on to slide 13, there are a number of restrictions that apply. No accelerated benefits are paid. Accruals cease. No shutdown or other unpredictable contingent event benefits are paid and no amendments can be made even if they’re paid for under a 436 contribution and we’ll talk more about that in a bit.
Now WRERA did provide for a plan freeze, for accruals freezing, but if your 2008 AFTAP is larger than the 2009 (and we’re dealing here with plans, beginning 10/1/08 through 9/30/09), then you look back and use the 2008 AFTAP. A question was submitted as to whether this look-back would apply when you move on to presumptions for the final year. We don’t have an answer for you yet on that one. We’re aware of the question and are looking into that.
Moving on to slide 14, before the AFTAP is actually available and certified, you can use a presumed AFTAP or a range certification. The presumed AFTAP goes off the prior year’s certified AFTAP; and on a calendar year basis, generally you would use it as certified from January 1 through March 31. April 1, you would generally decrease that by 10%. And at October 1, if the actual certification has not been made for the plan year (with exception of a range certification), then the AFTAP is conclusively presumed to be under 60% and all restrictions apply, even if the actual certification is made on October 2nd or even October 1st, for that matter.
Moving on to slide15, a range certification is a tool that is handy if you know what range that the AFTAP will be in, but you don’t have the actual results of the valuation. If that’s the case, then the actuary can certify to the range. The key is that this range certification is treated is an actual certification. So if something happens, if it’s too close to call, the actuary shouldn’t really be certifying under a range certification because if something happens and you end up in a different range, it’s considered a material change and could cause disqualification if that is wrong. While the range certification is in effect, it is treated as if the AFTAP is the lowest value in the range. From a practical standpoint, what that means is if you have a plan amendment that would lower your AFTAP (increase the liabilities, lower the AFTAP), then you would not be able to let that amendment go into effect because the range certification is treated as if it’s already down at 80% when you certified to that range. So an amendment would lower that, put it below 80% and so you would have to take some sort of action in order to let that plan amendment take effect.
Now you must have an actual certification by the end of the plan year. This is one of the changes in the final regulations. Originally, the proposed regulations required that the actual certification be made before October 1. We now have until the end of the year, but if the certification is not made at that point, then it’s retroactively presumed to be under 60% as of October , for a calendar year plan. So if the actuary is going to use a range certification, he or she wants to make absolutely sure that there’s a way to certify by the end of the plan year.
Moving on to slide 16, there are ways to avoid the restrictions. Again, some of this is information that you’ve been looking at before. But one way to avoid restriction is to elect to reduce the credit balances. As we mentioned briefly before, this works because the assets are reduced by the credit balances when calculating the AFTAP. So if you elect to reduce those credit balances, you’re counting more of the assets toward the AFTAP and, therefore, improving it. Now this election is required and deemed to occur if it effects the accelerated distributions, for all plans. For collective bargaining plans, this deemed election applies if you can remove any of the restrictions. And that is a key point, that if you have a credit balance, but it’s not large enough to avoid the restriction, there’s no deemed election. You can maintain that [the credit balance].
The final regulations enhance the definition of collective bargained plans. Now the plan is considered to be collectively bargained, if 25% of the participants are covered by a bargaining agreement or if 50% of the active employees are covered by a bargaining agreement. Now if you are not subject to the deemed election to reduce the credit balance, but you want to, the plan sponsor can do that at any time. [But note that this won’t affect restrictions for a given plan year unless the election is made by the end of that plan year.]
The next couple of slides show an example of how this works. I’m not going to cover the numbers, but it’s there for you if you want to refer to it.
Moving on to slide 19, the thing to keep in mind when you’re looking at the election to reduce the credit balance is that there is a tight interaction between that and the minimum funding requirement. The lower credit balance would affect the calculation of the minimum required contribution itself. And, of course, once an amount is waived, it’s gone and therefore, not available to offset future required contributions. For avoiding restrictions, the reduction is deemed to occur on the first day of the plan year. What that means is there may be situations where the plan sponsor may have already elected to use a credit balance for a current‑year quarterly contribution. And then if it later turns out that the credit balance needs to be waived or reduced to cover a restriction, that jumps ahead of the quarterly contribution because it occurs on the first day of the plan year. So you may find a situation where a quarterly contribution that you thought was covered is trumped and, therefore, is late or unpaid. So it’s very important when you’re making decisions as to whether to use a credit balance for a quarterly contributions or for lifting a restriction or anything along those lines, that you need to consider the implications on other aspects and make sure that you’re using the credit balance in a way that’s most advantageous.
Moving on to slide 20, another way to avoid the restriction is to make an additional prior‑year contribution or to make a section 436 contribution. Now section 436 contributions are considered to be current‑year contributions. They’re not available to avoid restrictions on accelerated distributions. You can only “buy up” for plan amendments, unpredictable contingent events or to avoid a freeze in accruals; 436 contributions don’t count toward the minimum required contribution. And if you’re using a 436 contribution, you cannot use a credit balance to do that. You have to use actual cash.
A key difference here is if you’re making a contribution that’s before 8.5 months before the end of the plan year and you want to credit that to the prior year, what that does is that actually increases your AFTAP for the year. The 436 contribution is something that’s made during the year and it does not increase the assets for the year. It only increases that for purposes of allowing a restriction to take effect.
One other option is to post security by the valuation date. We have had a number of questions on that over the past few months, but it doesn’t appear that many people are using this option.
Moving on to slide 21, looking at some of the specifics for specific types of restrictions, the first one applies to plant shutdown benefits or any other unpredictable contingent event benefits. These are benefits that rely on some sort of external event. It’s not just the individual deciding that they’re ready for retire and they meet other eligibility requirements. This takes something other than reaching a specific age or service or disability. The restrictions apply based on the AFTAP at the time of the event on a participant‑by‑participant basis. So what this means is if a plant or a division is shut down and there are different “waves” of layoffs, each “wave” would count as an event. This is often different from the way that this might work for accounting rules, but this allows for benefits to be paid group by group. However, what it does mean is if you hit a point where the restriction applies, any participants whose event occurs after that date are not able to get payment unless the restriction is lifted.
The final regulations provide that if you’re working under a given AFTAP (say, a presumed ATFAP at the time of an event), and that prevents the unpredictable contingent event from being paid, but later on an AFTAP is certified that is larger, then the unpredictable contingent events that occurred in that plan year are paid. So it’s an asymmetrical rule -- if an event occurs when the AFTAP would permit the payment to be made, but later the actual AFTAP is certified and it’s lower and that would otherwise impose a restriction, people that had already qualified for the unpredictable contingent event benefits can still get them.
However, if you have an AFTAP that’s lower, it prevents the benefits from being paid and then later in the plan year, there’s a higher AFTAP certified, people can get the benefits. So once you get it [a benefit], you don’t lose it, but if you initially lose it and the AFTAP is higher within the plan year, then those benefits can be paid.
The section 436 contribution depends on the AFTAP before the event. If you start out under 60%, then the current year 436 contribution that is required to lift the restrictions is the incremental cost of the benefit. If the AFTAP starts out over 60%, then the amount needed is the amount needed to raise the AFTAP back to 60%.
Now going on to slide 22, the restriction on plan amendments works essentially the same way. Again, if the AFTAP is too low when the plan amendment is scheduled to take effect, it cannot, unless there’s a contribution or some other action taken to lift the restriction. If later the ATFAP is higher, then the plan amendment would take effect, if the AFTAP is higher within that plan year.
Earlier I had pointed out the difference between prior‑year contributions and a 436 contribution. I was asked a question as to why somebody wouldn’t always just make a prior‑year contribution. There are two reasons. One is timing. If the plan amendment is after the 8.5 months allowed for prior‑year contributions, it would no longer be available. But I think what might be a more common occurrence is if you have a situation where the AFTAP is under 80%, it might cost more to raise the AFTAP (including the cost of the amendment) back up to that 80% threshold, which is what the requirement would be if you were using a prior‑year contribution. But if you’re using a 436 contribution, you would only have to pay for the incremental cost of the amendment and that might be something that would be easier to attain. Now notice that if the AFTAP is under 60% and the plan has frozen accruals that you cannot amend the plan to increase benefits even if you’re willing to make the 436 contribution.
Moving on to accelerated distributions on slide 23; again, these are primarily lump sums, and Social Security leveling options. This applies at the annuity starting date, this restriction, so you would test the funded status based on the AFTAP in effect at the annuity starting date. Now if you have a situation where the plan sponsor is in bankruptcy, keep in mind that the threshold there is 100%. And the presumed AFTAP doesn’t work in that situation. You need an actual certification. A range certification does count as an actual certification in that case.
WRERA made an exception for automatic cash-outs. Note that there’s still an issue if the plan’s limit is less than the $5,000 that’s allowed under the code for automatic cash-outs. If you have a situation where, for instance, the automatic cash-out under the plan is at $1,000 to avoid the automatic IRA rollover, then there is a question as to whether this exception applies for cash-outs between $1,000 and $5,000.
Moving on to slide 24, there are a number of things that happen if you are in the 60% to 80% range where there’s a partial restriction on accelerated distributions. Under this situation, you can only pay one‑half the benefit or the PBGC guaranteed benefit if less in the form of an accelerated distribution. The plan must provide that in this situation, the employee is given the chance to either bifurcate the benefit and split it into an accelerated and a non-accelerated portion. They can defer the entire benefit and just decide to wait until some later point where, I’m sure, they’d be hoping that the full lump sum would be available. Or they can elect an unrestricted option. The plan is also allowed to, but is not required to, make other options available. For instance, they can allow the person to defer the restricted portion of the bifurcated benefit and pay the lump sum now and get the rest later. Or they can make additional forms of payment available that are only available when the situation arises.
A question that was submitted in advance asked whether death benefits that are accelerated would be subject to these restrictions even if the form was elected before PPA. Now if the overall form of benefit is not considered to be accelerated, then the payment can continue to the beneficiary after the participant’s death without restriction. An example of that would be if a participant elected a ten‑year certain and life form of payment and then died, let’s say, when there’s only two years left of the ten‑year guarantee portion. Now, looking just at the beneficiary, that two‑year guarantee would look like an accelerated benefit, but because it was part of the overall package, that can continue to be paid. But the rules make an exception where the payment is accelerated upon death. So if you have a situation where benefits are paid to the participant, but on death the beneficiary would have the ability to elect to receive the remaining interest in a lump sum, that that would constitute an accelerated benefit. And there would be a new annuity starting date and the benefits would have to be tested to see if they could paid based on the AFTAP at the time.
Moving on to slide 25, under bifurcation of benefits, we’re looking at the present value of the total distribution on a 417(e)(3) basis. A question had been submitted asking whether if you had a situation where you had a plan that consisted of two pieces, let’s say, a grandfathered benefit with a lump sum and an ongoing portion of the plan that didn’t have a lump sum, how much of that benefit could be paid under this bifurcation rule. The answer to that is we look at the total distribution. I think in the example that was submitted, the frozen piece that was eligible for a lump sum was worth about $140,000, but the total distribution would be worth $250,000 counting the piece that did not have the lump sum available. So in that situation we would look at the $250,000 and say that $125,000 of the lump sum would be payable, even though that’s more than half of the lump sum the individual would otherwise have been eligible for.
[Note that this would only be available if the plan sponsor made this a special optional form of payment available when the plan was subject to the partial restriction on accelerated benefits. The default rule for partial lump sum payments -- other than refunds of employee contributions ‑- is that if the partial lump sum is more than 50% of the total present value of the benefit, only one‑half of the lump sum otherwise available can be paid. In this example, that would mean the participant could receive a lump sum of only $70,000 (i.e., one-half of $140,000), and the remainder would be paid as an annuity.]
One of the changes in the proposed regs, one of the clarifications, was that minimum present value rules would apply separately to each portion of the bifurcated benefit. That, I think, makes it much easier to apply, much easier for participants to understand what’s happening because you can split the benefit in half and pay half of the benefit in each form, lump sum and non-lump sum without worrying about the crossover for 417(e)(3).
We also have special rules for the Social Security leveling option. If you’re bifurcating the benefit, you treat the leveling option as if it were the only benefit. So you would make the calculation, based on the full Social Security amount that would otherwise be applied under the plan. That does have the effect of (in many cases) allowing all or most of the Social Security leveling option to be paid even if that would have constituted more than half of the benefit.
I also mention on slide 25, plan terminations. We have a number of questions about this. This issue is that when you have a plan termination if the last AFTAP that was certified happened to be too low to make lump sum distributions or buy annuities, there’s not a mechanism to certify another AFTAP. So there was a question as to whether terminations could be done. Now what the final rules say is that the restrictions continue to apply after the termination, because at plan termination is precisely when you don’t want money to be flying out of the plan and leaving other folks without the benefit security that they thought they had. But there is an exception for distributions that are made to complete a standard termination. The idea is that once you get to a point where you can wrap up the plan, you can still do so. We’ve had a number of questions there in terms of small plans that may not have enough money to pay all benefit liabilities. Here we’re saying that if you were able to wrap up the plan and distribute assets under a reasonable allocation method or under rules provided by the PBGC, you can still do that. What we’re trying to avoid by continuing the restrictions after termination is avoiding a situation where the termination is not completed and money is paid out before everyone is taken care of in some form.
A question was submitted before the session about distress terminations. And again, here you would follow the PBGC rules, just like you would have in the past if this is a PBGC plan. And under those rules you generally would not be paying lump sums in any event; you would be, again, following the PBGC rules. So again, basically wrapping up a plan in a termination would generally occur the same way that it would before, but you wouldn’t be paying out any accelerated benefits prior to that.
If we are looking at slide 26 then, we are talking about the freeze on benefit accruals if the AFTAP is under 60%. You can have a provision in the plan that provides for an automatic restoration of missed accruals. And if that occurs in a situation where the AFTAP would be at least 60% including the cost of the restored accruals, and if the freeze had been in effect for no more than 12 months, then those accruals can be automatically restored without being treated as an amendment. If the provision is not in the plan or if those conditions are not fulfilled, then the restoration is treated as an amendment and can’t take effect unless the AFTAP is at least 80%.
One of the areas that has received the most interest is outlined on slide 27, and that is what happens if the AFTAP changes after it is initially certified, and we know that will happen. A change is considered a material change and could result in possible disqualification of the plan if it changes the operation of the plan. So if you certify that an AFTAP is above 80% and you’ve been paying lump sums and then you find out it really should have been 79%, then there’s an issue and the plan can be disqualified.
It can be a material change, even if the only effect is to change the presumption that flows into the following year. So if you had an AFTAP that was certified at 91% say, and that means that the presumption in the next year would drop down to 81% in the following year. [Note that the presumption would not actually drop, because it was not within 10 percentage points of the next lower threshold.] Under either scenario during the certified AFTAP period and then also in the presumption period you would be able to pay lump sums. However, if a subsequent change dropped that AFTAP to 85% instead, then the 10% drop would put it in the 60% to 80% range and would result in a partial restriction on lump sums.
Now to clarify, if that happens during the current year or any time before on a calendar year basis before April 1 of the following year, then your actual operations have not been affected up until that date, and that would not be a disqualifying event. But if you discovered this after you passed that April 1 date, again speaking in calendar year terms, then you would have an issue.
Now there are exceptions to this rule. If this change occurs, even if it puts you in a different range, if this change occurs because you made additional contributions to the plan or there was an election to reduce or to apply credit balances, then this would not be considered a material change, and would not be an issue for the plan. If there is a subsequent plan amendment or an unpredictable contingent event, or if you’re making an assumption or method change and you were waiting for IRS approval, then once that approval is granted that assumption change/method change would not be a disqualifying event, even if it changes the AFTAP to a different range.
But this list of exceptions, those are the only cases in which the exceptions apply. So if you have a situation, like one of the questions that was asked that concerned an AFTAP that was changed from 72% to 91% because of the change to the yield curve; well, a change to the yield curve is not an assumption or a method that would have required IRS approval, and so therefore that change is considered a material change, and if that changed the operation of the plan then it could be a disqualifying event. So you really do need to watch when you’re changing any assumptions, method changes, etc. that if you’ve already certified an AFTAP and are relying on that, if changing the assumptions or methods puts you in a different range, that is considered a material change and could cause you problems.
Moving on to slide 28. The AFTAP can be recertified or may be required to be recertified if there are subsequent changes. If you have a material change, and again, including if that would affect next year’s presumed AFTAP, you need to recertify, and you need to recertify if the change would have been material except for the exception. So if you make an additional contribution that puts you in a better range it’s not a disqualifying event, but it does require a new certification.
There’s also a recertification required if a 436 contribution is needed to bring the AFTAP to 60% or 80%; and in that case it doesn’t count, it’s not a valid 436 contribution unless it is recertified. You can always recertify if you want. Any time you recertify you need to reflect any amendments, unpredictable contingent events, 436 contributions, etc. that occurred after the prior certification.
I’m going to move a little faster here because we do want to get to the funding rules. There are similar issues if there are changes in the presumed AFTAP. They are circumstances that are noted here and in the final regulations if you have any elections – I’m sorry, there are circumstances, in which you need to modify the presumed AFTAP if there is an election or deemed election to reduce the credit balance that changes a restriction, or if you make a 436 contribution to increase the AFTAP to 80% or 60%. There’s no modification to the presumed AFTAP if you have unpredictable contingent events or amendments that are permitted to take effect automatically or if you pay the full cost of those things or if you have a voluntary reduction in the credit balance that does not result in the removal of restrictions. If you have amendments or unpredictable contingent events that you need to test to see if those can take effect while you’re in the presumption period then you do need to reflect any prior events that occurred so that you have the cumulative effect.
Then move on to slide 31. We’ll move a little quicker here. Section 436 has effects on plan administration (as mentioned on slide 32, actually). There needs to be a great deal of coordination between the plan sponsor, the actuary, and the administrator so they’ll all know what to expect, know what the AFTAP is likely to be, and have a chance to think about what sort of actions they may take. Slide 33 has obvious implications on plan administration in that the systems have to be conformed to pay the appropriate benefits and not pay inappropriate benefits when that’s necessary, or not to pay prohibited benefits when necessary and to make the appropriate election forms and notices available.
On slide 34, drafting the document must reflect the 436 restrictions in a way that is definitely determinable. Announcement 2009-97 extended the deadline for that amendment until the end of the plan year beginning in 2010.
A question was submitted as to whether that announcement also extends the time period needed for reflecting the 436 restrictions in the SPD and the summary of material modifications, but those are governed by the Department of Labor, so our announcement does not affect those. I’m not sure where the Department of Labor would be as far as the timing.
Slide 35, a couple of things. If you’re putting 436 amendments in the plan, you want to keep in mind that if you want to do something like the automatic restoration of missed accruals you want to make sure that that is in the plan. Otherwise, it would count as an amendment at the time that it was put in. And generally, you cannot restrict the benefits more than required by law; that would be a violation of 411(d)(6).
Slide 36, collective bargaining implications -- it’s a perceived gotcha if you negotiate something and then they [the amendments] don’t take effect, so you may see more bargaining agreements that have funding commitments or “spring-back” provisions that would bring an amendment back in if it can’t take effect in the year that it would otherwise do so.
And then 38, some employee communications. You probably want to let your employees know just generally that these restrictions could apply, and of course, a notice is required when the restrictions actually apply.
Thirty-nine, there are implications for election forms as well. The final regulations outline three ways that this could be handled. And so plan sponsors and their advisors would need to decide what works best for them. And of course there are implications for the descriptions and relative value disclosures and so on, depending on how much is communicated at what time.
So, I kind of rushed through there, which gives us about 15 minutes to talk about the funding rules along with any questions that you might have afterwards. So let’s dive into the funding rules. And again, I will be giving a quick overview.
On the funding rules, there are many ways where they’re simplified. There’s one cost method, one amortization period, and fewer choices on actuarial assumptions, but this will require more involvement of the plan sponsor for some of the elections that are required. Now the plan sponsor always had to approve a change in funding method or a 412(c)(8) election (to consider certain amendments as effective at the beginning of the plan year). Those were relatively simple checkboxes on the 5500. Now they’ll have to make proactive elections, and I would still imagine that they would rely very heavily on the actuary’s recommendation. Note that elections are generally irrevocable for a given plan year and maybe even for future plan years and may need IRS approval [for a change].
My discussion is going to presume a general familiarity with the funding rules and we’re going to look at some of the highlights from the final regulations. Some of the changes, the change in the allocation of certain benefits -- and now I’m on slide 42 -- there’s a change in the allocation of certain benefits and this tends to decrease the funding target because it spreads benefits that are not related to the accrued benefit over a longer period of time.
They [the final regulations] would clarify the effect of 436 restrictions on the funding target and the target normal cost, and generally what this means is that if a restriction applies before the valuation date then in most cases you would reflect that restriction in your funding target. But any anticipated restrictions would not be anticipated. That’s partially to avoid a circular rule, where you exclude a benefit and find that lowers the funding target to a point where the AFTAP is below the percentage and below the trigger, and then would require reflecting the benefit again. So that’s part of it. And the other part is that you wouldn’t expect those restrictions to be imposed on the plan forever into the future. So in any event, anything that would be a restriction after the valuation date is not reflected in the cost.
One exception is if your plan is subject to the freeze on accruals, the full accruals would still be reflected in the target normal cost unless the plan has been amended to freeze the benefits outright, a hard freeze. So if you have a plan that’s still ongoing, still accruing, and you hit the freeze on accruals, you’d have a full target normal cost. If the restriction on accruals is not lifted during that plan year then you’d find a gain in the subsequent year. With respect to the funding target, if you have the automatic restoration of accruals in the plan document and it’s still in play, it could still result in a restoration, then you would include the cost of those accruals in the funding target.
The third bullet point on slide 42 has to do with replenishment of the credit balance. The proposed regulation said that if you used a credit balance to offset a minimum required contribution and then later ended up contributing enough cash, that you would not be able to replace that amount in the credit balance. And originally we did this because we were concerned about practitioners and plans avoiding the requirement to roll forward the credit balance with the actual rate of return on plan assets. But the final regulations allow replenishment of the credit balance, but the portion that’s being replaced has to be adjusted with the actual return on assets. And essentially what happens there, and you see this in some of the examples in the regulations, is that if you do that you end up pretty much where you would have been had you not elected to use the credit balance to start with. The only difference is the replaced amount would be in the prefunding, or the “new” credit balance, as opposed to the old, if that’s where it started.
The other thing that we did in the final regulations was to clarify the ordering rules for the use of credit balance, and generally it’s a chronological rule that would use the credit balance for the things that occurred first. So contribution by contribution, you would take that out of the credit balance. The exception is that if you have a deemed or voluntary election to reduce the credit balance, as we discussed in the context of 436, that would take precedence over any current-year contributions, whether or not those were made prior to the date that you knew about the election to reduce the credit balance. Any election to reduce the credit balance would also take priority over any prior‑year contributions that had not yet been offset.
So as you’re working your way through the year, any prior‑year contributions that were offset by the credit balance would “stick” until the point where you used up the credit balance for a reduction to avoid 436 restrictions or for any other purpose. Any prior‑year contributions due after that date would not be offset unless there was a credit balance remaining that would cover that.
Moving on to slide 43, we talk about some of the elections that must be made by plan sponsors. First, and one that seems to be getting the most attention, is the interest rate assumption. And as most of you know, the minimum funding requirement is no longer based on a single interest rate. We’re using the yield curve concept, which says that long-term rates are going to be different from short-term rates. The default is to use segment rates, which are based on a simplified yield curve, where it’s collapsed into three different segment interest rates, and the default would provide for no look-back and would use a transition rule for 2008 through 2010, where that’s weighted with the pre-PPA rates.
Moving on to slide 44, there are other options. You can use a full yield curve, you can use segment rates with a look-back for up to four months, and you can elect not to use the transition rule. Now one thing that’s missing from this list is a full-yield curve with a look-back, where you could go up to four months prior to the valuation date. Now our final regulation took the same position as the proposed regulations in saying that we did not feel it was appropriate to use a full yield curve with a look-back. However, before final guidance was issued we felt that it could be considered a reasonable interpretation to use that. So we had issues some “soft” guidance through the Employee Plan Newsletter saying that for plan years beginning in 2008 and 2009 we would not object to using a full yield curve with a look-back; however, going forward that will not be an option.
Now generally once you have made an election away from the default you need IRS approval to change that election. Some exceptions: you have more flexibility during the 2008 - 2010 plan years, and then after 2010 if you’re using the default you can make an election away from that default, and that’s considered your first election. So if for the plan year beginning in 2010 you’re using a segment rate, then when you get to a future year at some point you can decide to use the full yield curve. However, once you’re using the full yield curve, to change back to a segment rate would then be a change in election, and therefore you would need IRS approval to do that.
Moving on to slide 45, to make the interest rate election we have not specified any format or particular deadline, although that does have to be in place before the Schedule SB is filed. It’s done by written notification to the enrolled actuary. And notice that even though we say it has to be in place sometime before the Schedule SB is filed, you may in effect need to elect that earlier to avoid a material change in an AFTAP. As we said before, a change in election method, anything like that, that does not require IRS approval, is considered a material change if that changes the AFTAP to a different range than was originally certified.
Moving on to slide 46, another key area of elections is in the use of credit balances. And as I mentioned before, there’s a lot of interaction between the minimum funding requirements, benefit restrictions, etc., and so in making these elections you want to take a good look at the implications and make sure that you’re using the credit balance to its best advantage. Slide 46 just talks about the pre-PPA requirements, where there was one credit balance and that was automatically used towards minimum funding. Any excess contributions were automatically added to that and there was no ability, but again, there was also no need to reduce credit balances.
Slide 47 describes the post-PPA situation. Some key differences, which I’m sure many of you are aware of, credit balances cannot be used to offset the minimum required contributions unless the plan is at least 80% funded in the prior year. And elections are required to use the credit balance to offset the minimum required contribution, to add excess contributions to the pre-funding balance, or to reduce the credit balance.
Slide 48 is the caution that we did talk about a little bit before, that decision to use the credit balance can affect the calculation of the minimum required contributions. So if you change your mind about using a credit balance somewhere along the way, that could retroactively change your valuation results, can result in late or unpaid quarterly contributions, and, of course, can affect benefit restrictions as well. Although in that case a change in your election for the credit balance is a change that is deemed to not be material, so it would not affect the qualified status of the plan.
Moving on to slide 49, the final regulations provide for standing elections in certain circumstances. You can have a standing election to use a credit balance to offset the minimum required contribution. It’s not yet available for quarterly installments; we’re still sorting through those issues and seeing how that might work and particularly how that might interact with the 436 requirement. So there will be more information on that when we do the next round of regulations. You can also have a standing election to add excess contributions to the prefunding balance.
These standing elections are treated as if they are effective on the last day for making a specific election, and that’s so that the plan sponsor has as much flexibility as possible if they decide they want to revoke that election. These elections remain in effect until they are revoked in writing to the enrolled actuary or until the actuary signing the Schedule SB is not the actuary named in the election. And that latter provision was intended to protect the enrolled actuary so that the actuary is not held responsible for information that they did not necessarily receive personally.
Slide 50, elections on credit balances -- again, there’s no specific format. Other than the standing election, the election must include the specific amount involved, and again, must be provided in writing to the enrolled actuary and also to the plan administrator. Generally these are irrevocable. There is a new exception under the final regulation that if you elect to use a credit balance to offset a minimum required contribution, and generally this would occur if you’re making an election to cover a quarterly, and if it turns out that that amount is greater than the full minimum required contribution, that can be revoked. And of course, the standing election may be revoked before the date that it’s deemed to be effective.
Going to slide 51, timing of elections -- they can’t be earlier than the first day of the plan year, except for standing elections. An election to use a credit balance to offset a minimum must be made no later than the deadline for contributing the minimum. You may need to make a specific election earlier to cover a quarterly installment. There is another exception here; if you have a standing election and that is revoked because the enrolled actuary has changed, then you have until the Form 5500 filing due date with extensions to make a new election. So that gives essentially another month.
An election to reduce a credit balance must be made by the last day of the plan year, and an election to add excess contributions to the prefunding balance must be made by the deadline for contributing the minimum required contribution. And again, the standing election can be used to cover that.
Let’s see, slide 52 we’ve already covered. And so that brings us to questions. And before I turn this back to John we have a couple of questions that were submitted that didn’t dovetail into the earlier part of the presentation, so let me handle these now.
One of the things that I did not mention is that if a plan is considered in at-risk status, and that has to do with certain funding percentages. If it’s considered to be in at-risk status, not only are there some special assumptions that are used to value the funding target and the target normal cost, but there’s also a restriction on funding any non-qualified deferred compensation plans. There had been a question as to whether this restriction applies only to publicly-traded companies, and that’s based on the definition of covered employees within the statute. We’re aware of the question; we have not yet issued guidance. But I do want to point out that we have Notice 2007-78, and that allows plan sponsors and practitioners to use reasonable interpretation until guidance is issued on this point.
Another question, and I did handle this one. There was a question asked to a partial lump sum and we’ve already talked about that. The one thing I neglected to say earlier is that if you refer to example 2 in Section (d) of the 436 regulation, that shows what happens if you have a partial lump sum, and it walked through applying the partial restriction on that. [However, note that Example 2 applies only to a lump-sum refund of employee contributions.]
So I think with that, that’s the end of my prepared comments and these miscellaneous questions, so John, I’ll turn the mike back to you.
J. Schmidt:
Great. Thank you, Carol. I hope you’ve got a glass of water handy, because here is your chance to take a quick sip, I guess, because I’ll only have the microphone for just a minute or so. Again, I want to thank you for your willingness to conduct the phone forum and your ability at conveying the information. Thanks a lot.