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Update on Defined Benefit Restrictions under Section 436 2010 Great Lakes Benefits Conference June 16, 2010

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 436 2010 Great Lakes Benefits Conference June 16, 2010

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  1. 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.

  2. Benefit Restrictions Today • Still applicable: Treasury Reg. § 1.401(a)(4)-5(b) • PPA restrictions under IRC § 436

  3. 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

  4. 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

  5. PPA benefit restrictions

  6. 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

  7. 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

  8. Restrictions Based on AFTAP Assets – COB –PFB Funding Target Adjustment to numerator and denominator for NHCE annuity purchases for prior 2 years

  9. 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

  10. 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”

  11. 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]

  12. 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?

  13. 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]

  14. 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]

  15. 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]

  16. 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

  17. 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

  18. 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

  19. Present Value of PBGC GuaranteeSample Values for 2010 based on $4,500/mo(Aug. 2009 segment rates: 3.60%, 5.31%, 5.47%)

  20. 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]

  21. 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?

  22. 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

  23. 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

  24. 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

  25. 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%

  26. 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

  27. 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

  28. 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

  29. 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

  30. 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)

  31. 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

  32. 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%

  33. 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

  34. 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

  35. 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%

  36. 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]

  37. 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

  38. 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

  39. 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

  40. 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”

  41. 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?

  42. 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?

  43. 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

  44. 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

  45. Questions?

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