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Calculating Benefits

Calculating Benefits. G. Neff McGhie, III, COPA, MSPA Sierra Pension Services, Inc. sierrapension@mindspring.com. Ah, remember the simple days?. When a distribution election form was 1 page? When actuaries could choose their own assumptions?

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Calculating Benefits

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  1. Calculating Benefits G. Neff McGhie, III, COPA, MSPA Sierra Pension Services, Inc. sierrapension@mindspring.com

  2. Ah, remember the simple days? • When a distribution election form was 1 page? • When actuaries could choose their own assumptions? • When an employer could fund what ever they felt like to a plan? • When just about anyone could calculate a PVAB?

  3. Conversion of Benefits to Alternate Forms • Plan benefit is stated in its Normal Form • Usually a single life annuity, but could be other forms such as: • Period Certain • Joint & Survivor • Conversion to alternate forms is made using concept of Actuarial Equivalence • The alternate form is the same “value” as the normal form of benefit

  4. Actuarial Equivalence • Benefits are converted to actuarial equivalent forms of payment or retirement dates using the assumptions for interest and mortality • The plan will define a set of assumptions • The IRS also defines a set of assumptions for certain purposes (like lump sums)

  5. Converting to another Form • Using plan’s assumptions for interest and mortality at same retirement age, determine APR’s for different payment forms • EXAMPLE: • Mike’s benefit as life annuity at age 60 = $3000 • He wants benefit in the form of a Joint & 50% survivor • APR for life annuity = 154.758 • APR for J&50%S = 167.237 • Actuarial Equivalent = 3000 x 154.758 / 167.237 = $2,776.14

  6. Converting to a Different Age • A life annuity payable at an earlier age will be more valuable due to the longer years to death, so if we are to make it actuarially equivalent, must reduce the benefit by interest and mortality • EXAMPLE: • Mike decides to take life annuity, but retire at age 58. • APR at age 58 = 161.021 • APR at age 60 = 154.758 • Interest rate = 8.5% • Annuity at age 58 = 3000 x 154.758 / 161.021 x (1/1.085)^-2 = $2,449.37

  7. Conversion of benefits to Lump Sum • Any benefit form that is subject to Code Section 417(e), like lump sums, must have a present value that is not less than the value calculated using: • Applicable Interest Rate • Applicable Mortality Table

  8. Applicable Interest Rate • Rate of interest during a plan’s lookback month and stability period • Same definitions pre and post PPA • Plan Years beginning prior to 2008: • GATT rate = 30-Year Treasury Securities • Plan Years beginning after 2007: • 3-tiered segment rates • Phased in over 5 years as mixture of 30-year Treasuries

  9. Interest Rate Phase-in • 20% of segment rates is blended with 30-year treasuries per year • Example: • 30-year treasury = 4.53% • 3-tiered rates are: • First Segment = 4.93% • Second Segment = 6.13% • Third Segment = 6.69% • Blended: • [(1x4.93) + (4x4.53)]/5 = 4.61% • [(1x6.13) + (4x4.53)]/5 = 4.85% • [(1x6.69) + (4x4.53)]/5 = 4.96%

  10. Applicable Mortality Table • Pre-PPA = 1994 GAR mortality as published in Rev. Rul. 2001-62 • Post-PPA = Published by the IRS in Rev. Rul. 2007-67 • Unisex table that is to be updated every year • Not effective until the 2008 plan year.

  11. Anti-Cutback Relief for Change • Generally, plans that used the old applicable interest and mortality and change to the PPA applicable interest and mortality will not violate the anti-cutback rules. • This applies even if the plan referred to 417e applicable interest and mortality in the definition of plan actuarial equivalence (Notice 2008-30). • No ERISA 204(h) Notice required to alert participants of reduction.

  12. Calculating Lumps Sums under PPA • Data: • Participant: Hermione • Date of Birth: 8/17/1950 • Date of Distribution: 8/17/2008 • Straight Life Annuity: $10,000 per year • Normal Retirement Date: 8/17/2015 • Preretirement Death Ben: PVAB • 417(e) applicable interest rate: 5.1% • APR based on 5.1% 94 GAR: 12.153 • Normal Retirement Age: 65 • Old Calculation of 417(e) PVAB: • $10,000 x 12.153 x (1/1.051)^-7 = $85,795.50

  13. Continued • Segment Rates: • First: 4.75% • Second: 5.25% • Third: 5.75% • Phased-in Segment Rates: • First: (1 x 4.75% + 4 x 5.1%)/5 = 5.03% • Second: (1 x 5.25% + 4 x 5.1%)/5 = 5.13% • Third: (1 x 5.75% + 4 x 5.1%)/5 = 5.23% • “New Method” of Calculating Lump Sum: $10,000 x (1.0513)^-7 x 1.0000 x 12.30653 = 86,705.95 - $10,000 x (1.0513)^-20 x .77235 x 8.00312 = 22,726.88 + $10,000 x (1.0523)^-20 x .77235 x 7.96275 = 22,186.35 TOTAL: $86,165.41

  14. Continued • Method: • Line 1: Age 65 Benefit discounted to payment age using second segment rate, times a mortality discount, times age 65 APR at second segment rate. • Line 2: Age 78 annuity benefit discounted back to payment age at second segment rate, times a mortality discount to age 65, times age 78 APR at second segment rate. • Line 3: Age 78 annuity benefit discounted back to payment age at third segment rate, times a mortality discount to age 65, times age 78 APR at third segment rate. •   TOTAL = Line 1 – Line 2 + Line 3

  15. Impact of New Assumptions • Change in Lump sum value of Old law vs New law with static interest rates • Age 60: 2008 = .1% 2012 = -14.8% • Age 55: 2008 = -.5% 2012 = -21.2% • Age 45: 2008 = -2.8% 2012 = -35.6% • Age 35: 2008 = -4.6% 2012 = -45.5% • Change in Lump sum value of Old law vs New law with rising interest rates (25 basis pts/yr) • Age 60: 2008 = .1% 2012 = -24.7% • Age 55: 2008 = -.5% 2012 = -33.4% • Age 45: 2008 = -2.8% 2012 = -50.5% • Age 35: 2008 = -4.6% 2012 = -61.8% • Comparison of $1,000/month payable at age 65 using November 2007 3-segment rate structure

  16. Impact on Cash Balance Plans • New Cash Balance plans are not subject to 417e assumptions • Cash balance plan conversions must use an A + B approach to protect prior accruals • Most likely the prior accrued benefit will still be required to satisfy the 417e rules

  17. Can we use a Preretirement Mortality Decrement? • Good Question! • Courts have ruled that is “unfathomable” to discount using preretirement mortality if there is a full death benefit. • I have heard the IRS say verbally that you can (should?) discount 417(e) minimums using preretirement mortality. • You decide which poison to drink!

  18. What about Terminated plans? • If plan terminated in 2007 but is paying out lump sums in 2008, which 417e structure is used? • According to the PBGC, they want plans to use the old 417e structure • Termination date not distribution date governs the structure of the calculation of minimum values! • However, the rate is based on distribution date. • What about a 2008 termination paying out in 2009? • We’ll have to wait for guidance on the phase-in percentage to use.

  19. Section 436 Benefit Restrictions • If AFTAP is at least 80%: • No distribution restrictions • If AFTAP is at least 60% but less than 80%: • Prohibited payment is restricted to the lesser of 50% of Lump sum or 100% of PBGC guaranteed payment • If AFTAP is less than 60%: • No prohibited payments

  20. Prohibited Payments • This is a benefit payment whose value is: • In excess of the monthly amount of a straight-life-only annuity, • The amount of the payment to purchase an irrevocable commitment from an insurer, or • Anything else determined by IRS • Restrictions on benefit payments do not apply in first 5 years of plan.

  21. PBGC Maximum • PBGC has posted a table with the maximum present value at various ages at: • http://www.pbgc.gov/practitioners/miscellaneous-tables/pvmg.html

  22. 50% of Lump Sum • Example: • Suzie’s accrued benefit is $500 • Her 417e lump sum amount is $5,000 • Her restricted payment is $2,500 • Participant can only receive 1 such payment in consecutive plan years while restriction remains in effect

  23. Does this apply to All Plans? • Yes, even 1 participant plans • Yes, apparently even to terminated plans • Yes, to all sizes of benefits • Not to plans that were frozen prior to September 1, 2005

  24. Benefit Restrictions − Additional Rules • Presumption of applicability of restrictions • At fourth month if previous funded ratio is within 10 percentage points of a restriction • At tenth month for all other instances until next plan year’s AFTAP certification

  25. Lump Sum under 415 • Maximum Lump sum is lesser of: • Lump sum based on plan rates • Lump sum based on 5.5% rate • Lump sum based on 105% of 417e

  26. Example • Data: • Participant: Harry • Date of Birth: 8/17/1943 • Date of Distribution: 8/17/2008 • Straight Life Annuity: $180,000 per year • Normal Retirement Date: 8/17/2008 • Preretirement Death Ben: PVAB • Service and Participation: Greater than 10 years • 2008 Dollar Limit: $180,000 • Plan AE assumptions: 5.0% pre and post / 94 GAR

  27. Continued • APR based on 5.0% and 94 GAR: 12.252 • APR based on 5.5% and blended RP2000: 11.94629 • 417(e) applicable interest rate: 6.25% • Segment Rates: • First: 5.50% • Second: 6.00% • Third: 6.50% • Phased-in Segment Rates: • First: (1 x 5.50% + 4 x 6.25%)/5 = 6.10% • Second: (1 x 6.00% + 4 x 6.25%)/5 = 6.20% • Third: (1 x 6.50% + 4 x 6.25%)/5 = 6.30%

  28. Continued • Results: • Lump Sum based on Plan Rates: • $180,000 x 12.252 = $2,205,360 • Lump Sum based on 5.5% Rate: • $180,000 x 11.94629 = $2,150,332 • Lump Sum based on 417(e): • $180,000 x 11.3037 x 105% =$2,136,399 • §415 Maximum lump sum benefit for Harry is $2,136,399 • (I used annual APRs, but monthly would be required under the new regulations)

  29. Ah yes, the good ole days • Distribution election PACKAGES now must include: • 402(f) Special tax notice (6 pages) • Alternative benefit forms (3 pages) • Relative value disclosures (3 pages) • Joint & Survivor benefit notice and waiver (2 pages) • Withholding election form (4 pages) • Distribution election form (1 page) • And we must have the ACTUARY calculate the PVABs (hopefully he’ll have some good software for this!)

  30. Questions?

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