workshop 25: db funding 101 - asppa > news · 2016-10-18 · •cash balance (cb) plan ......
TRANSCRIPT
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Workshop 25:DB Funding 101
Lauren R. Okum, ASA, EA, MAAA, MSPA
Premier Actuarial Solutions
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What is a DC Plan?
• Defined Contribution (DC) plan
• Plan Sponsor promises to make annual contributions to each participant’s account
• The contribution is defined; there is no guaranteed benefit
– E.g. 3% of compensation will be deposited to participant’s account each year
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What is a DB Plan?
• Defined Benefit (DB) plan
• Plan Sponsor promises to pay a specific benefit at retirement
• Benefit is determined according to the formula in the plan document
– E.g. 10% of average compensation times years of service (subject to a maximum of 10 years)
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What is a DB Plan?
• Benefit is an annuity payable at Normal Retirement Age (e.g. age 62 or age 65)
– Payable for the lifetime of the participant
– Optional forms (e.g. lump sum) available
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What is a CB Plan?
• Cash Balance (CB) plan
• A DB plan that looks like a DC plan (aka “hybrid” plan)
• Plan Sponsor promises to credit annual amounts and interest to each participant’s hypotheticalaccount– Compare against DC plan: Plan Sponsor promises to
make annual contributions to each participant’s account
– E.g. $100,000 credit plus 5% interest annually
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What is a CB Plan?
• Hypothetical account balance
– Paper account only
– Plan assets not actually divided into individual accounts
• Hypothetical account balance is credited with
– Contribution credits (aka pay credits); and
– Interest credits at rate defined in plan document
• Benefit is not based on actual asset returns
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What is a CB Plan?
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Beginning Interest Cash Balance Ending
Age Balance Credit Credit Balance
50 0 0 100,000 100,000
51 100,000 5,000 100,000 205,000
52 205,000 10,250 100,000 315,250
53 315,250 15,763 100,000 431,013
54 431,013 21,551 100,000 552,564
55 552,564 27,628 100,000 680,192
56 680,192 34,010 100,000 814,202
57 814,202 40,710 100,000 954,912
58 954,912 47,746 100,000 1,102,658
59 1,102,658 55,133 100,000 1,257,791
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What is a CB Plan?
• A cash balance plan is not a profit sharing plan
– Cash balance contributions are not discretionary
– Cash balance plans must be “permanent”
• Client must commit to 3-5 year of contributions, subject to change in business conditions
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Comparison of DB and DC Plans
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Defined Benefit (including Cash Balance) Defined Contribution
Stated benefit Stated contribution
Guaranteed benefit Account balance – subject to investment performance
Required employer contribution Flexible employer contribution (exceptwhen needed to pass testing)
Trustee directed investments May allow for participant investment direction
Must have annuity distribution options May allow for lump sum only distributions
Top heavy requirement: 2% accrual Top heavy requirement: 3% contribution
Maximum benefit at age 62: lesser of $210,000 and 100% of average comp paid as an annual life annuity
Maximum annual contribution: lesser of $53,000 (+ $6,000 catch-up if age 50+) and 100% of compensation
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Actuarial Valuation
• Because DB (and CB) plans promise a certain future benefit, an actuary needs to perform an actuarial valuation every year
• Through the valuation process, the actuary determines the financial position of the plan and calculates the contributions required to pay future benefits (subject to tax limitations)
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Actuarial Valuation
• Valuation reports (also referred to as “Actuarial Reports”) show the following:
– The minimum amount the plan sponsor must contribute for the year to assure adequate funding
– The maximum amount the plan sponsor can deduct on their income tax return
– The funded status of the plan
– Optional: The amount required to fully fund the plan if the plan terminated
– Optional: The actuary’s recommended contribution
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Actuarial Valuation
• IRC §430 sets forth minimum funding standards
• IRC §436 requires the calculation of a funded ratio to determine whether a plan is subject to certain restrictions
• IRC §404 describes the limitations on deductible contributions to a pension trust
• IRC §417(e) sets standards for determining the minimum lump sum that can be paid (among other things)
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Actuarial Valuation
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December 31, 2015
1. Contributions
a. Minimum required 289,263 b. Maximum deductible 514,301 c. To meet termination liability 319,600
2. Funding percentages
a. FTAP under §430, for determining whether plan is at-risk 103.34% b. AFTAP under §436, for determining whether benefit restrictions apply 101.90% c. Prior year, for determining whether credit balances may be applied 80.00%
3. Plan liabilities Funding Target Target Normal Cost
a. For determining minimum required contribution 227,119 296,853 b. For determining whether benefit restrictions apply 227,119 296,853 c. For determining maximum deductible contribution 269,247 345,131 d. For determining termination liability 554,309 Included in FT
4. Plan assets
a. Market value of assets 234,709 b. Actuarial value of assets 234,709 c. Carryover balance 0 d. Prefunding balance 0
5. Key assumptions
a. Segment rates for §430 (effective interest rate) 4.72% / 6.11% / 6.81% (5.89%) b. Segment rates for §436 4.72% / 6.11% / 6.81% c. Segment rates for §404 1.32% / 4.06% / 5.09% d. Segment rates for §417(e) 1.40% / 3.88% / 4.96% e. Mortality 2015 Optional Combined Funding Target Mortality
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Liabilities
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Inputs
TheBlackBox
Output
Present Value of Future
Benefits
Ultimate Cost
PlanProvisions
Census
ActuarialAssumptions
Liabilities
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PresentValue ofFuture
BenefitsPast
ServiceLiabilities
FutureService
Liabilities
Past Years
Current Year
Future Years
Funding Target
Target Normal Cost
ActuarialTerminology
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Liabilities
What It’s Called What It Is
Funding Target (FT) The present value of benefits accrued on the first day of the plan year, regardless of BOY or EOY valuation
Target Normal Cost (TNC) The present value of benefits earned (or expected to be earned) during the yearBenefit earned = EOY accrued benefit minus BOY accrued benefit
Present Value of Accrued Benefits (PVAB) The present value of benefits accrued on the valuation date
Present Value of Vested Benefits (PVVB) The present value of vested benefits accrued on the valuation date
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Note: All present values are determined as of the valuation date
Liabilities
• The exhibit below may prompt 2 questions:
– Why are the assumptions and liabilities different for different purposes?
– What are segment rates?
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1. Plan liabilities Funding Target Target Normal Cost a. For determining minimum required contribution 227,119 296,853 b. For determining whether benefit restrictions apply 227,119 296,853 c. For determining maximum deductible contribution 269,247 345,131 d. For determining termination liability 554,309 Included in FT
2. Key assumptions
a. Segment rates for §430 (effective interest rate) 4.72% / 6.11% / 6.81% (5.89%) b. Segment rates for §436 4.72% / 6.11% / 6.81% c. Segment rates for §404 1.32% / 4.06% / 5.09% d. Segment rates for §417(e) 1.40% / 3.88% / 4.96%
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Liabilities
• Pension Protection Act of 2006 (PPA) established a 3-segmented yield curve that actuaries must use to calculate present values (optional lookback periods and full yield curve permitted)– 1st rate is used to discount benefits payable within 5 years
– 2nd rate is used to discount benefits payable between 5 and 20 years
– 3rd rate is used to discount benefits payable more than 20 years from now
• Effective Interest Rate (EIR) is the single interest rate which, if used instead of the segment rates, would result in the same funding target
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Liabilities
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Code Section Segment Rates
§430(h)(2) – Minimum 24-month average corporate bond segment rates, as amended by MAP-21 and HATFA, with an adjustment for the 25-year average segment rates from the 25-year period ending September 30 of the year before the year in which the calendar year begins
§436 – AFTAP Same as §430, though EOY valuations may use different rates, per actuary’s interpretation • 12/31/2015 liabilities are used to determine 2016 AFTAP• Since 12/31/2015 liabilities, use 9/30/2014 rates? (My
preference)• Since 2016 AFTAP, use 9/30/2015 rates?
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Liabilities
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Code Section Segment Rates
§404(o) – Maximum 24-month average corporate bond segment rates without adjustment by the 25-year average segment rates
§417(e) – Lump Sums Corporate bond segment rates without regard to the 24-month averageAlso used for determining the PBGC variable rate premium, unless Alternative Premium Funding Target is elected
Liabilities
• Notice the discrepancy between §430/§436 and §404 (approximately 18.5%!)
– §430 Funding Target = $227,119
– §404 Funding Target = $269,247
– Note: Ignore §417(e) rates, since they generally do not apply in a cash balance plan (which this example is)
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1. Key assumptions a. Segment rates for §430 (effective interest rate) 4.72% / 6.11% / 6.81% (5.89%) b. Segment rates for §436 4.72% / 6.11% / 6.81% c. Segment rates for §404 1.32% / 4.06% / 5.09%
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Plan Assets
• Plan assets aren’t as straightforward as you might think!
• Easy part: Start with the fair market value in the trust as of the valuation date
• More difficult part: Adjust for contributions and/or credit balances
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Plan Assets
For Form 5500 Reporting
1. Fair market value of assets in trust 234,709
2. Receivable contributions 311,636
3. Market value of assets: 1. + 2. 546,345
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For BOY Funding Valuation and BOY/EOY AFTAP Certification
1. Fair market value of assets in trust 234,709
2. Discounted receivable contributions Contribution made on 9/15/2016EIR = 5.89%311,636 ÷ (1.0589)^(259/366) = 299,267
3. Market value of assets: 1. + 2. 553,976
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Plan Assets
For EOY Funding Valuation
1. Fair market value of assets in trust 234,709
2. Current year contributions including in 1. 0
3. Interest on 2. 0
4. Market value of assets: 1. – 2. – 3. 234,709
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Plan Assets
• PPA permits plans to use up to a 24-month average, subject to a corridor
• See §1.430(g)-1(c)(2) and IRS Notice 2009-22
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Credit Balances
• Credit balances may be established when actual contributions exceed the minimum required contribution
• 2 components of credit balances
– Carryover balance (COB): Credit balance as of the last day of the 2007 plan year
– Prefunding balance (PFB): Credit balance created since 2008
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Credit Balances
• Plan sponsor must make certain elections regarding credit balances– Increase the prefunding balance by excess
contributions for the preceding year
– Use the credit balance to reduce the minimum required contribution (only allowed if plan was at least 80% funded in preceding year)
– Voluntarily reduce the credit balances
• COB must be used before PFB
• Standing elections may be used
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Credit Balances
Funding ElectionBy End of Plan
YearBy MRC
DeadlineBefore Signing
Schedule SB
Add prior year excess contribution to PFB X X
Use COB/PFB to meet MRC X
Revoke use of COB/PFB to meet MRC BOY vals EOY vals
Voluntary reductions X
Standing electionsNew election required by due date of 5500 if actuary changes
X X
Revoke standing elections X X
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Credit Balances
• Credit balances can provide cash flow flexibility for well-funded plans, but they can also increase cash requirements for under funded plans
• The law will not allow you to treat credit balances as both plan assets and future contributions
• Credit balances are a pain and should only be maintained in situations where the actuary feels it is necessary
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Applicable Assets
For FTAP, funding shortfall amortization, and determining if quarterlies are required next year
1. Assets used for funding (MVA/AVA) 234,709
2. Carryover balance 0
3. Prefunding balance 0
4. Applicable assets: 1. – 2. – 3. 234,709
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Applicable Assets
For funding shortfall exemption
1. Assets used for funding (MVA/AVA) 234,709
2. Prefunding balance used to offset MRC 0
3. Applicable assets: 1. – 2. 234,709
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For next year’s credit balance use test
1. Assets used for funding (MVA/AVA) 234,709
2. Prefunding balance 0
3. Applicable assets: 1. – 2. 234,709
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Minimum Required Contribution
• In general, the MRC will be:– Adjusted Target Normal Cost; plus
– Shortfall amortization installment
• The MRC is determined as of the valuation date. If actual payment is made on another date (usually is), then there’s an interest adjustment
• If a plan is ≥ 80% funded in preceding year, COB/PFB may be applied
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Minimum Required Contribution
What It’s Called What It Is
Adjusted Target Normal Cost Target Normal Cost, plusExpected plan expenses, minusFunding surplus (Applicable Assets – FT),Not less than $0
Shortfall Funding Target, minusApplicable Assets,Not less than $0
Shortfall Amortization Installment 7-year amortization of the shortfall using the segment rates in effect the year the base was established
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Minimum Required Contribution
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December 31, 2015
1. Minimum required contribution before application of credit balance
a. Target normal cost 296,853 b. Offset for overfunded status
i. Applicable assets 234,709 ii. Funding target 227,119 iii. Offset: i. – ii., not less than zero 7,590
c. Reduced target normal cost 289,263 d. Shortfall amortization installment 0 e. Waiver amortization charge 0 f. Preliminary minimum required contribution: d. – e., not less than zero 289,263
2. Application of credit balances
a. Carryover balance 0 b. Prefunding balance 0 c. Total 0
3. Minimum required contribution*: 1. – 2. 289,263
* The minimum required contribution is developed as if payment was made in full on December 31, 2015. If payment is actually made after that date, then an interest adjustment will be required. As of September 15, 2016, this amount is $301,219.
Maximum Deductible Contribution
• In general, the Maximum will be the greater of the following over plan assets:
– Funding Target + Target Normal Cost + Cushion Amount
– Funding Target as if At-Risk + Target Normal Cost as if At-Risk
• Unlike the MRC, there is no interest adjustment
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Maximum Deductible Contribution
What It’s Called What It Is
Cushion Amount 50% of the Funding Target + increase in Funding Target due to salary increases
Excludes any increases in benefits for HCEs in the preceding 2 years, if the increases were made by plan amendment
At-Risk Funding Target and Target Normal Cost
FT and TNC calculated assuming that each participant who is eligible to elect benefits within the next 10 years will:• Retire at their earliest retirement date
(but not before EOY); and • Elect the form of payment with the
highest value
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Maximum Deductible Contribution
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Tax Year Ending December 31, 2015
1. Funding target plus target normal cost plus cushion
a. Funding target 269,247 b. Target normal cost 345,131 c. Cushion
i. 50% of the funding target 134,632 ii. Increase in funding target due to salary increases 0 iii. Total 134,624
d. Total 749,010
2. Liabilities using at-risk assumptions a. Funding target 269,247 b. Target normal cost 345,131 c. Total 614,378
3. Greater of 1. and 2. 749,010
4. Assets 234,709 5. Maximum deductible contribution: 3. – 4. 514,301
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Maximum Deductible Contribution
• It’s not always wise to quote the true Maximum, unless you caveat the heck out of it
• It could lead to the plan being way too overfunded
– If the plan terminates and the owner is already at the maximum lump sum payable, you cannot increase benefits for him or her
– Excess assets upon plan termination that revert to the employer are subject to a 50% excise tax!
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Maximum Deductible Contribution
• Generally, the goal is to limit the assets to the benefit liabilities on a plan termination basis
• A little overfunding might be right for a particular plan
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Amount to Fully Fund Plan
• In general, plans must be fully funded in order to terminate (i.e. assets must be ≥ liabilities calculated on a termination basis)
• When plans terminate, participants must be offered an annuity and may be offered a lump sum
• Purchasing annuities is often more expensive than providing lump sums
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Amount to Fully Fund Plan
• Regardless, we (small plan actuaries) calculate the termination liability assuming all participants elect lump sums
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December 31, 2015
1. Termination liability 554,309
2. Assets 234,709 3. Contribution to meet termination liability: 1. – 2., not less than zero 319,600
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Recap of Contributions
• My report shows all three contribution calculations– Minimum required contribution $289,263
– Maximum deductible contribution $514,301
– Contribution to meet termination liability $319,600
• When the goal of the plan sponsor is to maximize the contribution, I usually recommend contributing the amount to meet termination liability, but not greater than the maximum deductible contribution ($319,600)
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AFTAP
• AFTAP = Adjusted Funding Target Attainment Percentage
• The AFTAP is the funded status of the plan
• The AFTAP determines whether the plan is subject to restrictions on plan amendments, benefit accruals, and lump sum distributions
• If restrictions apply, participants must be notified
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AFTAP
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December 31, 2015
AFTAP for the 2016 Plan Year
1. Funding target plus target normal cost 523,972
2. Valuation assets a. Market value of assets 234,709 b. Discounted contributions for plan year ending December 31, 2011 299,267 c. Carryover balance 0 d. Prefunding balance 0
3. Funding Target Attainment Percentage: (2a. + 2b.) 1. 101.90% 4. Adjustment for annuity purchases for Non-Highly Compensated Employees 0
5. Adjusted Funding Target Attainment Percentage: If item 3. is greater than 100%,
the AFTAP equals the FTAP in 3. Otherwise, (2a. + 2b. – 2c. – 2d. + 4.) (1. + 4.) 101.90%
AFTAP
• The actuary must certify the AFTAP every year
• The certification must be provided to the plan sponsor (email is OK)
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AFTAP
Key Date Action
End of the 3rd month of the plan year (March 31 for a calendar year plan)
If AFTAP hasn’t been certified, it is presumed to be:• Prior year’s AFTAP – 10%, if prior year’s
AFTAP was 60%-70% or 80%-90%• Prior year’s AFTAP otherwiseAs of the first day of the 4th month (April 1 for a calendar year plan)
End of the 9th month of the plan year (September 30 for a calendar year plan)
Actuary must certify AFTAP or provide a “range certification”If AFTAP hasn’t been certified, it is presumed to be less than 60% as of the first day of the 10th month (October 1 for a calendar year plan)
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AFTAP
Key Date Action
End of the plan year If actuary provided a “range certification” and doesn’t issue an actual certification, the AFTAP is presumed to be 60% as of the first day of the 10th month (October 1 for a calendar year plan)
Within 30 days after restrictions apply Plan administrator must notify participants of restrictions
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AFTAP
• Benefit restrictions depend on the AFTAP
– If AFTAP ≥ 80%: No restrictions
– If 60% ≤ AFTAP < 80%:
• Cannot pay accelerated benefits (e.g. lump sums) in excess of the lesser of1: – 50% of the otherwise payable lump sum; or
– PV of the PBGC maximum benefit
• Cannot adopt a plan amendment to increase benefits, unless plan sponsor makes an additional contribution2
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AFTAP
– If AFTAP < 60%:
• Cannot pay any accelerated benefits (e.g. lump sums)1
• Cannot provide additional accruals to participants (i.e. automatic plan freeze)2
• Cannot adopt a plan amendment to increase benefits, unless plan sponsor makes an additional contribution2
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1 Does not apply to plans frozen on or before September 1, 20052 Does not apply to the first 5 years of new plans
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Questions?
• Thank you!
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