415 and 436 Restriction Basics

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1 415 and 436 Restriction Basics Daniel Liss, EA, CEO, Economic Growth Pension Services, Inc. Daniel Liss, EA, CEO, Economic Growth Pension Services, Inc. Daniel began working at EGPS in 2003, where he spent several years learning the pension administration business from the many highly qualified pension specialists and actuaries. He qualified as an enrolled actuary in He has been a member of the Society of Pension Actuaries since He became C.E.O. in November He loves leading the team of experienced actuaries, administrators and salespeople, and constantly developing and improving the client service experience. He lectures regularly on pension topics such as wealth accumulation in pension and 401(k) plans, overfunded plans, and defined benefit/cash balance issues, and is qualified to give CPE credits to CPAs. 1

2 415 and 436 Restrictions The Basics Issues affecting small plan administration 415 Issues IRC section 415 limits the benefits payable from a defined benefit plan By contrast, there are no preset limits on contributions going into a plan Some practitioners think 415 does not limit the benefits accrued under the plan, as long as the final payouts are within limits The 2007 Regulations seem to contradict this position 412(e)(3) plans may be an exception, since they have no accrued benefit 2

3 415 Issues There are two separate limits for 415 the compensation limit and the dollar limit The compensation limit is 100% of the highest 3 consecutive salaries Salaries can be before the plan went into effect there used to be some controversy on this, but it is now codified into law 415 Issues Compensation limit is reduced if the participant has less than 10 years of service But it is not reduced for early commencement of benefits Compensation is now limited to the 401(a)(17) limits currently $265,000 3

4 415 Issues Plan must also obey the dollar limit The dollar limit is currently $210,000, but goes up with the cost of living IRS Regulations: you may not anticipate an increase in the dollar limit Payable as a life annuity no earlier than age Issues If benefit is payable before age 62, the dollar limit must be actuarially reduced If payable after age 65, the dollar limit is increased If payable in another form (like a lump sum) it must be actuarially converted back into a life annuity and tested against the annuity limit 4

5 415 Issues Plan can pay a spousal survivor annuity (as much as 100% J & S) This annuity can be ignored in 415 calculations Plan can also pay a $10,000 life annuity regardless of age, or compensation Cannot be converted into any other form Overfunded Plan Issues What happens if the 415 limit for the participants is less than the assets in the plan? You CANNOT pay anyone more than the 415 limit if you do, VCP is your friend main correction method is getting the money back! Secondary method is warning them very strongly to give the money back. Don t roll into your IRA not eligible to contribute excise taxes may apply 5

6 Overfunded Plan Issues So, what can you do? Increase benefits for other participants not a popular solution Add family members that are employed to the plan Drawback typically not enough to make a real difference Overfunded Plan Issues Maybe we need a new way of looking at overfunded plans Most people think The Thing To Do is roll the money into an IRA But DB plans are intended to pay lifelong annuities what if we did just that? 6

0% Asset value: $5,000,000 Max Lump Sum; $2,600,000 Scenario C Retirement Age: 62 COLA: 4.0% Inv. Return: 5.

7 Defined Benefit Analysis Scenario A Retirement Age: 62 COLA: 5.0% Inv. Return: 5.0% Asset value: $4,000,000 Max Lump Sum; $2,600,000 Scenario B Retirement Age: 62 COLA: 4.5% Inv. Return: 5.0% Asset value: $5,000,000 Max Lump Sum; $2,600,000 Scenario C Retirement Age: 62 COLA: 4.0% Inv. Return: 5.0% Asset value: $6,000,000 Max Lump Sum; $2,600,000 PPA added special requirements to insure that plans are well-funded Central to 436 is the AFTAP (Adjusted Funding Target Attainment Percentage) certification The AFTAP certification is provided annually by the plan s actuary to the plan administrator 7

8 Congress intended that this data arrive in real time; so, although the valuations and schedules SB typically were produced after the plan year ended, the AFTAP certification MUST be done during the plan year Central to the AFTAP certification is the funded percentage It s the ratio of assets to funding target, with certain adjustments (like annuity purchases) taken into account Depending upon the percentage, funding-based restrictions can take effect What does an AFTAP certification look like? Consider the following plan: Valuation date: 1/1/2016 Assets as of the valuation date: $1,200,000 Computed Funding Target as of 1/1/2016: $1,400,000 8

9 Prefunding balance (gets subtracted from the assets for the AFTAP): $25, contributions (not included in the $1.2mm above): $50,000 on 3/15/16 $100,000, on 9/15/16 Plan Effective Interest Rate for 2015: 4.5% No annuities were ever purchased The actuary certifies the AFTAP on May 1, 2016 Step 1: add to the year end assets the contributions actually made by the AFTAP date Discount back to valuation date at prior year s EIR: 9

10 $50,000 / 1.045^(4/12) = $49,271 So, AFTAP assets are $1,249,271 But, you must subtract out the prefunding balance, so the assets are really $1,224,271 So, the AFTAP % is 1,224,271 / 1,400,000, or (drumroll) 87.45% When the AFTAP percent is less than 80%: Plan amendments increasing benefits are restricted Full lump sums cannot be paid (basically, only half of the lump sum can be paid) 10

11 When the AFTAP % is less than 60%, additional restrictions take effect: All benefit accruals must cease Shutdown benefits and other special contingent benefits (not usually seen in small plans) are restricted No lump sums may be paid (life annuities or partial lump sums no more than a life annuity can be paid) Presumptions: if the AFTAP is not done by April 1 (for a calendar year plan), then the prior year s AFTAP is reduced by 10%, and that is the AFTAP until a new one is done 11

12 So if last year s AFTAP was 82%, then AFTAP automatically goes to 72%, and only partial lump sums may be paid When the new AFTAP is certified (if over 80%), the restrictions go away If the AFTAP is not certified by October 1 st, the presumed AFTAP drop to under 60%, and all the restrictions kick in The restrictions remain in place at least until the next plan year even if a new AFTAP is done 12

13 Range certifications: the actuary, if the AFTAP cannot be computed in time, may issue a range certification Ranges are a) less than 60%; b) 60%-80%; or c) more than 80% They only are effective until October 1 (for calendar year plans) Suppose last year s AFTAP was 85%. It s now Mar 29 th At April 1, the AFTAP, if not certified, automatically drops to 75% and restrictions kick in. In this case, the actuary happens to know (asset growth) that the AFTAP went up, but without census data he can t tell how much 13

14 The employer would like to pay out some employees A range certification will buy time and save the day. ERISA section 101(j) requires notice to employees when any restrictions take effect No notice necessary for one man (EZ filers) plans. But they have the same funding restrictions Notice due 30 days after effective date of restrictions Not clear what penalties apply for not giving notices 14

15 How to freeze a plan without a plan amendment or 204(h) notice: if the actuary sits on the AFTAP certification past October 1 st, accruals stop by law Note that depending upon how your document is drafted, when an AFTAP is certified, you may recoup old accruals or you may not The recoupment of old accruals is probably deemed a plan amendment, which means you have to back out the increases for HCE s from the cushion Plans frozen since 2005 are exempt from the fundingbased restrictions Plans in the first five years are exempt from three of the four restrictions (but not the one on lump sums) You cannot contribute for this year to get out of the lump sum restrictions 15

16 You may, however, be able to contribute money now as a receivable for last year, if done by the AFTAP certification date. This will increase the assets as of the val date and possibly avoid going below 60%/80%. Remember: only cash in the plan counts for the AFTAP. Money contributed later doesn t count. Does the decision to issue an AFTAP or not make the actuary a fiduciary? This is an open question 16

17 Other Restrictions Note that the early termination restrictions are still in effect Plan must satisfy both sets of restrictions These restrictions depend upon current liability, which no longer exists Other Restrictions TPAs have been substituting funding target for current liability, and using various methods to calculate it IRS has been tolerant of this process 17

DB Distributions - Addressing the Common Questions. Daniel Liss, EA, CEO, Economic Growth Pension Services, Inc.

DB Distributions - Addressing the Common Questions Daniel Liss, EA, CEO, Economic Growth Pension Services, Inc. 1 Daniel Liss, EA, CEO, Economic Growth Pension Services, Inc. Daniel began working at EGPS