Defined Benefit Regulatory Update

Defined Benefit Regulatory Update Kyle N. Brown, Special Counsel, IRS Chief Counsel TE/GE Thomas J. Finnegan, MSPA, CPC, The Savitz Organization Judy Miller, MSPA, ASPPA/ACOPA Agenda IRS Reorganization Hybrid regulations Ann. 2015-3 Pre-approved DB plan delay Mortality update Temporary nondiscrimination testing relief for closed DB plans IRS upcoming guidance Cromnibus Other DOL FAB 2015-1 PBGC 401(k) rollover guidance PBGC risk transfer reporting 2 1

IRS Reorganization IRS Announcement 2014-34 Transfer of responsibility for preparing revenue rulings, revenue procedures, and certain other forms of published guidance, and issuing technical advice and certain letter rulings from TE/GE to the Office of Associate Chief Counsel (Tax Exempt and Government Entities). HYBRID REGULATIONS 4 2

New Hybrid Regs Market Rate of Return Plan Termination Lump Sum Based Formula Conversion Amendments Self Direction Proposed Regulations Permitted Interest Credit Rates - Overview Regulations continue closed list approach for returns not considered above market IRS does not want burden of determining whether other rates are above market IRS retains authority to provide additional acceptable rates, e.g. to Increase allowable margins, fixed rates or annual minimums Allow a reduced investment-based return with an annual minimum Certain minimum rates (either annual or cumulative) are acceptable 6 3

Permitted Interest Credit Rates - Overview Any rate that is never more than a specific acceptable rate is acceptable - The rate must by definition never be greater. - Not an annual test that is passed if the current year rate does not exceed an acceptable rate. Greater of rates not permitted except for fixed minimum rates described above Transition rules to conform impermissible rates to permissible rates by 2016 411(d)(6) protection required for existing balance when a change is made among permissible rates A pattern of changing rates will be treated as providing the greatest of the rates 7 Non-Investment Based Interest Credit Rates Any of the segment rates under IRC 430(h) (24-month average) or IRC 417(e)(3) (one month average) With or without reflecting MAP-21/HATFA, although selection is 411(d)(6) protected Safe Harbor Treasury Rates Unchanged from Notice 96-8 Treasury Constant Maturities 7 to 30 years Shorter term treasury rates with the margins provided in Notice 96-8 3 month Treasury bills plus 175 bp s 3+ to 12 month Treasury bills plus 150 bp s 1-year Treasury Constant Maturities plus 100 bp s 1+ to 3-year Treasury Constant Maturities plus 50 bp s 3+ to 7-year Treasury Constant Maturities plus 25 bp s 8 4

Non-Investment Based Interest Credit Rates IRS did not increase margins to be equivalent to 3 rd segment rate Can use the lesser of one of these rates with a higher than permitted margin and 3 rd segment rate CPI plus 300 basis points Fixed rates up to 6% (up from 5%) 9 Return on plan assets IC equal to actual rate of return on the plan's assets positive or negative Plan's assets must be properly diversified to minimize volatility of returns. IC must be return for the period for which the return is credited (not prior year) 5

Return on Portion of Plan Assets IC equal to actual rate of return (positive or negative) on a properly diversified sub-group of the plan's assets Same standards as for plan assets plus Fair value of assets must approximate, using reasonable assumptions, liabilities that are adjusted by reference to the assets Contributions to sub-account equal to TNC plus amortization of gains/losses over 7 years (ignore at-risk assumptions even if atrisk) If contributions not made (e.g., funding balance used), money transferred from remainder of plan to sub-account All assets are still available to pay all benefits Permits designs where active liabilities are variable and retired liabilities are not, and investment accordingly Annuity Contract IC rate is the return on an annuity contract purchased to cover the employee s benefit Must not be structured to provide an above market return 6

RIC Plan credits the rate of return from a registered investment company (e.g. a mutual fund) Reasonably expected not to be more volatile than broad U.S./international equities. Not concentrated in a single non-u.s. country Not concentrated by industry Not leveraged No significant use of derivatives Examples include: S&P 500 index funds Broad based small cap indices (e.g., Russell 2000) Broad based international funds Minimum Interest Credit Rates Permitted annual minimum rates With segment rates: 4% (unchanged) With Notice 96-8 rates (including CPI + 300%) : 5% (up from 4%) With investment based rates : None permitted 14 7

Minimum Interest Credit Rates Permitted cumulative minimums 0% required by statute preservation of capital rule Up to 3% allowed for any interest crediting basis (including investment based) Prospectively applied from date added to plan only for pay credits thereafter Requires separate tracking of pre-existing balance Applies only at annuity starting date (ASD) when full benefit is distributed Probably means ignored for 411(b), 401(a)(4) and 415 Somewhat unclear rules to take account of prior distributions Option to only look at pay credits post rehire if there is a full cashout followed by a 5-year break in service before rehire Can be applied to only part of a benefit 15 Stability Periods and Look-backs Same allowable stability periods and look-backs as 417(e) Stability periods of plan or calendar year or quarter, month Look-back to 1st to 5th month preceding the first day of the stability period Can change stability period or look back months Apply one year hold harmless approach from 417(e) (new in final regs) Protection is from the earlier of the effective date and the adoption date of the amendment to one year after the adoption date May be treated as exceeding market rate if changed repeatedly. 16 8

Issues for Plans Using Investment Based Rates No annual minimum interest credit rate is allowed IRS requires that current interest crediting rate be used for annual accrual rule testing (133 1/3% rule) 1.411(b)-1(b)(2)(ii)(D) requires that relevant factors be assumed to remain constant. While not completely clear, this appears to require an assumption of: Rate as of the first day of the plan year for noninvestment based rates Return for the prior plan year for investment based rates Can use 0% if prior year return was negative 17 Issues for Plans Using Investment Based Rates On ERIC call and recent Intersector meeting, IRS and Treasury folks noted that they have not yet made decisions on whether the accrued benefit for other purposes must be the same as for accrual rule testing, and they are working those issues. Leaves open potential for other methods of projecting cash balance account for purposes other than 411(b) They did not mention what other purposes likely Applying IRC 415 limits Nondiscrimination testing 401(a)(26) Currently IRS podium position has been same as 411(b) projection, without the 0% floor 18 9

Plan Termination Plan Termination: Statute Interest = 5-year average of interest crediting rates Plan Termination: 2010 Regs If crediting return on assets or mutual funds, Interest = 5-year average of 3 rd segment rates Plan Termination: 2014 Regs If crediting return on assets or mutual funds, Interest = 5-year average of 2 nd segment rates 19 Plan Termination In determining 5-year average: Determination of whether any rate used in average is a market rate is based on time rate applied and not year of termination Minimums, maximums, etc. recognized But not cumulative minimums Per PBGC guidance, if final year is a short year, ignore final year rate in average Still use final year rate for crediting to termination date 20 10

Plan Termination Example: plan used lesser of 30-year rate for preceding October or 4% for interest crediting October 2013 3.68% October 2012 2.90% October 2011 3.13% October 2010 3.87% October 2009 4.00% (actual 4.19%) October 2008 4.00% (actual 4.17%) 21 Plan Termination Plan terminates April 1, 2014 Interest used post termination would be 3.58% (average 2.90, 3.13, 3.87, 4.00, 4.00) Oct 2013 rate ignored in average since 2014 is not a full plan year (But used in interest crediting up to termination date) 22 11

Lump Sum Based Formulas The regs make it clear that in order to understand the rules affecting a hybrid plan, you must first determine if it contains a lump-sum based benefit formula. Lump sum based benefit formula must Define the accumulated benefit as the balance of a hypothetical account or as a PEP benefit Provide that the immediate benefit payable is at least the actuarial equivalent on a reasonable actuarial basis of the account balance If it provides a single sum benefit, it must equal the account balance 23 Lump Sum Based Formulas If a plan has a lump sum based formula Exempt from whipsaw Eligible for age discrimination safe harbor Plans that are statutory hybrid plans and not lump sum based Are subject to whipsaw Not eligible for age discrimination safe harbor But still subject to 3 year vesting Are subject to the market rate rules Are subject to the conversion protection rules 24 12

Conversion Amendments 2010 regs provided three methods to convert a traditional DB plan to a CB plan Pure A+B Maintain traditional DB accrued benefit plus create a new cash balance account Set and Check Convert the existing DB balance to an opening CB balance At ASD check to ensure no less than under A+B Set and Forget Complicated rules around establishing balance Only applied to non annuity benefits Set and check still needed for annuities Final regs eliminated Set and Forget 25 Self-directed Investment Statutory hybrid plans with participant directed investment returns still not addressed Preamble Because of the significant concerns relating to the use of statutory hybrid plan designs that would permit participants to choose among a menu of investment options specified in the plan document, the Treasury Department and the IRS continue to study these issues. It is possible that the Treasury Department and the IRS will conclude that such plan designs are not permitted. In that event, it is anticipated that any statutory hybrid plans that permitted participant choice among a menu of investment options on September 18, 2014 pursuant to plan provisions that were adopted by September 18, 2014 would receive anti-cutback relief that would permit any such plans to be amended to provide for one or more appropriate alternative replacement interest crediting measures. 26 13

Self-directed Investment Pros: - Would increase popularity of CB plans vs. DC plans - Provide life income marketplace for DC-type accumulations - Reasonable alternative to terminating/freezing existing DBs - Generally well funded would support PBGC 27 Cons Self-directed Investment Essentially a DC plan, with no requirement it be fully funded Is there a public policy basis for underfunded DC plans? Nothing like 404(c) protection for participants Since the CB plan is not required to INVEST in accordance with instructions Investment menu is a settlor function; > Employer actually better off if menu is terrible Fiduciary and 401(a)(26) issues if plan does invest according to instructions 28 14

Proposed Hybrid Regs 29 Reducing Above Market IC Rates Can change before the first day of 2016 plan year with 411(d)(6) relief Path to change is now clear for most plans Although reg is still proposed so most plan sponsors will wait 411(d)(6) relief for complying with Final regs only If you comply and eventual reg is less restrictive; qualification issue - Applies to interest crediting periods that begin on or after later of adoption and effective dates Note that preamble says on or after ; reg says after 204(h) notice will be needed 45 days in advance of effective date Frozen plans must also comply 30 15

Reducing Above Market IC Rates Proposed reg does not grant ability to change to any maximum permitted rate Notice 96-8 rates with maximum spreads are not equivalent to 3 rd segment rates, so this would be a greater cutback than needed General principle for changes Individually fix nonconforming aspects of a rate, e.g. Change impermissible look-back month to a permissible one Change impermissible timing of interest credits to permissible timing 31 Reducing Above Market IC Rates Single rate plans can change rate as follows: Reduce fixed rate to 6% Reduce margin above an acceptable 96-8 rate to permitted level Eliminate margins used with segment rates For a non-permitted rate that is not investment based If a permitted alternative exists that has similar duration/credit quality characteristics, change to that permitted rate No guidance as to how to make this determination Example indicates a long term investment grade index would change to 3 rd segment rate Otherwise, change to lesser of plan rate and 3 rd segment rate Have discretion as to what 3 rd segment rate means Example indicates an index of short term non-investment grade bonds would be capped at 3 rd segment rate 32 16

Reducing Above Market IC Rates For an investment based rate that is not properly diversified (or otherwise noncompliant) If possible use RIC or plan assets (or subset) with similar risk/return characteristics If not possible (i.e., plan basis was too volatile) change to RIC or plan assets (or subset) that is similar other than being less volatile 33 Reducing Above Market IC Rates Composite rate plans Greater of permissible bond rate and fixed minimum rate larger than minimum allowed Reduce the fixed minimum to 5%/4% as required, or Eliminate the bond rate and make it a fixed 6%. Greater of 2 individually permissible bond rates Keep both, and cap result at the 3 rd segment rate Lesser of rates where each rate is impermissible Not described directly, but appears to require cap at 3 rd segment rate 34 17

Reducing Above Market IC Rates Composite rate plans Investment-based rate with impermissible annual fixed or variable minimum No guidance yet IRS requested comments on what should be required In many cases currently, these plans have a reduction to the investment based return, or a cap, to account for the minimum IRS also requested comments on whether they have missed any types of noncompliant interest crediting rates that need to be addressed 35 411(d)(6) and Interest Credits From PPA until last day of 2009 Plan Year 411(d)(6) relief under Section 1107 of PPA for changes in accordance with a reasonable interpretation of the statute 2010 to 2014 411(d)(6) relief only granted if amendment complies with FINAL regulations,no reliance on proposed regulations 2014 to 2015 411(d)(6) relief granted if amendment complies with FINAL regulations,no reliance on proposed regulations Unless needed change is covered by final regs, should wait until the recent proposed regs are finalized 36 18

411(d)(6) and Interest Credits Example ABC Company Cash Balance Plan Established 2004 with a 6% interest credit rate In 2009 changed IC rate to 5.5% Done under PPA 1107 has 411(d)(6) relief In 2010, IC rate changed to 5% to comply with 2010 proposed regs Since not done before 1107 period ended, no 411(d)(6) relief unless the change was only to the extent the change was necessary to comply with the final regulations 37 411(d)(6) and Interest Credits Example In 2014, Final regs issued The 2010 amendment was not needed to comply with final regulations No 411(d)(6) relief must correct»retroactively reinstate the 5.5% rate for entire balance or at least the balance prior to the amendment Similar qualifications issues can arise if amendment fixing a nonconforming rate is adopted before the 2014 proposed regs are finalized No reliance on 2014 proposed regs 38 19

Hearing on Proposed Reg January 9, 2015 hearing Speakers requested more flexibility Prognosis? OTHER IRS GUIDANCE 40 20

Announcement 2015-1 Automatic approval of change in funding method for takeover plans Expansion of Ann. 2010-3 Must meet all of the following criteria 1) Change in both EA and firm with differences in applying the funding method (software, eg) 2) FT and TNC within 5% of amounts in prior year SB or actuarial report 3) Actuarial value of assets within 5% of amounts in prior year SB or actuarial report 4) Substantially the same funding method, consistent with description of method from prior SB or report Option to compare 2 through 4 based on current plan year, provided the prior EA has issued a report, or prepared a signed SB (whether or not filed) with those amounts. Pre-Approved DB Plan Delay Announcement 2014-41 extended deadline to submit on-cycle pre-approved DB plan to June 30, 2015 Last extension was to February 2, 2015 Also provides a two day extension (from Saturday, January 31, 2015, to Monday, February 2, 2015) for Cycle D on-cycle submissions (primarily individually designed plans). Intended to allow time to expand program to include cash balance plans Tools to be available before June 30 to help draft CB plans Extension applies to all pre-approved DB plans not just those with cash balance features 21

UPDATED MORTALITY TABLE 43 SOA 2014 Pension Plan Mortality Study Life expectancies at age 65 have increased more than 10% since last study in 2000 Purpose of SOA study was to develop a table for IRS to use as an update to the current basis mandated for ERISA funding and valuing lump sum payments Adoption no earlier than 2016 for funding and lump sum calculations Accountants (at least the big 4) are insisting you use the new table for year end disclosures or justify why not. New mortality assumption could increase plan liabilities 5% - 10% Life expectancy at age 65, U.S. population Source: Health, United States, 2012: (Table 18); National Center for Health Statistics Current law basis (2014): Male 19.3 years Female 21.1 years New Basis Male 21.6 years Female 23.8 years 44 22

SOA 2014 Pension Plan Mortality Study More heavily retired/ beneficiaries than RP 2000 More heavily blue collar Dropped a large amount of data submitted for the study 120 private plans submitted 38 used 3 large public plans submitted 0 used 59.9 million life-years submitted 9.5 million used Some concerns about reasons records were dropped, and effect on results 45 SOA 2014 Pension Plan Mortality Study Tables provided Separate pre- / post-retirement Separate blue collar / white collar Separate tables by amount (salary/ benefits) Disabled (but not select-and-ultimate) Projection scale MP-2014, 2 (3?) -dimensional (gender, age, calendar year) 46 23

IRS Mortality Current tables issued in 2007 and 2008 regulations Code includes a mandate to update tables at least every 10 years 2017 or 2018? Static mortality tables published for use through 2015 47 IRS Mortality Far too early to predict what tables will be issued by IRS Comments requested Any other mortality studies? Separate mortality table warranted for pre-1995 disabled participants? Simplified tables still needed? Combined vs. annuitant / nonannuitant? Static vs. fully generational? Can software accommodate 2-dimensional projection scales? 48 24

NON-DISCRIMINATION RELIEF FOR CLOSED PLANS 49 Nondiscrimination testing for closed DB plans Closed DB plans = DB plans closed to some participants, with ongoing accruals for others Over time, participants of closed plan tend to become more concentrated in HCEs Concerns that closed plans are failing gateway test Employers unable / unwilling to make minimum 7.5% DC contributions plus matching contributions Tendency to freeze DB plan altogether without relief Requested permanent relief from gateway test if met conditions when plan closed 50 25

Nondiscrimination testing for closed DB plans IRS sympathetic, but concerns: Avoid creating incentive to close plans to gain relief Relief could be used to design plans the IRS would consider discriminatory Potential for unintended consequences if isolated changes made to nondiscrimination testing rules 51 Nondiscrimination testing for closed DB plans IRS Notice 2014-5 offers limited relief through 2015 provided: Amendment to close plan was adopted before notice issued Nondiscrimination requirements met for year beginning in 2013 without using minimum allocation gateway Meet primarily DB or broadly available separate plans gateway DB plan passes coverage and nondiscrimination without aggregating with DC plan 52 26

Nondiscrimination testing for closed DB plans Feedback indicates relatively few plans are helped by the current relief IRS requested comments on other alternatives for future relief, including: Use of average DC allocations rather than requiring minimum for each NHCE Counting average NHCE match toward gateway No gateway if pass general test using lower interest corridor 53 Nondiscrimination testing for closed DB plans IRS requested comments regarding possible relief: Benefits, rights or features testing for ongoing accruals 401(a)(26) minimum participation rules 54 27

IRS UPCOMING GUIDANCE 55 2014 CROmnibus More regs on IRS to-do list Pension provisions added by amendment in the House (Division O): Multiemployer reforms House Ed and Workforce chair and ranking members (Kline and Miller) 4062(e) modifications S 2511 (Harkin-Alexander) NRA of earlier of specified age and 30 years of service ok if plan already so provides and age otherwise acceptable for participants hired by 1/1/2017 only Boy Scouts covered by the CSEC rules 28

CROmnibus Multiemployer Reform Signature provision - Plans in critical and declining status can apply to suspend a portion of the accrued benefits. Plans that have taken all reasonable measures to avoid insolvency, but are still projected to become insolvent in the current or next 14 years (19 years if #inactive/# active >2 ) Plan sponsor must show that with the benefit suspension it is projected to avoid insolvency and preserve benefits above 110% of the PBGC maximum guarantee level that applies to insolvent multiemployer plans (currently $12,870 per year). No reduction for those age 80+ on the suspension date. Suspension ratably phased out for those who are between age 75 and age 80. No suspension of disability benefits permitted Multiemployer Benefit Suspension Reduction must be equitable distributed. Special priority of allocation of suspended benefits applies where an employer has withdrawn, paid wdl liability and promised to make whole Suspension must be approved by Secretary of the Treasury in consultation with DOL and PBGC Participants must be given an opportunity to vote on the suspension before it is effective. Negative vote ignored if present value of projected required PBGC assistance in excess of $1 billion ( systemically important plan). If benefit improvements to actives during suspension, must provide equitable improvements for those in pay status. Equitable means pv for actives not > for those in pay status Plan must still be projected to avoid insolvency indefinitely after the improvements Treasury to provide guidance within 180 days 29

More Upcoming IRS Guidance Already discussed hybrid transition rules, cash balance volume submitter, mortality tables, nondiscrimination in closed plans. What else? Finalizing proposed regulations - 430 Mechanics of constructing MRC Quarterly contributions Excise taxes - 417(e)(3) Finalize bifurcation rules Propose rules, miscellaneous 417(e)(3) issues More auto-approvals for change in funding method - 404(o) - Other? DOL FAB 2015-1 60 30

DOL FAB 2015-1 AFN requirements following HATFA With HATFA s 5-year extension of corridor, temporary reporting requirements for plans with >50 participants and >$500,000 underfunding also extended 5 years. No corrected notice required for 2013 if HATFA rates used for funding. If 2013 Notice not issued by February 13, 2015 (30 says after FAB publication), AFN must use funding assumptions. FAB 2013-01 should be read as MAP-21 rates as amended by HATFA Q7 reverses Q 14 of FAB 2013-01. No longer required to state the value of plan assets determined without regard to adjusted interest rates or include an accompanying explanation PBGC GUIDANCE 62 31

DC Rollovers to DB Plans IRS previously issued rules (in 2012) allowing qualified defined benefit plans to accept rollovers from qualified defined contribution plan Lump sum converted to annuity using plan s 417(e) factors May use alternate basis if more favorable to participant Excess over 417(e) conversion treated as accrual subject to 415 PBGC has issued final regulations addressing treatment in the case of plan termination Treated as a benefit derived from mandatory employee contributions if use mandated lump sum factors Not subject to maximum benefit guarantee limit or 5-year phasein limitation Additional amounts from alternate conversion basis afforded lesser protection, and subject to maximum guarantee amount and 5-year phase-in PBGC Risk Transfer Reporting 2015 premium filing to require after-the-fact reporting of risk transfers through lump sum windows and annuity purchases Data not otherwise available, affects premiums, and will be used to project finances Report # eligible to elect Do not report annuity purchase if annuity is held as plan asset Limited duration lump sum windows are the target, not permanent lump sum provisions Recurring lump sum windows still reportable No reporting for early retirement windows 60 day lag between event and premium filing (was 30 in initial proposal Comments due February 11, 2015 32

PBGC Electronic Filings 2015 premium filing changes include requirement that paper copy be signed before the filing is submitted. Currently can file and then sign Commenters indicated this created inefficiency, but PBGC compared this to the 5500 filing process and concluded this would still be less burdensome 33