Workshop 17: 436 Restrictions James E. Holland, Jr. Lawrence Deutsch 436 Restrictions We should all know by now that under IRC 436, if the AFTAP is less than 80% certain restrictions apply to a plan, and if less than 60% additional restrictions apply The focus of this session is managing the restrictions, not determining the restrictions or applying the restrictions 1
436 Restrictions This session will highlight Issues surrounding restrictions on plan amendments Using the rules regarding restrictions on plan amendments to help control when benefits may or may not be restricted for other purposes Quick Overview To understand these questions, a review of the types of restrictions is necessary Payment of unpredictable contingent event benefits are restricted if the AFTAP is below 60% increasing benefits are restricted if the AFTAP is below 80% Accelerated benefit distributions are restricted if the AFTAP is below 80% Accruals are restricted if the AFTAP is below 60% Unpredictable Contingent Benefit These restrictions will be ignored for purposes of this outline, as they apply to only a very small percentage of plans 2
Under 436(c), an amendment which increases liabilities under the plan may not take effect if either: The AFTAP is below 80% or The AFTAP would be below 80% if the amendment were taken into account If the restrictions would apply, there are three basic ways to avoid the restriction Make a 436 contribution (i.e. a contribution to allow the amendment which is not treated as used to meet minimum funding) to bring the AFTAP (reflecting the amendment) up to 80% Make a 436 contribution equal to the full increase in liability Have no increase in liability Important note Depending on circumstances the full amounts in choice 1 and choice 2 will not be considered a 436 contribution 3
To illustrate the following examples, consider the following plan: Benefit is 2% of final average pay per year of service Funding Target is $1,000,000 Assets are $900,000 No Prefunding Balance All participants are currently employed The subject amendment would increase the formula from 2% to 3% This would be a 50% increase in all benefits, so Funding Target would increase from $1,000,000 to $1,500,000 This would make the AFTAP $900,000 / $1,500,000 or 60% reflecting the plan amendment (down from 90%) Because 60% is less than 80%, the amendment is restricted 4
Choice 1 would be to make a 436 contribution In order for the AFTAP to be 80%, the assets would need to be equal to 80% of $1,500,000 80% * $1,500,000 = $1,200,000 $1,200,000 assets of $900,000 = $300,000 Therefore a 436 contribution of $300,000 would allow the amendment to take effect Choice 2 would be to make a 436 contribution equal to the increase The increase in the Funding Target is the increase for $1,000,000 to $1,500,000 or $500,000, therefore a contribution of $500,000 could be made, allowing the amendment to go into effect Note this works without regard to asset level, but is not required in this situation Choice 3 is have no increase in the Funding Target If the plan amendment is structured such that the full increase in accrued benefit occurs during the plan year rather than effective at the beginning of the plan year, then the increase is not part of the accrued benefit at the beginning of the year 5
Assuming that the plan amendment is adopted after the valuation date, it seemingly could be ignored in the funding for the plan year, which would allow the amendment to go into effect, and sidestep the 436 restrictions The regulations prevent this from happening, by requiring that if An amendment takes effect during the plan year The amendment increases liabilities (i.e. increases benefits at some point) If the Target Normal Cost attributable to the plan amendment were included in the Funding Target, then the amendment would have been restricted Then the amendment must be reflected in funding for the year All this raises several questions (which lead to potential management opportunities) What is an amendment? How is the AFTAP determined (and by whom) including the amendment? What happens if the amendment does not go into effect? What if there are multiple amendments? How is the AFTAP increased? 6
Motivation So consider an employer who either wants to increase an AFTAP (for example to enable unrestricted lump sum payments) or lower the AFTAP (to restrict lump sum payments) Managing the AFTAP through a plan amendment can reduce the AFTAP and allow applying the restrictions for other reasons What is an amendment On the surface, this seems like a silly question, but consider the following. Is the increase in the 415 limit an amendment? Is the increase in the 401(a)(17) limit? Is an amendment adopted in 2015, but only with an automatic increase in 2016 and 2017 an amendment? Is an increase in a pay credit for the owner from $50,000 to $60,000 an amendment? Is an increase in the 415 limit an amendment? This issue is not addressed head on in the regulations, but in the Grey Book the IRS has indicated (presumably based upon the logic of 404(j)) that an increase in the 415 limit is generically a plan amendment. When benefits are below the dollar limit, this may be moot. This raises the interesting problem of what happens if the 415 limit increase is restricted (discussed later). 7
Is the increase in the 401(a)(17) limit a plan amendment? Like the increase in the 415 limit, the regulation does not address this issue directly, but the IRS has indicated that it is a plan amendment. But, because the change in the 401(a)(17) limit cannot change the Funding Target (because it does not change the average compensation at the beginning of the plan year) the amendment cannot be restricted (or can it, will come back to this issue). An amendment with scheduled increases in future plan years? Consider an amendment made in 2015 that provides a 10% increase in benefits effective on 1/1/2016 (but only for participants employed on 1/1/2016) and then another 10% increase in benefits effective on 1/1/2017. Such an amendment has three years to examine, 2015, 2016 and 2017 An amendment with scheduled increases in future plan years? 2015 is easy. Since the accrued benefit as of both 1/1/2015 and 1/1/2016 are not impacted by the plan amendment, there is no increase in the Funding Target and no increase in the Target Normal Cost for 2015 caused by the plan amendment, so there would be no restriction applied to the plan amendment for 2015 8
An amendment with scheduled increases in future plan years? 2017 has an interesting analysis, in that if the amendment is potentially restricted for 2017, can that restriction be applied independently from 2016? This issue is discussed later, but the short answer is no. Therefore any restriction that would be applied for 2017 must be in lock step with 2016. An amendment with scheduled increases in future plan years? This leaves 2016 as the real question. So consider, WHEN is the 10% increase in the accrued benefit that takes effect on 1/1/2016 accrued, i.e. is it part of the 2016 Funding Target (i.e. accrued prior to 1/1/2016) or part of the 2016 Target Normal Cost (i.e. accrued during 2016)? An amendment with scheduled increases in future plan years? Since the amendment does not take effect AFTER the valuation date it is reflected in the 2016 valuation, and therefore the amendment cannot be restricted Put simply if an amendment increases benefits in a future plan year, it is not restricted (unless there are increases in the year adopted that would cause a restriction) 9
Is an Increase in a Flat Dollar Pay Credit an Amendment? This becomes an interesting problem Under 1.436-1(c)(4)(i)(A) if a benefit that is unrelated to pay is increased in a percent that is smaller than the increase in the average wages during the period from the last amendment to the current amendment, then 436(c) does not apply. Is an Increase in a Flat Dollar Pay Credit an Amendment? It is unclear how the math here is done, for example, consider the last amendment was made in 2010, and a new amendment is made in 2015, is the increase The average ratio of 2015 wages to 2010 wages The rate of average 2015 wages to 2010 wage Is it base on rate of pay, or some historic average What wage is used (e.g. 401(a)(17), base, gross) Is an Increase in a Flat Dollar Pay Credit an Amendment? So an increase in a flat dollar pay credit may or may not be a plan amendment So consider 2 employees, A and B The desire is to increase A by 10%, but A s wages only increased 5% B s average pay increased 15% By increasing B by 10% also, the increase is not an amendment What if B only gets a 1% increase? 10
Planning Scenarios There are several possible issues Increasing the AFTAP (after it has been certified) Decreasing the AFTAP (after it has been certified) Decreasing the available prefunding balance (so as to cause the AFTAP to decrease at the fourth month) Allowing an amendment to not be restricted Timing the revision in the AFTAP Increasing the AFTAP Consider a 2016 plan year On February 1, 2016 the AFTAP is certified as 79% A participant terminates in March 2016 The plan sponsor wants to pay an unrestricted lump sum Obviously, can make contributions for prior year to raise AFTAP Increasing the AFTAP It is generally assumed that a plan cannot make a 436 contribution to increase the AFTAP, (see, for example 1.436-1(f)(2)(i)(A)(1) which indicates 436 contribution can be used to limit restrictions on unpredictable event payments, plan amendment and benefit accruals, but not benefit payments), but By funding a plan amendment 11
Increasing the AFTAP Consider the series of events that occurs The AFTAP is certified at 79% The plan is amended in a manner that is restricted The sponsor makes a contribution equal to amount of increase Under 1.436-1(h)(4)(v)(C) the AFTAP can be recertified upon request Further, once the AFTAP is recertified, this becomes the new AFTAP for all purposes Increasing the AFTAP The net result is that by making some small amendment, then making a 436 contribution sufficient to make the AFTAP 80% or more, benefit restrictions no longer apply This might have to be combined with contributions for prior year Decreasing the AFTAP It is generally not possible to lower the AFTAP below 80% once the AFTAP is certified above 80%, but it can be lowered (for example from 90% to 80%) The advantage of this would be to stop further plan amendments (such as the next year s 415 increase) and cause the presumed AFTAP to fall below 80% in the fourth month 12
Decreasing the AFTAP So consider that the AFTAP is certified as 90% All participant have 8 years of accrual service The plan is amended to set the accrued benefit as of the beginning of the year equal to the accrued benefit at the end of the year This increases the funding target by 9/8 So the AFTAP is no 90% / (9/8) = 80% There is no actual increase in cost Decreasing the AFTAP Remember that it is generally accepted that once the AFTAP is certified, the assumptions for funding must match the AFTAP certification, and so, if there is a second AFTAP certification, it must use the same assumptions This will be discussed in more detail later Timing of Recertification Consider the following situation AFTAP has been certified at 79% Plan amendment made and 436 contribution made equal to value of increase so amendment can take effect If AFTAP recertified, then AFTAP will be 82% Plan provides lump sum if AFTAP at 80%, but only partial lump sums and annuity if below 13
Timing of Recertification Further facts Participant Rick is departing next month and would be due a rather large lump sum Participant Helen is departing in three months and has a more modest lump sum Can plan restrict Rick but pay Helen full lump sum? Timing of Recertification Appears yes if plan administrator is careful Rick departs and is told AFTAP is 79% and he is restricted Plan administrator then requests actuary to recertify AFTAP based upon payment of 436 contribution, which is then done before Helen departs Now Helen is told AFTAP is 82% and she can have her lump sum Reducing Prefunding Assume that the plan is amended prior to the fourth month (but for the current year) Assume that the prior year AFTAP is 80% If the plan administrator (not the enrolled actuary) determines that the prefunding balance is sufficient that a deemed reduction is sufficient to keep the AFTAP at 80% 14
Reducing Prefunding In this case the plan administrator determines the amount of the deemed reduction Therefore the current year amendment could reduce the available prefunding balance, such that when the deemed reduction in the AFTAP at the fourth month occurs there is insufficient prefunding balance to keep that deemed AFTAP above 80% Allowing an Amendment There are multiple ways to help an amendment take effect, but an interesting one is The amendment treats the past service portion of the increase as a current year accrual This means that must be treated as Target Normal Cost, but This means the amendment can go into effect, but be funded as much as a year and a half after participants get the benefit increase Multiple Features Assume that a single plan amendment has multiple changes, some of which increase liabilities, and some of which do not Are the separate features restricted independently, or is the amendment taken as a whole? 15
Multiple Features It seems clear that the amendment is taken as a whole This would seem to imply that since the 415 and 401(a)(17) increases are tied together that if the 415 increase is restricted, so is the 401(a)(17) increase Multiple If there is an amendment that is restricted, how does it impact subsequent amendments? Note that these rules are unique to 436 Multiple First, if an amendment does not go into force, because it is restricted, then If it could go into force later in the same plan year (for example due to additional contributions for the prior plan year) then the amendment takes force (absent special language in the amendment) If the amendment does not go into force in the current plan year, then (absent special plan language) the amendment never goes into force 16
Multiple So, assume that the AFTAP is exactly 80% on 1/1/2016 A plan amendment fails to go into force during 2016 (for example the 415 increase) A second amendment is made, which the plan sponsor is willing to fund to allow to take force, what happens? Multiple It is unclear whether the second amendment can go into effect without the first amendment first taking effect, but it appears that it can Amendment effecting assumptions Assume that a plan has an AFTAP of 80% The plan only allows an annuity payment, and only at age 65 The plan is amended to provide a fully subsidized benefit at age 60 Under the assumptions prior to the amendment there is no cost for the amendment because the assumption is that all participants will take a benefit at age 65 17
Amendment effecting assumptions So is such an amendment restricted? It would seem that it should be It also seems that the regulation would prohibit changing the assumptions once the original AFTAP is certified, which would prohibit there being a liability for amendment Questions 18