QUESTION 1: I have a U.S. qualified plan, subject to the single-employer PPA funding rules, that provides a benefit of $20 per month for all years of service, negotiated to increase on 7/1/2010 to $21 per month for all years of service. The plan year is the calendar year and the valuation date is 1/1/2010. The plan amendment changing the benefit level is to be recognized in the valuation performed for the 2010 plan year. How can I code the scheduled benefit increase to comply with IRS Regulation 1.430(d)-1 and the answer to the 2008 IRS Gray Book question #7?

ANSWER: As indicated in the Frequently Asked Questions article entitled Flat dollar plan with increasing benefit level, there are many ways to code this type of benefit formula. In general, any of the coding options presented in that FAQ may be used, with parameter entries of “7/1/2010” in place of the date of the benefit level increase in the FAQ’s example, “1/1/2011”. For purposes of Regulation §1.430(d)-1), to reflect the amendment in the liability for both funding target (unit credit) and maximum tax deductible contribution (projected unit credit) calculations, either of Options 3a or 3b will provide these results.

Alternatively, there is a Reflect new accrual rates during the valuation year in PUC and UC liabilities check box under the Liability Methodology topic of Valuation Assumptions. If this box is checked, any new accrual rates that are effective in the upcoming valuation year (year beginning on the valuation date) and applicable to all years of service will be reflected in the PPA liabilities. Using this option allows you to simply set up “new rates as of” in your Benefit Formula Component, without setting up any increase rates or custom attribution.

When benefit formula increases occur in the current valuation year (i.e., the year beginning on the Valuation Date), checking this option will yield the same liability as 3a and 3b for beginning of year decrements. For mid-year decrements, however, this check box will yield slightly different results for the portion of a person decrementing in the valuation year.

Options 3a and 3b will determine the mid-year benefit during the valuation year as the average of the benefit at the beginning of the year (not reflecting the new rates) and the benefit at the end of the year (reflecting the new rates). The option to reflect new accrual rates during the valuation year in PUC and UC liabilities will determine the mid-year benefit during the valuation year as the average of the beginning of year benefit reflecting new accrual rates and the end of year benefit (also reflecting new accrual rates).

Note that, for purposes of determining liability and normal cost, the Reflect new accrual rates during the valuation year in PUC and UC liabilities check box will ignore any benefit level increases that occur one year or more after the valuation date.

 

QUESTION 2: How can I comply with the 1997 IRS Gray Book question #2 for ERISA and current liability calculations other than those subject to PPA single-employer funding rules?

ANSWER: For ERISA calculations recognizing the plan amendment, the desired result under your cost method may be accomplished by using the options of either Result 2 or Result 3 of the Flat dollar plan FAQ, i.e., reflect the benefit increase in both the accrued liability and normal cost under the projected unit credit cost method. Code the year 2010 increase rate (Options 2a and 3a) to reach 21 or code “21” as the new accrual rate, effective 7/1/2010 (Options 2b and 3b).

For current liability calculations, which are computed under the unit credit cost method, the desired result determines the choice of coding option – and the desired result depends on which of the three approaches of the 1997 Gray Book Q&A is taken. All three can be coded in ProVal.

Approach 1: Calculate current liability based on the plan provisions in effect as of the beginning of the plan year and base the current liability normal cost on prorated benefit levels.

That is, calculate the current liability based on the plan provisions as of the beginning of the plan year and compute the current liability normal cost as the weighted average of the benefit levels in effect during the plan year. Therefore, for the 1/1/2010 valuation, the current liability will be based on the 1/1/2010 benefit level of $20 and the current liability normal cost will be based on the prorated benefit level of $20.50. You may accomplish the desired result by using the options of either Result 1 or Result 2 of the Flat dollar plan FAQ, but particularly if you are using the options of Result 2 for ERISA calculations, you may prefer to use the options of Result 2 for current liability also. Code the year 2010 increase rate (Option 2a) to reach 20.50, rather than 21, or code 20.50, rather than 21, as the new accrual rate effective 7/1/2010 (Option 2b). For example, under Option 2b, you could use a Benefit Formula Component, e.g., “Prorated_Ben”, that is an accrual definition with rates that change on 7/1/2010, for all years, from 20 to 20.50. Because ERISA liabilities are based on coding a rate effective 7/1/2010 of 21, not 20.50, you need to run a separate Valuation for current liability. Then, in the Valuation Set, use the Overrides button to select this run for current liability calculations.

A special case is a benefit level increase on 12/31/2010. If you wish your 1/1/2010 valuation to reflect the benefit increase for ERISA calculations but ignore the benefit increase in current liability calculations, run a separate Valuation that does not reflect the plan change (i.e., no new rates, no increase rates). Again, use the Overrides button in the Valuation Set to select this run for current liability calculations.

In a forecast, the desired result (under this approach) for valuations as of future valuation dates (i.e., after 1/1/2010) – that is, base the current liability and current liability normal cost on the new benefit level without proration – can be attained by using the replacement benefits feature of the Plan Amendments topic of Projection Assumptions. Note that, for a forecast, Option 2a should be used to model plan amendments changing benefit levels. The replacement Benefit Definition for the current liability Core Projection (to be selected under the Overrides button in the Deterministic Forecast or Stochastic Forecast) would use a Benefit Formula Component with a year 2010 increase rate to reach 21 by the first forecast valuation date (1/1/2011), whereas the initial Benefit Definition uses a component with a year 2010 increase rate to reach 20.50.

Approach 2: Calculate current liability and current liability normal cost based on the benefit level in effect at the end of the plan year.

Therefore, for the 1/1/2010 valuation, the current liability and the current liability normal cost will be based on the end-of-year benefit level of $21. Use the options of Result 3 of the Flat dollar plan FAQ to achieve this result.

Approach 3: Calculate current liability based on the plan provisions in effect as of the beginning of the plan year but include the full impact of the mid-year plan amendment in the current liability normal cost.

Therefore, for the 1/1/2010 valuation, the current liability will be based on the 1/1/2010 benefit level of $20 and the current liability normal cost will be based on the 7/1/2010 benefit level of $21. You may use the options of either Result 1 or Result 2 of the Flat dollar plan FAQ, but if you are using a Result 2 option for your ERISA calculations, you may prefer to use the same option for current liability, so that a separate Valuation run will not be needed.

Note: For simplicity, this FAQ details the procedure for reflecting a single change in benefit level, but you can apply this procedure to reflect multiple changes in benefit level – e.g., a second increase in benefit level at 7/1/2011, for which you have a non-zero increase rate in the 2011 row (options 2a and 3a) or new rates as of 7/1/2011 (options 1, 2b and 3b).