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5500 Preparer's Manual for 2012 Plan Years
The premier resource in the field of Form 5500 preparation, 5500 Preparer's Manual will help you handle the required annual Form 5500 filings for both pension benefits and welfare benefit plans.
The changes to the rules used for calculating minimum lump-sum distributions made by the Pension Protection Act of 2006 (PPA, P.L. 109-280) would tend to have the effect of substantially reducing lump-sums for younger participants, especially after 2011, and minimally reducing lump-sums for older participants, especially prior to 2011, according to a study by the Congressional Research Service (CRS).
When a pension plan permits accrued benefits to be paid in a lump-sum distribution rather than as an annuity, the lump sum must be equal to the present value of the future annuity to which the plan participant is entitled. Calculation of the present value of the accrued benefit requires the use of mortality assumptions to calculate life expectancy, and interest rates to discount a future stream of income to present value. In order to assure that such lump sum distributions do not fall below minimum permissible values, the IRS specifies the mortality assumptions and interest rates which must be used for this purpose.
Prior to the passage of the PPA, lump-sum calculations were based upon 30-year Treasury bond interest rates and certain mortality tables. The PPA established new rules prescribing the use of different mortality tables and interest rates for lump-sum distributions, beginning in 2008.
According to the CRS, the new mortality tables prescribed by the PPA, reflecting increases in life expectancy, would, by themselves, increase the value of lump sums by 1% to 2%, depending on the age of the participant. The newly-prescribed interest rates, however, would have the opposite effect on lump-sums. The PPA rules require a phased in use of corporate bond rates instead of 30-year Treasury bond rates, which historically have been lower. The increase in interest rates would, by themselves, lower lump-sum values because the present value of an annuity is inversely related to the interest rate used to convert the annuity to its present value, the CRS states.
The change from the use of 30-year Treasury bond rates to corporate bond rates is gradually phased in during the years 2008 through 2011, the CRS notes. In 2008, for instance, the 30-year Treasury bond rates will be weighted at 80% and the corporate bond interest rate will be weighted at 20%. By 2011, the 30-year Treasury bond rates will be weighted at 20% and the corporate bond interest rate will be weighted at 80%. The corporate bond interest rate will be solely used in 2012 and beyond.
Under Code Sec. 417(e) as amended by the PPA, a three-segment “yield curve” of investment-grade corporate bonds is used to determine the minimum lump-sum value of an annuity. Under the scheme, the present value of the portion of the annuity that is payable within 5 years will be valued using the first segment of the yield curve, a short-term corporate interest rate; the portion payable in 6-20 years will be valued using the second segment of the yield curve, a medium-term corporate interest rate; and the portion payable in more than 20 years will be valued using the third segment of the yield curve, a long-term corporate interest rate.
The CRS sought to evaluate the real-world effect of these rules by presenting certain hypotheticals. How the PPA will affect the value of any given individual’s lump sum will depend on the participant’s age, whether he or she is eligible for an immediate annuity or a deferred annuity, and the difference between the Treasury bond interest rate and the corporate bond interest rate in each segment of the yield curve, the CRS states.
Under a hypothetical assuming an immediate annuity of $12,000 per year, a participant who is age 60 would see a small reduction of 1.2% in his lump sum under the PPA using 2008 rules, as compared to pre-PPA rules. But the same participant would suffer a much larger 10.8% reduction under the PPA using 2012 rules, as compared to pre-PPA rules. An individual older than age 60 would see lesser reductions as compared to pre-PPA rules, because a larger portion of their lump sum would be based on first segment, short-term corporate rates. Conversely, an individual younger than age 60 would see greater reductions as compared to pre-PPA rules because a larger portion of their lump-sum would be based on third segment, long-term corporate rates.
Under a second hypothetical assuming a deferred annuity of $12,000 per year, a 55-year-old participant would see a reduction of 2.6% in his lump sum under the PPA using 2008 rules, as compared to pre-PPA rules. The same participant would suffer a substantial 20.7% reduction under the PPA using 2012 rules, as compared to pre-PPA rules. As before, an individual older than age 55 would see lesser reductions and an individual younger than age 55 would see greater reductions as compared to pre-PPA rules.
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