5500 Preparer's Manual for 2012 Plan Years
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The IRS has issued final regulations under Code Secs. 430 and 436 regarding funding balances and benefit restrictions for underfunded plans, and the measurement of assets and liabilities for pension funding purposes in single-employer defined benefit plans. These regulations finalize the rules proposed in August 2007 and December 2007, with certain revisions. The final regulations apply to plan years beginning on or after January 1, 2010. For plan years beginning before January 1, 2010, plans may rely on the final regulations, or they may rely on the proposed regulations.
CCH Note: The IRS gave a preview of some of the guidance in a special September 25, 2009 edition of Employee Plans News, in which it clarified the interest rates that may be used under the final regulations.
Determining funding target and target normal cost
The final regulations provides rules for determining the funding target and target normal cost for plans that are not in "at risk" status. Under the regulations, the target normal cost of a plan for the plan year is the present value (determined as of the valuation date) of all benefits under the plan that accrue during, are earned during, or are otherwise allocated to service for the plan year, subject to certain special adjustments as added by the Worker, Retiree, and Employer Recovery Act of 2009 (WRERA; P.L. 110-458). These special adjustments are optional for plan years beginning during 2008, but are required to be made for later plan years. Under the special adjustments, the target normal cost of the plan for the plan year is adjusted (not below zero) by adding the amount of plan-related expenses expected to be paid from plan assets during the plan year, and by subtracting the amount of any mandatory employee contributions expected to be made during the plan year. For this purpose, the final regulations reserve the issue of the definition of plan-related expenses, which is expected to be addressed in forthcoming proposed regulations.
Effect of prefunding balance and funding standard carryover balance
The final regulations generally adopt the proposed rules relating to the application of prefunding and funding standard carryover balances under Code Sec. 430(f). Under the regulations, a plan sponsor is permitted to elect to maintain a prefunding balance for a plan. A prefunding balance maintained for a plan consists of a beginning balance of zero, increased by the amount of excess contributions to the extent the employer elects to do so, and decreased (but not below zero) by the sum of, as of the first day of a plan year, any amount of the prefunding balance that was used to offset the minimum required contribution of the plan for the preceding plan year and any reduction in the prefunding balance for the plan year. The plan sponsor's initial election to add to the prefunding balance constitutes an election to maintain a prefunding balance (so that no special election is necessary to establish a prefunding balance). The prefunding balance is adjusted further for actual investment return for the plan year.
The present value of the excess contribution for the preceding plan year is the excess, if any, of the present value of the employer contributions (other than contributions to avoid or terminate Code Sec. 436 benefit limitations) to the plan for such preceding plan year over the minimum required contribution for such preceding plan year. In addition, a contribution for a plan year to correct an unpaid minimum required contribution for a prior plan year is not treated as part of the present value of excess contributions. This present value is increased with interest from the valuation date for the preceding plan year to the first day of the current plan year. The regulations provide that the plan's effective interest rate for the preceding plan year is generally used to calculate the present value of the contributions for the preceding plan year and for adjusting the excess amount. Unlike the proposed regulations, the final regulations permit an excess contribution to be added to the prefunding balance for a plan year notwithstanding that the amount is an excess contribution solely because an election is made for that plan year to use the funding standard carryover balance or prefunding balance to offset minimum required contributions.
Valuation date and value of plan assets
Under the regulations, the determination of the funding target, target normal cost, and value of plan assets for a plan year is made as of the valuation date of the plan for that plan year. Except in the case of a small plan, the valuation date of a plan for any plan year is the first day of the plan year. The selection of a plan's valuation date is part of the plan's funding method and, accordingly, may only be changed with the consent of the IRS Commissioner. However, a change of a plan's valuation date that is required by Code Sec. 430 is treated as having been approved by the Commissioner and does not require the Commissioner's prior specific approval.
CCH Note: To reflect changes to the rules regarding determination of average plan assets made by WRERA, portions of the regulations have been reserved to provide rules regarding adjustments for expected earnings that are applied in determining average plan assets. These issues are expected to be addressed in future proposed regulations.
Interest rates used to determine present value
The interest rates used in determining the present value of the benefits that are included in the target normal cost and the funding target for the plan are generally based on the 24-month moving averages of three separate segment rates for the month that includes the valuation date (which are determined based on the monthly corporate bond yield curves for the preceding 24 months). The regulations provide for elections that a plan sponsor can make to use alternative interest rates rather than the segment rates for the month that includes the valuation date.
The proposed regulations would have required plan sponsors to obtain approval for an election to use alternative interest rates. However, the final regulations do not require approval for the initial adoption of these elections for any year. Thus, for example, a plan sponsor that was using segment rates for the plan year beginning in 2010 can elect to switch to use the monthly corporate bond yield curve for the plan year beginning in 2011 and subsequent years without approval of the IRS Commissioner. However, once an election has been made, any subsequent change requires the approval of the Commissioner.
Plans in at-risk status
Significantly underfunded plans, referred to as "at-risk," have special rules for determining funding targets. In general, the regulations provide that a plan is in at-risk status for a plan year if the funding target attainment percentage (FTAP) for the preceding plan year is less than 80% (65%, 70%, and 75%, respectively, for plan years beginning in 2008, 2009, and 2010), and the at-risk FTAP for the preceding plan year is less than 70%.
The at-risk rules do not apply to small plans, defined for this purpose as plans with 500 or fewer participants within the employer's controlled group during the preceding plan year.
Unpredictable contingent event benefits
Code Sec. 436(b) sets forth a limitation on plant shutdown and other unpredictable contingent event benefits in situations where the plan's adjusted funding target attainment percentage (AFTAP) for the plan year is less than 60%, or would be so, taking into account the benefits attributable to the unpredictable contingent event. The final regulations state that plans with such benefits must provide that they will not be paid to participants if the AFTAP for the plan year is less than 60%. However, the prohibition on payment will not apply during plan years where the employer makes a contribution, as specified in Code Sec. 436(b)(2), in addition to any minimum required contribution. The regulations note that if a plant shutdown or other event occurs during a plan year where unpredictable contingent event benefits are not subject to limitation, then benefits paid pursuant to that shutdown are permitted to be paid in a later plan year, even if the plan's AFTAP for the subsequent year is less than 60%. Also, the regulations clarify that the limitations of Code Sec. 436(b) apply on a participant-by-participant basis.
Limitations on plan amendments increasing plan liabilities
Code Sec. 436(c) provides that a plan amendment which increases plan liabilities by a benefit increase may not take effect if the plan's AFTAP for the plan year is less than 80%, or would be less than 80% taking into account the amendment, unless the plan sponsor makes a specified contribution, in addition to any minimum required contribution. Under the regulations, the limitation on amendments increasing liabilities does not apply to any amendment that provides for an increase in benefits under a formula that is not based on a participant's compensation, but only if the rate of increase in benefits does not exceed the contemporaneous rate of increase in average wages of participants covered by the amendment.
Limitations on prohibited payments
Code Sec. 436(d)(1) provides that, if the plan's AFTAP for a plan year is less than 60%, a participant or beneficiary is not permitted to elect an optional form of benefit that includes a prohibited payment, and the plan will not pay any prohibited payment, with an annuity starting date that is on or after the applicable measurement date. The final regulations clarify that, if a participant requests a prohibited payment at a time when that form of payment cannot be made, the participant retains the right to delay commencement of benefits only if the right to delay commencement is in accordance with the terms of the plan and applicable qualification requirements.
Under Code Sec. 436(d)(3), if the plan's AFTAP for a plan year is 60% or more but is less than 80%, a participant or beneficiary is not permitted to elect the payment of an optional form of benefit that includes a prohibited payment, and the plan will not pay any prohibited payment, with an annuity starting date that is on or after the applicable measurement date, unless the present value of the portion of the benefit that is being paid in a prohibited payment does not exceed the lesser of: (1) 50% of the present value of the benefit payable in the optional form of benefit that includes the prohibited payment; or (2) 100% of the PBGC maximum benefit guarantee amount.
Under the final regulations, the determination of the portion of the benefit that is a prohibited payment is made based on the applicable optional form of benefit. If the benefit is being paid in an optional form for which any of the payments is greater than the amount payable under a straight life annuity to the participant or beneficiary (plus any social security supplements) with the same annuity starting date, then the portion of the benefit that is being paid in a prohibited payment is the excess of each payment over the smallest payment during the participant's lifetime under the optional form of benefit (treating a period during the participant's lifetime in which no payments are made as a payment of zero). Like the proposed regulations, the final regulations require that, if an optional form of benefit that is otherwise available under the terms of the plan is not available as of the annuity starting date because of the application of the requirements of Code Sec. 436(d)(3), the plan must permit a participant or beneficiary to elect to bifurcate the benefit into unrestricted and restricted portions.
The regulations define the term "prohibited payment" under Code Sec. 436(d)(5) as any payment for a month that is in excess of the monthly amount paid under a single life annuity (plus any social security supplements) to a participant or beneficiary whose annuity starting date occurs during any period that a limitation on prohibited payments is in effect, as well as any payment for the purchase of an irrevocable commitment from an insurer to pay benefits. This includes any transfer of assets and liabilities to another plan maintained by the same employer (or by any member of the employer's controlled group) that is made in order to avoid or terminate the application of the benefit limits of Code Sec. 436 and other payments identified as a prohibited payment in IRS guidance.
The regulations require plans to not pay any prohibited payment with an annuity starting date that is during a plan year in which the plan sponsor is a Chapter 11 bankrupt debtor, until such time as the plan's enrolled actuary certifies that the plan's AFTAP is not less than 100%.
Limits on benefit accruals
Under the regulations, a plan must provide that, in any case in which the plan's AFTAP for a plan year is less than 60%, benefit accruals under the plan will cease as of the applicable measurement date, unless the plan sponsor makes an additional contribution as specified in Code Sec. 436(e)(2). Certain amendments made by WRERA are expected to be addressed in future proposed regulations.
Rules on contributions made to avoid benefit limitations
An employer sponsoring a plan that would otherwise be subject to the limitations of Code Sec. 436 can avoid the application of those limits by: (1) reducing the funding standard carryover balance and prefunding balance; (2) making additional contributions for a prior plan year that are not added to the prefunding balance; (3) making the specific contributions described in Code Sec. 436, or (4) providing security, as described in Code Sec. 436(f)(1).
The regulations set forth a series of presumptions that are used to apply the Code Sec. 436 benefit limitations in situations where the plan's enrolled actuary has not yet issued a certification of the plan's AFTAP for the plan year and that describe the interaction of the application of those presumptions on plan operations with plan operations after the plan's enrolled actuary has issued a certification of the plan's AFTAP for the plan year. The rules in the final regulations have been revised from those in the proposed regulations.
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