Benefit Restrictions Including Top-25 Paid Group Restrictions 2009 ACOPA Advanced Actuarial Conference June 8th – 9th,

1. Benefit RestrictionsIncluding Top-25 Paid Group Restrictions2009 ACOPA Advanced Actuarial ConferenceJune 8th – 9th, 2009 Joan Gucciardi, MSPA, COPA, CPC Summit Benefit & Actuarial Services, Inc.

2. Benefit Restrictions Today • Treasury Reg. § 1.401(a)(4)-5(b) • PPA restrictions under IRC § 436

3. PPA Benefit Restrictions • Coordination with §401(a)(4) restrictions on accelerated distributions for HCEs • Restrictions still apply under Treas. Reg. §1.401(a)(4)-5(b) • Look at different purposes of rules: • §401(a)(4): protect the benefits of NHCEs • PPA restrictions: improve funding of the plan

4. Treas. Reg. §1.401(a)(4)-5(b) Restrictions

5. Treas. Reg. §1.401(a)(4)-5(b) Restricted employees are HCEs Required provision in defined benefit plan document Restriction of benefits upon plan termination

6. Treas. Reg. §1.401(a)(4)-5(b) • Accelerated distributions cannot be made to HCEs unless: • After taking into account the amount of the distribution for the restricted employee, • The value of plan assets must equal or exceed 110% of current liabilities

7. Definition of a Restricted Employee HCE or former HCE One of the 25 (or a larger number chosen by the employer) nonexcludable employees or former employees with the largest amount of compensation in the current or any prior year. Should be defined in the plan document

8. Definition of a Restricted Employee Determined on a controlled group basis Definition of pay: use §415(c)(3) pay on a consistent basis Re-determine the list each year IRS regulations provide anti-cutback relief for plan amendments that alter the restricted group

9. Example 1 Art is an HCE for the plan year ended 12/31/08 (he earned $150,000 in 2007) Art only earns $50,000 in 2008, so he is not an HCE for 2009 Art terminates employment in 2009 Question: Is Art a restricted employee?

10. Example 1: Solution List all highly compensated employees for the years 1995 (the year the business started) - 2009 Arrange list in order of compensation, using the highest compensation earned by each HCE Art is number 30 on the list and is, therefore, not a restricted employee

11. Definition of Benefits for Purposes of Restriction Lump sum distributions Loans in excess of §72(p) Any periodic income Death benefits not provided by insurance QDROs for a non-participant spouse

12. Restrictions on Distributions Limited to a straight life annuity that is the actuarial equivalent of the accrued benefit Plus a Social Security supplement (if the restricted employee is entitled to receive one)

13. Determination of Current Liability and Plan Assets • “…any reasonable and consistent method may be used in determining the value of plan assets and current liabilities.” • Plan Assets: • No guidance as to whether actuarial or market value of assets should be used.

14. Definition of Current Liability2008 Plan Years and Later • “Current Liability” is not defined for 2008 plan years (and later) • IRS has suggested that you may: • Substitute “target liability” for current liability; or • Continue to calculate current liability on pre-PPA basis [EA Meeting 2008 Gray Book Update, Q&A 30]

15. Example 2 Calendar plan year As of 1/1/08, plan assets are more than 110% of current liability (determined after the distribution) Restricted HCE terminates in May 2009 and wants a lump sum 1/1/09 actuarial valuation has not been done What should the actuary do?

16. Example 2: Possible Options Advise plan sponsor that restrictions do not apply Advise plan sponsor to wait for the calculation of the 1/1/09 target liability to assure that (after the distribution): plan assets > 110% of target liability Plan sponsor tells HCE “no distribution” or put up security Advise plan sponsor to call ERISA counsel

17. Security Arrangements (Participant Action) • Deposit funds equal to 125% of the restricted amount in an escrow account • Post a bond equal to 100% of the restricted amount • Purchase a bank letter of credit equal to 100% of the restricted amount • Security can be released if: • Participant drops off high-25 list • Plan becomes 110% funded

18. Security Arrangements Restricted Amount Must be Recomputed Each Year (if collateral agreement is used or other security is provided) During a plan year, the amount that may be required to be repaid to the plan is the restricted amount

19. Security Arrangements • Restricted amount is the excess of: • The accumulated amount of distributions made to the employee during the period of restriction, over • The accumulated amount of the unrestricted limit during the restriction period

20. What happens if Restricted Lump Sums are Paid? Violation of plan terms Disqualifying defect

21. What Happens if Restricted Lump Sums are Paid? Seek a collateral agreement or other security agreement from recipient Ask for the money back VCP Contribute enough to get the plan assets up to 110% (measured after the distribution)

22. PPA benefit restrictions

23. PPA Benefit Restrictions PPA restricts distributions to plan participants from plans that are not fully funded to the amount of the participant’s monthly life annuity Effective for plan years beginning after 2007

24. PPA Benefit Restrictions • PPA also requires the freezing of benefits under certain circumstances • The degree of restriction depends on the level of funding for the defined benefit plan • Applicable to: • Benefit increases • Available benefit forms • Benefit accruals • Shutdown benefits

25. Calculation of AFTAP • 430: [Assets ÷ 100% Funding Target] = FTAP Transitional Relief for 2008 - 2010 MRC = TNC + Amortization of FTAP • 436: [Assets + Annuity Purchases]÷[100% Funding Target + Annuity Purchases] = AFTAP Normally Assets are Net of COB/PFB Exception: If FTAP is 100% or more (or transitional rule), then Assets are Not Net of COB/PFB • 436: AFTAP must be determined as if the plant shutdown or increased benefits would occur • In calculating AFTAP for 2009 and beyond, prior year ER contributions are considered only if actually contributed by the certification date • Final certified AFTAP reported on the Form 5500 Schedule SB but otherwise not filed with the IRS

26. Various Types of Restrictions • 436(b) limits plant shutdown & other unpredictable contingent benefits for plans less than 60% funded • 436(c) limits the ability to amend a plan to increase benefits for plans less than 80% funded • 436(d) limits the ability to pay full or partial lump sum distributions depending on whether the plan is less than 60% or 80% funded • 436(e) freezes future benefit accruals for plans less than 60% funded

27. Various Types of Restrictions:Exception • Exception to 436(d) limitation on lump sum distributions • Applicable to a plan frozen on or before 9/1/05

28. Section 436 Measurement Dates • 436(d) and (e) limits can start and stop during a plan year • 436(b) and (c) limits must be determined immediately prior to paying the shutdown benefit or increasing plan benefits

29. 1st Limit – Plant Shutdown & Unpredictable Contingent Benefits • Portion of the benefit paid solely due to the plant shutdown or other event (not related to age, service, receipt or deprivation of compensation, death or disability) • Example: subsidized benefits paid upon a plant shutdown or layoff even though the employee hasn’t attained age/svc criteria • Proposed regulations silent as to whether plan liababilities should include probability of paying these benefits • If 2009 funding is less than 60%, plant shutdown benefits for 2009 + 2010 cannot be paid; 2010 benefits can be restored but regs treat them as “increased benefits”

30. 2nd Limit – Amendment Increasing Benefits • Any amendment increasing benefits, establishing new benefits, changing the existing accrual rate or changing vesting schedule • Exception for flat dollar plans • IRS view is that COLA increases under 415(b) and 401(a)(17) are “benefit increases” but mandatory vesting changes are not

31. 2nd Limit – Amendment Increasing Benefits • Increase in 415 Limit is deemed to be a plan amendment • If AFTAP < 80%, plan sponsor may elect not to make 436 contribution to cover cost of amendment • If AFTAP later increases to >80%, plan sponsor would need to retroactively pay benefits up to 415 limits (unless automatic COLA is removed from plan) [2009 EA Meeting Gray Book, #20]

32. 2nd Limit – Amendment Increasing Benefits • What about an increase in lump sum benefit due to the annual update to the applicable mortality table? • Is it a deemed amendment for 436(c) purposes? • To be clarified in final combined 430/436 regulations [2009 EA Meeting Gray Book, #25]

33. 2nd Limit – Amendment Increasing Benefits • Plan sponsor wants to provide an early retirement window • Current AFTAP is 70% • Increase in funding target is based on assumed utilization [2009 EA Meeting Gray Book, #22]

34. 2nd Limit – Amendment to G/F Frozen Plan: Will it Cause Plan to Lose Exemption? • Plan is amended to reflect PPA Applicable interest rate (AIR) and Applicable mortality table (AMT)? NO • Plan protects pre-PPA AIR and AMT? NO • Plan changes lookback month/stability period? NO • Plan is amended to provide in-service distributions at NRA or 62? NO [2009 EA Meeting Gray Book, #23]

35. 2nd Limit – Mid-Year Amendment Under proposed 436 regs, plan amendment adopted and effective in mid-2008 is only reflected in 2008 AFTATP if plan sponsor makes a 412(d)(e) election 2009 presumed AFTAP is based on final 2008 certified AFTAP No adjustment to 2009 presumed AFTAP to reflect 2008 mid-year amendments, regardless of impact on funding target? Is it reasonable to adjust 2009 presumed AFTAP to reflect mid-year 2008 amendment?

36. 3rd Limit – Accelerated Benefit Payments • Plans less than 60% must not allow any “prohibited payments” for participants with an annuity starting date on or after the measurement date (exception for de minimis amounts) • “Prohibited payments” = any payment in excess of the monthly single life annuity, plus Social Security supplements • Plans with funding between 60% and 79% may make “prohibited payments” but only to the extent the present value of the payments doesn’t exceed 50% of the total benefits (or the PBGC guaranteed amount if less) • Annuity starting date – regs require participant’s election • Participants with restricted and unrestricted benefits must be offered the choice to defer payment of the restricted portion or bifurcate the benefits

37. Present Value of PBGC GuaranteeSample Values for 2009 (Aug. 2008 segment rates: 4.78%, 5.45%, 5.46%)

38. 3rd Limit – 60% - 79% Rangeaka “No-Man’s Land”Options Offered to Plan Participants Take the QJSA or equivalent benefit forms, other than a lump sum Take a 50% lump sum (limited to PBGC maximum) and defer the rest of the benefit until the AFTAP increases to 80% Take a 50% lump sum (limited to PBGC maximum) and receive the balance of the benefit in annuity form Defer the entire benefit until the AFTAP increases to 80%

39. 3rd Limit – 60% - 79% Rangeaka “No-Man’s Land”Options Offered to Plan Participants What if the actuary does not issue an AFTAP? Then AFTAP is deemed to be below 60% No 50% lump sum option needs to be provided Is this administrative discretion on the part of the actuary? Might this ultimately violate the terms of the plan?

40. 3rd Limit – 60% - 79% Rangeaka “No-Man’s Land”Designing New DB Plans Consider drafting a new DB plan by limiting lump sum distributions Lump Sum is only available when AFTAP is 80% or above Certainly no help for existing DB plans that offer a lump sum

41. 3rd Limit – Options when Distribution Restrictions Cease • If AFTAP was 60 – 79% and then certified to be 80% or more, plans must then offer lump sums for anyone with ASD occurring after the resumption. The restriction is not retroactive for anyone with ASD during the restricted period unless the plan so provides or is amended to so provide. • The following options are available: • Plan can continue to pay benefits in the same form • Plan may automatically allow participants to change elections, triggering a new ASD • Plan sponsors may amend plan with a one-time opportunity for participants to change their elections

42. 4th Limit – Freeze on Future Benefit Accruals • Plans with less than 60% funding must freeze future benefit accruals • Once frozen, benefit accruals are not retroactively restored if funding improves • Plan may provide or be amended to provide for retroactive accruals but this is deemed to be a plan amendment increasing benefits • Under a special rules, plans that automatically restore missed accruals when AFTAP improves to 60% do not have to fund to the 80% AFTAP level unless the accruals have been frozen for more than one year • Worker, Retiree, and Employer Recovery Act of 2008 will not impose this restriction for the 2009 plan year if the plan was at least 60% funded during 2008

43. Material Change in AFTAP: Asset Smoothing • After AFTAP certified for 2008, plan sponsor changes asset smoothing method • Certified AFTAP > 80%, but now < 80% • Plan pays full lump sums • Revised certification is required • Could subject plan to disqualification [2009 EA Meeting Gray Book, #18]

44. Three Ranges of AFTAP • AFTAP is between 80% to 99% - bankrupt ER must limit benefit increases + prohibited payments • AFTAP is between 60% to 79%, no benefit increases + partial ban on accelerated payments • AFTAP is below 60%, all the restrictions apply • Three of the restrictions can be avoided if the ER makes additional contributions

45. Can the Plan Pay Lump Sums? • Under PPA, a plan can pay full lump sum benefits only if its AFTAP is 80% or more • WRERA exception: can pay lump sum if PVAB is less than $5,000

46. WRERA Exception? • Lump sums are allowed despite 436(d) restrictions • Payment of a benefit under section 411(a)(11) • May be distributed without consent of the participant • Applicable to beneficiaries, alternate payees, and 401(a)(9)

47. Statutory Presumptions • Intent: Obtain the actuarial certification ASAP during PY • First Two Ranges are split into two halves • Range 1: 80% to 89% and 90% to 99% • Range 2: 60% to 69% and 70% to 79% • Jan. 1st – current year AFTAP same as prior year AFTAP • April 1st – if prior year AFTAP was in first half of either range, current year AFTAP = prior year AFTAP less 10% • Oct. 1st – current year AFTAP deemed to be < 60% • Transitional rules for determining 2007 AFTAP

48. Range Certification • Actuary can certify that current year AFTAP is in one of 3 ranges: • 60% to 79% • 80% to 99% • 100% or higher • Advantage: ignore the first two statutory presumptions • Disadvantage: must make actual certification of AFTAP by Oct. 1st + actual AFTAP must fall within the range • If actual AFTAP is not within the range, plan may have failed the qualification rules or not been administered in accordance with its terms • If the actuary makes a range certification, plan is treated as having a certified AFTAP at the smallest value within the range • For example, if range certification is 60% to 79%, then AFTAP is deemed to be 60%

49. End of Year Valuationsfor Small Plans (< 100 participants) 2009 AFTAP Use 12/31/08 Funding Target + 2008 Target Normal Cost Use 12/31/08 assets Decreased by credit balance as of 1/1/09 (adjusted for earnings/losses based on 2008 actual rate of return if Assets < 94% 12/31/08 Funding Target or 12/31/07 Assets < 92% 12/31/07 Current Liability Increased for any 2008 contributions (discounted back to 1/1/09) made by the date of certifying the AFTAP

50. What Asset Value is Used? • Must be same value as used for §430 purposes • Fair market value on valuation date • Use FMV in calculating average value of assets • FMV does not have to be updated to match audited assets • If §430 asset value changes, then AFTAP must be updated [2008 EA Meeting Gray Book, Q&A 20]