Honor thy 409A grandfather

Pizzano-DominickThis blog is part of a 12-part series entitled “The nonqualified deferred compensation plan (NDCP) dirty dozen: An administrative guide to avoiding 12 traps.” To read the introduction to the series, click here.

Section 409A certainly has set forth more than its fair share of commandments; however, “Honor thy 409A grandfather” has to rank very close to the top of the “most need to follow” list. While Section 409A’s regulatory reach has been described as overwhelmingly widespread, there is still one 409A-free safe haven for NDCP sponsors and participants – the past. Because the 409A rules generally are effective only for amounts deferred after December 31, 2004, benefits attributable to the period prior to January 1, 2005, can avoid 409A coverage provided that they are correctly calculated under and maintained in accordance with the grandfather rules. This blog will review these rules in an effort to provide NDCP sponsors with a reminder of the importance of preserving their grandfathers and a guide to assisting them with such maintenance.

Correct creation and identification of the grandfather
As briefly indicated above, this topic only affects those NDCPs that were in effect prior to January 1, 2005 (i.e., the date that 409A officially became effective). Furthermore, even if an NDCP was in effect prior to that date, the grandfather treatment is only available if the NDCP sponsor made a timely decision to elect grandfathering and met the required documentation and administrative conditions to effect such treatment. To meet the documentation requirement, the sponsor would have had to adopt an amendment to the plan clearly stating that the applicable amounts would be grandfathered and that only the benefits accrued on and after January 1, 2005, would be subject to the 409A rules. The administrative requirement is a bit trickier. First, the plan sponsor had to correctly identify and calculate the permissible amount to be grandfathered. The general rule is that grandfathered treatment is available for any amounts that were both earned and vested as of December 31, 2005. The specific calculation of the applicable amounts depends on whether the NDCP under consideration is a defined contribution (DC) or defined benefit (DB) style plan:

DC style
The permissible grandfather amount equals the sum of (1) the vested portion of the participant’s account balance as of December 31, 2004, plus (2) any future contributions to the account, the right to which was earned and vested as of December 31, 2004, to the extent such contributions were actually made, plus (3) any future earnings (whether actual or notional) on such amounts.

DB style
As one might imagine, the calculation of the permissible grandfathered amount under DB style is considerably more complex. It equals the present value of the amount to which the participant would have been entitled under the plan if such participant (1) voluntarily terminated services without cause on December 31, 2004, (2) received a payment of the benefits available from the plan on the earliest possible date allowed under the plan to receive a payment of benefits following the termination of services, and (3) received the benefits in the form with the maximum value. There are various ways that this amount may increase over time without violating the grandfather rules; however, an increase in the potential benefits under a DB NDCP due to, for example, an application of an increase in compensation after December 31, 2004, to a final average pay plan or subsequent eligibility for an early retirement subsidy does not constitute earnings on the amounts deferred under the plan before January 1, 2005, and thus are not permissible reasons to increase the grandfathered amount. A complete description of how such increases can occur without violating the grandfather rules is beyond the scope of this blog. The calculation of any such increases should be made by the sponsor only after consultation with its actuary and legal counsel to ensure that they are completed in a permissible manner. The 409A rules indicate that when performing such calculations, “reasonable” actuarial assumptions and methods must be used. While no exact definite of “reasonable” is offered, the rules do provide two pieces of guidance to assist with this process:

(1) Whether assumptions and methods are reasonable for this purpose is determined as of each date the benefit is valued for purposes of determining the grandfathered benefit, provided that any reasonable actuarial assumptions and methods that were used by the plan sponsor with respect to such benefit as of December 31, 2004, will continue to be treated as reasonable assumptions and methods for purposes of calculating the grandfathered benefit.

(2) Actuarial assumptions and methods will be presumed reasonable if they are the same as those used to value benefits under the qualified plan maintained by the NDCP, provided that such qualified plan’s benefits are part of the benefit formula under, or otherwise affect the amount of benefits under, the NDCP.

Accordingly, sponsors need to have not only correctly calculated their plan’s original grandfathered amounts, but also to have established and continue to maintain administrative systems that accurately track such amounts (along with any applicable future earnings attributable to such amounts) separately from any non-grandfathered amounts that may exist under their plans.

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Communicating lump-sum windows

Lump-sum windows are common ways for defined benefit (DB) plan sponsors to shed pension liabilities. According to Milliman consultant David Benbow, effective communication is essential when employers consider offering of a lump-sum window. He offers his perspective in a recent Money Management Intelligence article.

Here is an excerpt:

Three things are necessary to make a lump-sum window successful: communication, communication, communication. In addition to the required legal notices informing participants of their rights, you should do your best to create a package that is eye-catching (not many people read their mail after it goes in the trash) and easy to read (if it reads like stereo instructions, people will jump to the election forms and make up their own rules). The communication should spell out the pros and cons of taking a lump sum so that the participant can make an informed decision. The last thing anyone wants is for a well-intended offer to turn into a class action because participants were misled.

It takes time to create a good communication package, and usually there will be several people who wants to take a whack at the piñata, including legal counsel. Just know that clear communication up front will reduce the number of questions and follow-up on the back end.

For more Milliman perspective on lump-sum distributions, click here.

Managing Australian’s longevity and investment risk closer to retirement

Reducing an investor’s exposure to growth assets as they approach retirement is common. However, this strategy may increase the chance that an investor will outlive their retirement savings. This is a predicament that many Australians face. In his article “Australia’s retirement challenge,” Milliman consultant Wade Matterson offers some perspective on how strategies employing derivatives can help Australians manage longevity and investment risks.

Regulatory roundup

More retirement-related regulatory news for plan sponsors, including links to detailed information.

IRS nixes use of safe harbor if lump sum is not equal to cash balance plan hypothetical account balance
The Internal Revenue Service (IRS) released Chief Counsel Memorandum 2016032811224324, which responds to a taxpayer’s question about a cash balance plan’s eligibility for the tax code section 411(b)(1)(H) safe harbor rules that pertain to lump-sum based benefit formulas and indexed benefits.

The memo focuses on cash balance plans that provide that a lump-sum distribution that is not equal to the participant’s hypothetical account balance but instead is determined as the present value of the participant’s accrued benefit using the actuarial assumptions specified in tax code section 417(e)(3). The IRS concludes that because the amount of the single-sum distribution is not equal to the hypothetical account balance, the plan is not eligible for the safe harbor rules.

To read the entire memo, click here.

Recurring plan issues found in determination case review
The IRS posted a number of defects in plan language that would require corrective amendments and delay the issuance of a determination letter.

For more information, click here.

IRS Chief Counsel issues memo on minimum participation standards; testing otherwise excludable employees
The IRS released Chief Counsel Memorandum 201615013, which responds to whether certain positions related to the definition of “otherwise excludable employees,” used for purposes of coverage testing under § 410(b)(4)(B) and computing the actual deferral percentage (ADP) under § 401(k)(3), are supportable.

To read the entire memo, click here.

IRS webinar on related to 401(b) retirement plan
The IRS has scheduled a free webcast entitled “Understanding the universal availability rules in a 403(b) retirement plan” on Thursday, May 19, 2016 at 2 pm EST. The webinar will focus on the following:

• Basic universal availability rules
• Treatment of adjunct faculty at universities
• Treatment of part-time, seasonal, and temporary employees
• The 20 hours per week and the 1,000 hours rules
• Controlled group situations and concerns
• Mayo ruling on medical residents and its impact
• The required notice to employees each year
• Ways to find, fix, and avoid universal availability errors

To register for the webinar, click here.

Multiemployer pensions lost $26 billion in funded status during the second half of 2015

Campe-KevinMilliman today released the results of its Spring 2016 Multiemployer Pension Funding Study, which analyzes the funded status of all multiemployer pension plans. In the second half of 2015, these pension plans experienced a funding percentage decrease of 4%, declining from 79% at the end of June to 75% at the close of 2015. During that time, pension liabilities for these plans increased by $8 billion and the market value of assets declined by $18 billion, resulting in a $26 billion-increase in the funded status shortfall. Since undergoing a minor rally in funded status that peaked in 2013, multiemployer pensions have experienced continued deterioration in funded status.


Multiemployer plans continued to be stuck in a rut in 2015. Currently at least 76 plans with $28 billion of shortfall are projected to be insolvent at some point. These plans may be beyond help at this point, and several more may be headed this direction.

Results vary by plan. Of the plans studied, 192 were over 100% funded at year end (compared to the 279 plans over 100% funded as of June 30, 2015). The number of plans that are less than 65% funded grew from 214 to 264. The most poorly funded pensions are of particular interest, because plans in “critical and declining status” may reduce benefits in an effort to stay solvent. Currently, 31 of the critical plans who have reported results have stated they are projected to go insolvent before 2025, and this number could rise as more plans file their reports.

Regulatory roundup

More retirement-related regulatory news for plan sponsors, including links to detailed information.

Withdrawal of proposed nondiscrimination rules
The Department of the Treasury and the IRS announce that they will withdraw certain provisions of proposed regulations published on January 29, 2016 relating to nondiscrimination requirements applicable to qualified retirement plans under § 401(a)(4).

The provisions of the proposed regulations that will be withdrawn are the provisions that would modify §§ 1.401(a)(4)-2(c) and 1.401(a)(4)-3(c). These provisions were intended to address certain qualified retirement plan designs that take advantage of flexibility in the existing nondiscrimination rules to provide a special benefit formula for selected employees without extending that formula to a classification of employees that is reasonable and established under objective business criteria.

For more information, click here.

New PBGC multiemployer data tables
The Pension Benefit Guaranty Corporation (PBGC) released the “2013 PBGC data tables: Multiemployer supplement” containing 10 charts that illustrate zone status over time (participant); zone status over time (plans); direction of zone status changes; zone status and tests for declining status; and administrative expenses (across various parameters).

To download the tables, click here.

GASB releases pension guidance addressing issues raised by stakeholders during implementation
The Governmental Accounting Standards Board (GASB) issued guidance addressing practice issues raised by stakeholders during implementation of the GASB’s pension accounting and financial reporting standards for state and local governments. GASB Statement No. 82, Pension Issues, addresses:

• Presentation of payroll-related measures in required supplementary information
• Selection of assumptions and the treatment of deviations from guidance in Actuarial Standards of Practice for financial reporting purposes
• Classification of payments made by employers to satisfy plan member contribution requirements.

The statement is designed to improve consistency in the application of the pension standards by clarifying or amending related areas of existing guidance.

For more information, click here.

Funded status deficit increases to $390 billion after rates fall below 4%

Wadia_ZorastMilliman today released the results of its latest Pension Funding Index (PFI), which analyzes the 100 largest U.S. corporate pension plans. In March, these pension plans experienced a $20 billion decrease in funded status due to a $30 billion increase in asset values and a $50 billion increase in pension liabilities. The funded status for these pensions decreased from 78.4% to 77.9%.


These pensions lost $83 billion in the first quarter. We saw impressive asset performance last month, but with rates slipping back below 4% for the first time since May 2015, we have an even deeper pension funding hole. Hopefully this trip below 4% is brief—the prior visit to record-low territory lasted seven months.

This edition of the PFI reflects the annual update of the Milliman 2016 Pension Funded Study, which was released on April 7.

Looking forward, under an optimistic forecast with rising interest rates (reaching 4.23% by the end of 2016 and 4.83% by the end of 2017) and asset gains (11.2% annual returns), the funded ratio would climb to 86% by the end of 2016 and 98% by the end of 2017. Under a pessimistic forecast (3.33% discount rate at the end of 2016 and 2.73% by the end of 2017 and 3.2% annual returns), the funded ratio would decline to 73% by the end of 2016 and 66% by the end of 2017.

Overview of GASB Statements 73, 74, and 75

In June 2015, the Government Accounting Standards Board (GASB) released new accounting standards for public sector postretirement benefit programs and the employers that sponsor them. GASB Statement 73 is for accounting and financial reporting for pensions not within the scope of GASB Statement 68 and will apply for employer fiscal years beginning after June 15, 2016. GASB Statements 74 and 75 reflect a fundamental overhaul in the standards for accounting and financial reporting for postemployment benefits other than pensions. GASB 74 is effective for plan fiscal years beginning after June 15, 2016, and GASB 75 is effective for employer fiscal years beginning after June 15, 2017. In this article, Milliman’s Daniel Wade provides an summary of GASB Statements 73, 74, and 75.

Pension eligibility in Canada

Longer life expectancy can put a financial strain on pension plans because more money is needed to pay beneficiaries for an extended period of time. One solution enacted by the Canadian government in 2012 was to gradually increase the eligibility age for its Old Age Security Pension program from 65 to 67. However, Canada is returning the eligibility age to 65 this year.

In this Globe and Mail article, Eckler actuary and managing principal Jill Wagman discusses the effects that increased life expectancy has on pensions, providing reasons for the age requirement to remain at 67.

Here is an excerpt:

In 1967, the eligibility age was changed to 65, and the expected payout period was 15 years. Today, the average life expectancy for a 65-year-old Canadian is more than 20 years – a third longer than the payout period anticipated in 1967. If the eligibility age isn’t changed, the payout period will continue to grow as life expectancy increases….

According to the latest OECD Pensions Outlook Report, postponing retirement as life expectancy increases is the best approach to address the challenges faced by publicly funded pay-as-you-go pension schemes. The United States, Britain, Germany, France, Spain, Italy and the Netherlands all have plans in place to increase the general retirement age to 67 from 65 by 2028 or sooner. Canada should be taking similar measures.

Regulatory roundup

More retirement-related regulatory news for plan sponsors, including links to detailed information.

Final fiduciary conflict of interest rule issued
The Department of Labor (DOL) released its final “Conflict of interest rule.” The rule contains final regulation defining who is a “fiduciary” of an employee benefit plan under the Employee Retirement Income Security Act of 1974 (ERISA or the Act) as a result of giving investment advice to a plan or its participants or beneficiaries. The final rule also applies to the definition of a “fiduciary” of a plan (including an individual retirement account (IRA)) under the Internal Revenue Code of 1986 (Code). The final rule treats persons who provide investment advice or recommendations for a fee or other compensation with respect to assets of a plan or IRA as fiduciaries in a wider array of advice relationships.

To read the entire final rule, click here.

Correct the failure to adopt the pre-approved plan by the applicable deadline
The IRS introduced a new option for an employer to correct not signing a pre-approved defined contribution (DC) retirement plan by the deadline. The new option allows the financial institution or service provider that offers the plan document to request a closing agreement on behalf of all adopters who missed the deadline.

For more information, click here.

Cautionary note on discriminatory plan designs using short service
The IRS published commentary concerning recently found discriminatory plan designs in DC plans, defined benefit (DB) plans, and DB/DC combination plans. These plans provide significant benefits to the highly compensated employees (HCEs) and a specified group of non-highly compensated employees (NHCEs), who work very few hours or receive very little compensation, and exclude other NHCEs from plan participation.

For more information, click here.

GAO publishes report on retirement security
The Government Accountability Office (GAO) released “Retirement security: Shorter life expectancy reduces projected lifetime benefits for lower earners.” The report examines the implications of increasing life expectancy for retirement planning and the effect of life expectancy on the retirement resources for different groups, especially those with low incomes.

To read the entire report, click here.