Category Archives: Defined benefit

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.

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.

Milliman Hangout: 2016 Pension Funding Study

The 100 largest U.S. corporate pension plans experienced a minuscule funding improvement of 0.1% in 2015, according to the Milliman 2016 Pension Funding Study. The aggregate funded ratio increased from 81.7% to 81.8% based on a $75.8 billion decrease in the market value of plan assets and a $94.5 billion decrease in the projected benefit obligation (PBO). This resulted in an $18.7 billion improvement in funded status.

In this Milliman Hangout, PFS coauthor Zorast Wadia discusses the results of the study with Amy Resnick, editor of Pensions & Investments.

To read the entire study, click here.

The 100 largest U.S. corporate pension plans’ funded status improved by only 0.1% in 2015

Wadia_ZorastMilliman today released the results of its 2016 Pension Funding Study, which analyzes the 100 largest U.S. corporate pension plans. In 2015, these pension plans experienced a relatively small funding improvement of 0.1%, as the aggregate funded ratio increased from 81.7% to 81.8% based on a $75.8 billion decrease in the market value of plan assets and a $94.5 billion decrease in the projected benefit obligation (PBO). This resulted in an $18.7 billion increase in funded status. The miniscule improvement belies the fierce dynamics facing these pensions last year.

2014 2015 CHANGE
MARKET VALUE OF ASSETS $1,453.6 $1,377.8 ($75.8)
PROJECTED BENEFIT OBLIGATION $1,779.7 $1,685.2 ($94.5)
FUNDED STATUS ($326.1) ($307.4) ($18.7)
FUNDED PERCENTAGE 81.7% 81.8% 0.1%
NET PENSION INCOME/(COST) ($37.3) ($33.7) $3.6
DISCOUNT RATE 4.00% 4.25% 0.25%
ACTUAL RATE OF RETURN 10.8% 0.9% -9.9%
Note: Numbers may not add up precisely due to rounding

What a strange year for these 100 pension plans. These pensions weathered volatile markets, unpredictable discount rate movements, adjusted mortality assumptions, pension risk transfers, and an industry-wide decline in cash contributions…and yet they still finished the year almost exactly where they began. Given all that transpired in 2015, plan sponsors may be relieved that plans did not experience funded status erosion like that of the prior year. But that doesn’t change the fact of a pension funded deficit in excess of $300 billion.

Study highlights include:

Surprising move toward spot rates. Thirty-seven of the largest 100 plan sponsor companies will record fiscal year 2016 pension expense using an accounting method change linked to the spot interest rates derived from yield curves of high quality corporate bonds. The move to spot rates will result in pension expense savings.

Actual returns well below expectations. Actual plan returns were 0.9% for the year—just a fraction of the expected 7.2%.

Impact of updated mortality assumptions. Pension obligations at the end of 2015 were further reduced to reflect refinements in mortality assumptions. While we are unable to collect specific detail regarding the reduction in PBO, a 1% to 2% decrease has been anecdotally reported. Additional revisions to mortality assumptions may be published in the fourth quarter of 2016.

Cash contributions reduced by almost $9 billion. Approximately $40 billion was contributed in 2014, with that number falling to $31 billion in 2015. The likely cause of the decline: the continuation of interest rate stabilization (funding relief) courtesy of the Bipartisan Budget Act of 2015.

Pension Risk Transfers continue. The estimated amount of pension risk transfers collected from the accounting disclosures was nominally higher in 2015 ($11.6 billion) compared to 2014 ($11.4 billion). It seems likely these transactions may increase in 2016, spurred by the significant increases during 2015 in premiums payable to the Pension Benefit Guaranty Corporation (PBGC); the extension of these premium rate increases was also courtesy of the Bipartisan Budget Act of 2015.

Equity allocations reach a record low. By the end of 2015, equity allocations had dropped to 36.8%, the lowest in the 16-year history of this study. In recent years, the companies in the study generally shifted toward fixed income investments. However, unlike 2014—when plans with high allocations to fixed income outperformed plans with lower allocations—2015 saw plans with higher allocations to fixed income experience the same rate of return as those with lower allocations to fixed income.

Under the radar. The 2016 Pension Funding Study also reports on the funded status of Other Postemployment Benefits (OPEB) Plans.

To download the study, click here.

Top hat plans are not one size fits all

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.

“Nonqualified deferred compensation plan” (NDCP) is a widely used term and has even been set in statutory stone by its inclusion as a definition in the final 409A regulations.  However, while 409A defines what constitutes such a plan and creates numerous rules governing these arrangements, one area it does not address is which employees of the plan sponsor are permitted to participate in an NDCP.  Nevertheless, accurately capturing the correct covered group is an essential first step and ongoing process for NDCP sponsors.  So who exactly can be included in an NDCP? Well, due to the lack of any specific, official government guidance on this topic, the process of determining the answer to that question is really more of an art than a science.  In order to attempt to paint a proper picture of permissible NDCP participation, we must first look to the Employee Retirement Income Security Act (ERISA).

Sizing NDCPs for an ERISA’s “top hat”
ERISA imposes a number of substantive and procedural requirements on qualified plans.  Similarly, the Internal Revenue Code (IRC) creates additional restrictions through its various limitations on compensation and benefit amounts. However, ERISA includes an exemption for plans that are unfunded and “maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees.”  Plans that fit this standard are exempt from many ERISA and IRC requirements and are commonly referred to as “top hat” plans.  However, given that to date the only official ERISA definition of which employees can be included in such plans consists solely of the above general description, the identification process, like art, is very much subject to interpretation.

While the IRC has its own definition of “highly compensated employee,” this definition is not the standard for “top hat plan” purposes. The U.S. Department of Labor (DOL) has the authority to impose ERISA penalties and thus it is the DOL definition that must be met. Generally, the IRC definition is much less restrictive than the DOL definition. In fact, the DOL has indicated that the IRC definition of highly compensated employee (generally earning at least $120,000 for 2016 limit as indexed) is not appropriate for this purpose. The DOL would presumably focus on a more restrictive group of employees as it issued a past ERISA advisory opinion that warned employers to restrict eligibility for top hat plans to only those individuals who, by virtue of their position in the company, have the ability to negotiate the terms of their employment and thus influence the design and operation of the plan. This rule would be very limiting and, as several commentators have noted, would exclude some people who in the past clearly have been considered “top hat” individuals. The DOL, however, has never issued regulations formalizing its position on this matter. 

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Will more corporations need to file PBGC Form 4010 for their defined benefit pension plans for the 2016 fiscal year?

Kamenir-JeffThis blog post was originally published on January 5, 2016. It has been updated to reflect the PBGC’s final rule in March 2016.

The Pension Benefit Guaranty Corporation (PBGC), the federal agency responsible for insuring unfunded liability for single-employer defined benefit pension plans in the event of a distress plan termination, issued final guidance in March 2016 that will likely increase the number of companies required to submit a 4010 filing for the 2016 fiscal year and beyond. An example of a circumstance in which a distress plan termination can occur is when a company files for bankruptcy.

The PBGC is charged under federal law with monitoring poorly funded defined benefit pension plans in part by requiring a special filing under ERISA Section 4010, commonly referred to as a “4010 filing.” This filing requires the employer to submit defined benefit pension plan financial and actuarial information as well as the company’s financial information. The filing is generally due three and a half months after the end of the fiscal year. The PBGC keeps this information shielded from public disclosure, which protects the privacy of closely held companies, which are not required to follow U.S. Securities and Exchange Commission (SEC) regulatory rules for listed companies.

Under current rules, employers with defined benefit pension plans that are less than 80% funded based on prescribed interest rates are required to report under Section 4010 unless they can meet the requirements for certain limited exemptions. Plans with under 500 participants are exempt if they are underfunded by $15 million or less. Companies that sponsor one or more pension plans with a combined participant count of 500 or more are exempt if the combined underfunding of all plans is $15 million or less.

Beginning with the 2016 fiscal year, PBGC modified the actuarial assumptions used for determining the underfunding exemption if the combined pension plan participant count is 500 or more. The modified assumptions use lower interest rates for determining pension plan liabilities that will increase liabilities and therefore make it more difficult to qualify for the underfunding exemption. For example, a plan with 500 or more participants that is less than 80% funded and may have been exempt from submitting a 4010 filing because the underfunding was less than $15 million may no longer qualify for the exemption under the new final rules. A guess is that this plan deficit would swell to over $15 million and a 4010 filing will be required. On the other hand, if the combined participant count is less than 500, the final rules automatically exempt the plans from 4010 filing requirements.

Companies that sponsor pension plans with 500 or more participants that wish to avoid the 4010 filing requirements under the final rules should work with their actuaries to take steps to bring each plan up to at least 80% funded for the 2016 plan year or to meet the $15 million or less underfunding exemption based on the newly required actuarial assumptions.

Lack of guidance may extend “window” for lump-sum distributions

The Internal Revenue Service (IRS) has not issued the anticipated guidance pension plan mortality tables. A recent Bloomberg BNA article quotes Milliman’s Zorast Wadia discussing what plan sponsors must consider, or reconsider, if the IRS does not issue guidance in the coming months.

“The longer we go into 2016 without seeing the IRS issue guidance on new mortality tables,” the less likely such guidance will be issued this year and in place for plans to follow before 2018, said Zorast Wadia, a principal and consulting actuary in the benefits consulting firm Milliman’s New York office… sponsors may want to begin monitoring interest rates to determine the optimal time to offer lump-sum distributions, Wadia said.

Until recently, many plan sponsors and their advisers have been anticipating that these new mortality tables would be required for plans in 2017. The tables are expected to incorporate longer life expectancies and thus make it more expensive for sponsors to offer lump-sum payouts to participants. A delay in the required use of the tables could affect a sponsor’s decision on whether to offer a lump-sum window—a temporary opportunity to take benefits in that form—in 2016.

Wadia said the IRS must also decide whether its new guidance will incorporate the original base tables issued by the Society of Actuaries [SOA] in 2014 with their revised projection scales issued in 2015 or some other basis.

In a 2015 Benefits Law Journal article, Zorast offered perspective on how implementation of the new SOA mortality tables would reduce the accounting gains that are one of the key economic benefits associated with lump-sum distributions. Therefore, if the IRS does not issue guidance concerning mortality tables this year, plan sponsors may have an extended window to consider the potential benefits of offering lump-sum distributions. Any lump-sum offering would of course require a strong communication and education effort to ensure that plan participants are well equipped to make the important retirement decision that lies ahead.

To read the article, click here.

Harmonizing DB plan documents and administration

Tax-qualified plans must not only comply with certain rules and regulations but also remain true to the terms of the plan document itself. Plan sponsors need to remain aware of the operational procedures stipulated within their plan documents. In this Benefits Perspectives article, Milliman’s Dominick Pizzano reviews a few common provisions found in DB plans that at the very least can produce frustration for administrators and, at worst, create scenarios where the plan no longer operates in accordance with the document, potentially resulting in fines and fees. He also provides perspective on how plan sponsors can administer the plan in harmony with its document as well as federal rules.

Funded status deficit increases by $35 billion in February, has ballooned by $68 billion so far in 2016

Milliman today released the results of its latest Pension Funding Index, which analyzes the 100 largest U.S. corporate pension plans. In February, these pension plans experienced a $35 billion decrease in funded status, which was due to a $5 billion decrease in asset values and a $30 billion increase in pension liabilities. The funded status for these pensions decreased from 80.8% to 79.1%.


The pension funding deficit continues to move in the wrong direction. In January, poor asset performance drove declining funded status. In February, interest rates were the culprits. We’re off to a rough start in 2016.

Looking forward, under an optimistic forecast with rising interest rates (reaching 4.56% by the end of 2016 and 5.16% by the end of 2017) and asset gains (11.3% annual returns), the funded ratio would climb to 89% by the end of 2016 and 102% by the end of 2017. Under a pessimistic forecast (3.56% discount rate at the end of 2016 and 2.96% by the end of 2017 and 3.3% annual returns), the funded ratio would decline to 73% by the end of 2016 and 66% by the end of 2017.