Consulting Firm Offers Comments on Minimum Present Value Regs

To Whom It May Concern:

Mercer is pleased to provide input to the Treasury Department and the Internal Revenue Service on proposed regulations under Internal Revenue Code (IRC) Section 417(e) relating to the minimum present value requirements applicable to certain defined benefit pension plans. Mercer is a global consulting firm helping more than 1,500 US employers address retirement plan risks and evolving realities such as market volatility, uncertain liabilities, shifting regulations, and pressure to reduce expenses and contributions.

While Mercer agrees the regulations need updating and generally supports the proposal, we have certain compliance concerns. Our comments focus on the following areas:

• Plans with subsidized early retirement annuities. The current requirement to have a minimum present value equal to the present value of the annuity payable at normal retirement age determined in accordance with section 417(e)(3) provides the protection required by section 417(e)(3) and should not be modified.

• Social Security level income options (SSLIOs). An SSLIO with a continuing lifetime annuity is a combination of a temporary annuity and a lifetime annuity, both starting on the same annuity starting date. Plans offering SSLIOs should be allowed to apply 417(e)(3) minimum present value rules to only the temporary annuity portion of the benefit, rather than the total benefit.

• Clarification of treatment or preretirement mortality. The proposed clarification that preretirement mortality is taken into account when determining the minimum present value of employer-provided accrued benefits, but is ignored when determining the minimum present value of accrued benefits derived from participants' own contributions, raises potential compliance concerns for plans that currently ignore preretirement mortality when valuing employer-provided accrued benefits and with respect to distributions commencing after a participant's normal retirement date.

The Treasury Department and the IRS specifically request comments on:

We agree with the court's decision and believe Treasury Regulations § 1.411(a)-11(a)(2) should be modified to clarify that this approach is acceptable. The requirement to have a minimum present value equal to the present value of the annuity payable at normal retirement age determined in accordance with section 417(e)(3) provides the level of protection required by section 417(e)(3) and should not be changed. Employers that wish to provide, in the court's words, "some icing on the early retirement cake" by offering a lump sum that includes the early retirement subsidy -- determined with fixed plan assumptions -- should not be required to further increase the lump sum to equal the present value of the early retirement annuity using variable 417(e)(3) assumptions. Doing so could force substantial additional costs on employers beyond what they contemplated when the related plan design decisions were made. It would also require affected employers to modify their benefit calculation systems, incurring substantial administrative costs.

Social Security level income options

An SSLIO with a continuing lifetime annuity is a combination of a temporary annuity and a lifetime annuity, both starting on the same annuity starting date. For example, an SSLIO paying $1,800 per month from age 55 to age 62 and $500 per month thereafter consists of (i) a seven-year temporary annuity of $1,300 per month (which would be subject to 417(e) minimum present value rules) plus (ii) a lifetime annuity of $500 per month, both starting at age 55. The 417(e)(3) minimum present value rules should apply to only the temporary annuity portion of the benefit -- not the total benefit -- as provided in recently finalized Treasury Regulations § 1.417(e)-1(d)(1)(ii)(B). To facilitate this option, Treasury Regulations § 1.417(e)-1(d)(7)(ii)(B) should be modified to include the text highlighted in red font below:

The proposal to clarify that preretirement mortality is taken into account when determining the minimum present value of employer-provided accrued benefits, but is ignored when determining the minimum present value of accrued benefits derived from participants' own contributions, raises compliance concerns for plans that currently ignore preretirement mortality in minimum present value calculations. It also raises a number of concerns with respect to benefits starting after normal retirement date.

Plans that currently ignore preretirement mortality in minimum present value calculations

Many plans that provide death benefits at no cost to participants currently ignore preretirement mortality when determining the minimum present value of employer-provided accrued benefits. The proposed clarification that preretirement mortality should be taken into account in this calculation without regard to a plan's death benefit provisions raises a compliance "catch-22" for these plans:

• Amending the plan to take preretirement mortality into account would appear to be a reduction in an optional form of payment that is prohibited under Code Section 411(d)(6) anti-cutback rules. Furthermore, some plans may be operating under court orders requiring them to ignore preretirement mortality. It would be difficult and costly for these plans to change their minimum present value calculations, even if anti-cutback relief were available.

• Continuing to ignore preretirement mortality could violate the requirement in Treasury Regulations § 1.401(a)-20, Q&A-16, that the qualified joint and survivor annuity (QJSA) for married participants must be at least as valuable as any other optional form of benefit payable under the plan at the same time. The exception to this "QJSA-most-valuable rule" for 417(e) payment forms apparently would not be available to these plans because the minimum present value calculated ignoring preretirement mortality would exceed the amount "calculated using the applicable interest rate (and, for periods when required, the applicable mortality table) under section 417(e)(3)."

• Revise Treasury Regulations § 1.401(a)-20, Q&A-16, to provide that plans do not violate the QJSA-most-valuable rule merely because the amount payable under an optional form subject to the minimum present value requirement of section 417(e)(3) is calculated using the applicable interest rate and applicable mortality table, regardless of whether preretirement mortality is ignored or taken into account in that calculation.

• Provide anti-cutback relief for plan amendments to determine the 417(e)(3) minimum present value of employer-provided accrued benefits reflecting preretirement mortality, if adopted by the last day of the plan year in which the final rule first takes effect for the plan.

The proposal would provide that the present value of a 417(e) payment form "cannot be less than the present value of the accrued benefit payable at normal retirement age, except to the extent that, for an optional form of benefit payable after normal retirement age, the requirements for suspension of benefits under section 411(a)(3)(B) are satisfied." In addition, the proposal would provide "Except as provided under paragraph (d)(2)(ii)(B) of this section, the probability of death under the applicable mortality table is taken into account for purposes of determining the present value under this paragraph (d) without regard to the death benefits provided under the plan (other than a death benefit that is part of the normal form of benefit or part of another optional form of benefit, as described in § 1.411(d)-3(g)(6)(ii)(B), for which present value is determined)." The proposed requirement to take preretirement mortality into account when valuing employer-provided benefits, regardless of the plan's death benefit provisions, could be interpreted to apply both before and after normal retirement date.

These provisions raise questions as to exactly what IRS intends with respect to benefits starting after the participant's normal retirement date:

• When a participant remains in service after normal retirement date, how do benefits accrued after normal retirement date factor into minimum present value calculations (if at all)?

• When benefits are actuarially increased for late retirement (rather than suspended), must the late retirement increase be determined using 417(e)(3) assumptions with respect to 417(e) payment forms, rather than with plan factors?

• To prevent a forfeiture under Code Section 411, must actuarial increases for late retirement include a survivorship credit, even when benefits aren't forfeited by death before the starting date, regardless of whether the payment form is subject to the minimum present value requirements of Section 417(e)(3)?

Assumptions used to determine the late retirement adjustments. The proposed clarification could be interpreted as requiring plans to use 417(e) assumptions -- taking preretirement mortality into account -- in the late retirement adjustment calculation as well as in the optional payment form factor in step 2. This would be a significant change for most plans and raises a number of concerns:

• 417(e) interest and mortality assumptions, which change at least annually, are inherently forward-looking in that they are current as of the annuity starting date and, in the case of the segment rates, apply to specific future periods. This structure does not logically lend itself to application to periods prior to the annuity starting date, as is required when determining actuarial increases for late retirement. For example, consider a plan that uses a plan-year stability period to set 417(e) assumptions. Could the plan use the 417(e) assumptions in effect on the annuity starting date to determine the actuarial increase for the entire period from normal retirement date to late retirement date? If so, what interest rate should apply for the period from normal retirement date to annuity starting date? Or would the plan need to use the 417(e) assumptions in effect during each plan year to determine the actuarial increase for that plan year, and the assumptions in effect at the late retirement date to determine the optional form factor? Requiring the latter would greatly complicate late retirement calculations and require extensive reprogramming of benefit calculation systems.

• Plans providing ancillary death benefits between normal and late retirement date would be forced to pay for them twice: once by providing ancillary death benefit coverage to participants during this period (and paying benefits to surviving spouses or other beneficiaries of deceased participants), and a second time by providing survivorship credits to those who survive to their late retirement date. This situation differs fundamentally from payments made before normal retirement age, where the death benefit coverage hasn't been provided by the time payments commence and could be taken away (by imposing a charge on participants) at any time. In the late retirement case, the retiring participant has already received the death benefit coverage and as a result it is no longer forfeitable. Requiring late retirement adjustments to include a survivorship credit regardless of the plan's death benefit could lead these plans to drop ancillary death benefits, to the detriment of plan participants and their surviving spouses or other beneficiaries.

• A requirement to take preretirement mortality into account in late retirement adjustments regardless of whether benefits are forfeited on death would be inconsistent with IRS rules for calculating 415 limits (Treasury Regulations § 1.415(b)-1(e)(3)).

Recommendation. The final regulations should make clear (and provide examples illustrating) that when a participant delays starting benefits until after normal retirement age, the accrued benefit at the participant's late retirement date reflects benefits accrued after normal retirement date and any actuarial adjustments for late retirement, as determined under the plan's terms, using the plan's actuarial equivalence assumptions, which may ignore preretirement mortality to the extent benefits are not forfeited upon death, consistent with Treasury Regulations § 1.415(b)-1(e)(3). The 417(e) minimum present value of a late retiree's accrued benefit is the actuarial equivalent of the accrued benefit payable at the participant's late retirement date in the plan's normal form of payment, determined using the 417(e) applicable interest and mortality assumptions. Preretirement mortality is not relevant for late retirement calculations because the 417(e) and normal form benefits use the same annuity starting date.

If you have any questions or would like to discuss these items further, please contact me via phone or email at (212) 345-7257 or bruce.cadenhead@mercer.com.

Sincerely,