Title: 2006 Enrolled Actuaries Meeting Session 303 Mergers and Spinoffs: Applying Rules under 414lC
12006 Enrolled Actuaries MeetingSession
303Mergers and Spinoffs Applying Rules under
414(l)(C)
March 27, 2006
2Agenda
- Applying the rules of 414(l)
- Funding rules after mergers and spinoffs
- IRS Perspective
3Mergers and Spinoffs Applying Rules under 414(l)
- Lonie A. Hassel
- Groom Law Group, Chtd.
- 2006 Enrolled Actuaries Meeting
- March 27, 2006
4Section 414(l)
- Legal Requirements
- Agency Enforcement
- Applying the Rules
5414(l) Requirements
- In the case of merger, consolidation, or transfer
of assets or liabilities to another plan - Each participant in the plan would (if the plan
then terminated) receive a benefit immediately
after the merger, consolidation, or transfer
which is equal to or greater than the benefit he
would have been entitled to receive immediately
before the merger, consolidation, or transfer (if
the plan had then terminated)
6Internal Revenue Service
- Benefit determinations based on reasonable
actuarial assumptions - PBGC termination assumptions are safe harbor,
but not required - Current liability rate may be reasonable interest
rate for this purpose
7Pension Benefit Guaranty Corporation
- Does not enforce section 414(l), but could
intervene in a spinoff or merger under its Early
Warning Program - Under Early Warning Program, PBGC monitors
- Plan sponsors that have below investment grade
credit rating with plan that has more than 25
million in current liability - Plans that have more than 25 million in current
liability and more than 5 million in unfunded
current liability
8Pension Benefit Guaranty Corporation
- Early Warning Program may target the following
events that could involve a spinoff or merger - Break up of a controlled group
- Transfer of significantly underfunded pension
liabilities in connection with sale of business - Leveraged buy-out
- Major divestiture of assets and retention of
significantly underfunded pension liabilities
9Pension Benefit Guaranty Corporation
- Under Early Warning Program, PBGC has challenged
transactions in which part of a plan is spun off
to a financially weaker controlled group - PBGC has sought the use of safe harbor
assumptions to maximize assets in the plan
transferred to weaker controlled group
10Pension Benefit Guaranty Corporation
- Spinoff may be a reportable event
- 20 active participant reduction
- Change in contributing sponsor or controlled
group - Transfer of 3 or more of benefit liabilities
- Notice generally required within 30 days after
the event - Notice required 30 days before event for
non-public companies with defined benefit plans
less than 90 funded for vested benefits and with
more than 50 million in unfunded vested benefits
11Department of Labor
- May address spinoffs indirectly through its
authority to enforce fiduciary rules under
sections 404 and 406 of ERISA - Courts have concluded that decision to spin off
is not a fiduciary decision governed by fiduciary
rules - Implementing a spinoff decision may involve
fiduciary actions, but generally, compliance with
section 414(l) has been found to meet fiduciary
requirements - Failure to use safe harbor assumptions is not,
standing alone, a breach of fiduciary duty
12Allocating Excess AssetsSame Controlled Group
- Transfer of assets from an overfunded plan to
another plan in the same controlled group
requires transfer of applicable percentage of
excess assets - Applicable percentage is derived from a fraction
- Numerator is excess of plans full funding
liability over plans termination liability - Denominator is sum of all excess amounts for all
plans involved in transfer
13Allocating Excess AssetsSame Controlled Group
- Applicable percentage formula does not work
because termination liability generally exceeds
full funding liability - Plans therefore use reasonable method for
allocating excess assets, such as pro rata
14Allocating Excess AssetsDifferent Controlled
Group
- Transfer of assets from an overfunded plan to
another plan in a different controlled group does
not require transfer of excess assets - May trigger lawsuit by plan participants, however
- Where excess is not attributable to employee
contributions, courts have concluded that section
414(l) and parallel ERISA section 208 do not
require transfer of excess assets in spinoff to a
different controlled group
15Allocating Excess AssetsDifferent Controlled
Group
- Participants have sought a share of earnings on
assets pending transfer to new plan - Participants have challenged investment vehicle
for assets pending transfer to new plan
16Allocating Assets and Liabilities in Underfunded
Plan
- After the transfer, the funded level of each
participants benefit on a termination basis must
be the same as or better than the funded level of
the participants benefit on a termination basis
before the transfer - Benefits on a termination basis are benefits
determined under priority categories in section
4044 of ERISA
17Allocating Assets and Liabilities in Underfunded
Plan
- Priority categories are
- Benefits derived from voluntary participant
contributions - Benefits derived from mandatory participant
contributions - Benefits payable to participant who was or could
have retired three years before the
termination/transfer date - Guaranteed benefits
- Nonforfeitable benefits (vested benefits not
guaranteed by PBGC, e.g., benefits subject to
phase-in) - All other accrued benefits
18Allocating Assets and Liabilities in Underfunded
Plan
- Because assets are allocated first to benefits of
retirees, one plan could be less well-funded on
an aggregate basis after the spinoff if a
disproportionate number of retiree liabilities
are spun off to another plan
19Full Funding Upon Termination
- Is plan requirement of full funding upon
termination triggered by spinoff? - Requires careful examination of plan documents
- Could have substantial effect on spinoff
20Undoing a Spinoff
- May require additional funding if spun off plan
was merged into better funded plan - Spin off of less well funded plan would violate
section 414(l) requirement to maintained funded
level on a termination basis - If merger is subject to contingencies, consider
maintaining free standing spinoff plan until
contingencies are met, then merging
21Funding Rules after Mergers and Spinoffs
- Tom Swain, F.S.A.
- Bryan, Pendleton, Swats McAllister, LLC
- 2006 Enrolled Actuaries Meeting
- March 27, 2006
22DB Plan Merger/Spinoff Definitions
- Single Plan means all of the assets are
available to pay all of the benefits - Single Plan can have
- Multiple benefit structures
- Multiple trust funds and investment managers
- Multiple plan documents and SPDs
- Multiple plan sponsors (multiple-employer plan,
if not same controlled group) - Availability of assets is the only test
23DB Plan Merger/Spinoff Definitions
- Merger Combination of 2 or more plans into one
surviving single plan - Spinoff Splitting of one plan into two or more
new single plans - Asset/Liability transfer same number of plans
after transferno creation or absorption of plans - Treated as spin-off followed by merger
24Mechanics of Plan Mergers
- Selection of Surviving Plan
- a/k/a Ongoing Plan
- Documentation
- Board resolution(s) by plan sponsor(s)
- Amendments to Plan and Trust Agreement
25Mechanics of Plan Mergers
- Reporting and disclosure
- Notice to IRS Form 5310A, due 30 days before
effective date - Notice to PBGC Notice of reportable event
- Notice to participants
- New SPD or SMM, particularly for participants in
disappearing plan - Notice to collective bargaining representatives
- Notice to other regulators
- Form 5500 for disappearing and surviving plans
- PBGC premium filings for disappearing and
surviving plans
26Mergers Focus on Funding Issues
- Rev. Proc. 2000-40
- General concepts
- Types of Mergers covered
- Areas without guidance
- Examples
27Mergers General Concepts
- Rev. Proc. 2000-40Automatic approval of funding
method change for merged plans under specific
circumstances - Rev. Proc. 2000-41File for IRS approval of
funding method change for merged plans if
circumstances not covered by Rev. Proc. 2000-40. - May be difficult to get approval for alternative
method if merger fits one of the scenarios
outlined in Rev. Proc. 2000-40
28Mergers General Concepts
- Automatic approval subject to general conditions
- Not after Schedule B filed (or due date passed),
without reflecting merger method change - Plan administrator must agree (check box on Form
5500, Schedule R) - No minimum funding waiver requested or being
amortized - No extension of amortization periods requested or
in effect - Not under audit, pending audit or appeal
- No plan termination
29Mergers General Concepts
- Method change on merger not subject to some
restrictions applicable to change in actuarial
valuation method for ongoing plan - Automatic approval available to change
asset/funding method for merger, even if changed
in previous four years - Cant use automatic approval for subsequent
change until five years later - Automatic approval available, even if negative
normal costs, negative unfunded liability, or
frozen benefits - Treat in same way as in ongoing plan
30Mergers General Planning Issues
- Classification of merger and transition period
expected - Selecting the surviving plan/funding method
- Selecting the asset valuation method
- Timing of plan amendments
- Credit balances
- Deduction limits and contributions
- Contribution deadlines
- Filing deadlines
- Quarterly contribution requirements
- Contributions made after the merger
31Rev. Proc. 2000-40 Mergers
- De Minimis Mergers
- Beginning of Year
- Mid-Year
- Simple Mergers
- More Complex Mergers
- Transition Period of less than 12 months
- Transition Period of more than 12 months
32De Minimis Merger
- Merger of smaller plan is considered de minimis
- Definition Small Plan (liabilities less than 3
of Large Plans assets) merges with Large Plan - Surviving plan ignores smaller plan funding
standard account post-merger - Automatic approval if no changes to surviving
plan methods - Value assets and liabilities of smaller plan with
larger plan - Treat addition of smaller plan as an actuarial
gain or loss
33Mid-Year De Minimis Merger
34Mid-Year De Minimis Merger
- Disappearing Plan
- Small plan has short plan year running from
beginning of plan year to date of merger - Prorate funding standard account entries to
reflect duration of short plan year, under Rev.
Rul. 79-237 - Ignore funding standard account charges for small
plan for remainder of plan year - Contributions made within 8 1/2 months after date
of merger can be credited to short plan year for
smaller plan - Any deficiency in smaller plan results in 10
excise tax for underfunded plans, but not 100 tax
35Simple Merger
- Requirements
- Same plan years
- Valuation dates first or last day of plan year
- Merger occurs first or last day of plan year
- Funding method for each plan must be standard
method under Rev. Proc. 2000-40 - Neither plan has a funding deficiency
36Simple Merger
- Minimum/maximum contributions unchanged prior to
merger - Full-funding limit for merged plan does not
cancel funding requirements or maximum
contribution levels for plan merged in at end of
year - Contributions made after end of plan year (but
before 8 1/2 months after end of plan year) can
be credited to either plan
37Simple Merger
- Asset valuation method
- If both use exactly the same method, continue
after merger - Otherwise, can change to ANY method described in
Rev. Proc. 2000-40 - Funding valuation (cost) method
- Use ongoing plans method
- Plan administrator designates ongoing plan
- Combine credit balances
38Simple Merger
- Amortization bases
- Maintain bases according to general rules of Rev.
Proc 2000-40 - For spread-gain methods Re-set unfunded
liability - For immediate gain methods
- Establish gain/loss base for each plan BEFORE
changes due to merger, change in assumptions, or
plan amendments - Establish base for funding method change,
reflecting changes in assumptions and methods - Method change base amortized over 10 years
39Simple Merger Funding Example
40MergerTransition period up to 12 months
- Valuation date first day of plan year
- Period between first day of plan year A and last
day of plan year B is up to 12 months
41MergerTransition period up to 12 months
- Other Requirements
- Same general conditions as simple merger, except
that valuation date for both plans must be
beginning of plan year - Divide funding standard account entries for
disappearing plan between - Short plan year period between beginning of
plan year and date of merger - Interim period period between date of merger
and end of plan year, ongoing plan
42MergerTransition period up to 12 months
- Division of funding standard account entries for
disappearing plan - Entries should be prorated to reflect portion of
the year covered by each period - Entries for interim period should reflect
interest during short plan year
43MergerTransition period up to 12 months
- Combine entries for interim period with funding
standard account entries for ongoing plan (use
credit balance as of end of short plan year) - Other Schedule B entries based on ongoing plan
without merger - Assumptions, methods do not have to conform to
ongoing plan until next valuation - Contributions made within appropriate timeframes
can be credited to either plan
44MergerTransition period up to 12 months
- Example Plan A merges into Plan B as of
9/30/2003 - Plan A Plan year 7/1 6/30, PUC method 8
assumed interest - Plan B Calendar year plan, PUC method 8
assumed interest - Both plans use three-year average assets
- Transition period 7/1/2003 to 12/31/2003
45MergerTransition period up to 12 months
- Plan A Funding standard account
46MergerTransition period up to 12 months
Example (contd) Reconcile with full-year totals
47MergerTransition period up to 12 months
Example (contd)
48MergerTransition period up to 12 months
- Procedure for maximum tax-deductible contribution
is analogous to minimum - Limit for short plan year determined without
regard to merger - Add pro-rata contribution for interim period to
maximum determined for ongoing plan
49MergerTransition period over 12 months
- Valuation date first day of plan year
- Period between first day of plan year A and last
day of plan year B is over 12 months
50Rev. Proc. 2000-40No Guidance Issues
- How to handle other FSA entries use consistent
principles (and see past Gray Books!) - Quarterly contributions
- Additional interest charge for late quarterly
contributions - Additional funding charge
- Full-funding limit
- Accumulated reconciliation account
- Volatility rule and gateway percentages
51Spinoffs Focus on Funding Issues
- General concepts
- Planning Issues
- Types of Spinoffs
52Spinoffs General Concepts
- Spunoff plans divide the funding standard
account, amortization bases, etc., of previous
single plan - No change in funding method is ordinarily
required because spunoff plans retain funding
method of previous single plan - For de minimis spinoff, spunoff plan is treated
as a new plan which can use any reasonable
funding method IRS approval not needed! - Rev. Rul. 81-212 gives a basic recipe for
splitting funding standard account - Rev. Rul. 86-47 addresses additional situations
of plans with surplus assets which the formulas
in Rev. Rul. 81-212 do not address
53Spinoffs General Planning Issues
- Classification of spinoff and transition period
expected - Timing of plan changes
- Credit balances
- Deductible limits and contributions
- Contribution deadlines
- Filing deadlines
- Quarterly contribution requirements
- Valuations
- Contributions made after the spinoff
54Types of Spinoffs
- De Minimis
- Beginning of Year
- Mid-Year
- Simple Spinoff
- Mid-Year Spinoff
55De Minimis Spinoff
- Requirements
- Spinoff of smaller plan is considered de minimis
- Small Plan (assets less than 3 of Large Plans
assets) spins off from Large Plan - Spunoff assets equal present value of accrued
benefits spun off (whether or not vested) - Ongoing plan ignores smaller plan funding
standard account post-spinoff
56De Minimis Spinoff
- Ongoing plan treats spinoff of smaller plan as an
actuarial gain or loss - This is not considered a change in funding
method, so no IRS approval needed if no changes
to ongoing plan methods - Value assets and liabilities, apply funding rules
to smaller plan as if it is a brand new plan with
no prior history - As a new plan, smaller plan may adopt any
reasonable funding method (including asset
method) not tied to previous plan
57De Minimis Mid-Year Spinoff
58De Minimis Mid-Year Spinoff
- Small Plan
- Value assets and liabilities, apply funding rules
to smaller plan as if it is a brand new plan with
no prior history - Small plan has short plan year running from date
of spinoff to end of first plan year - Prorate funding standard account entries to
reflect duration of short plan year, under Rev.
Rul. 79-237 - Ongoing (Large) Plan
- For first valuation of larger plan on or after
spinoff date, the difference between assets and
liabilities is a gain or loss. No change in
funding or asset valuation method.
59Simple Spinoff
- Requirements
- Valuation date is first day of plan year
- Spinoff occurs first day of current plan year or
last day of prior plan year
60Simple Spinoff
- Funding Standard Account Allocation
- Amortization bases, credit balance, etc., may be
allocated based on reasonable methods. See Rev.
Rul. 81-212 or Rev. Rul. 86-47. - Asset valuation method and funding valuation
(cost) method can remain the same as previous
plan no IRS approval needed since no change is
being made - Rev. Proc. 2000-40, section 6.02(7), denies
automatic approval for most method changes in
connection with a spin-off - Presumably could apply for approval of a change
under Rev. Proc. 2000-41 if desired
61Simple Spinoff
- Unfunded Liability
- Unfunded is split between ongoing plan and new
plan based on other allocations - If one plan results in a negative unfunded, that
is set to zero other plan receives all
amortization bases and must establish a new base
to keep the equation of balance in balance
62Simple Spinoff
63Simple Spinoff
64Mid-Plan Year Spinoff
- Valuation date first day of plan year
- Spinoff occurs during the plan year of the
continuing plan
652006 EA Meeting
- Session 303
- Mergers and Spinoffs IRS PerspectiveCarol
Zimmerman, F.S.A. - March 27, 2006
66When do plan sponsors have to file for a merger?
- Deficiency in either plan
- Valuation date not on the first or last day of
the plan year - Funding method not automatically approved
- Not on the list of approved methods
- Plan administrator does not want to use the
default method
67What do we look for?
- Be sure funding standard account entries are
split appropriately in mid-year merger - Total charges for the split plan year should be
the same as the whole - Be careful with calculations involving actuarial
value of assets
68What do we look for?
- Check to be sure that bases are carried over
appropriately - Bases retained in accordance with Rev. Proc
2000-40 - Experience bases added prior to merger if
appropriate for funding method - Bases reamortized if interest rate changed
- Bases, amortization charges and credits rolled
forward appropriately especially where partial
plan years are involved
69What do we look for?
- Follow Rev. Proc. 2000-40 to the extent possible
- Check to be sure that balancing equation works
before and after the merger
70Other considerations
- Be sure funding method is reasonable
- Dollars-times-service benefits should not be
funded as a percentage of future compensation
even if that was the method for the surviving
plan - Frozen plans should be valued using the unit
credit method
71Other considerations
- Think about alternative approaches example
- Merge plan using FIL as percentage of pay with
plan using FIL as level dollar amount - Merged plan uses FIL as a level dollar amount
- 2000-40 calls for re-establishment of UAL, change
in funding method base includes accumulated gains
and losses
72Other considerations
- Think about alternative approaches (continued)
- Could calculate change in funding method base as
the change in UAL for conforming plan and
continue to fund gains/losses through normal cost - Does not qualify for automatic approval
73Spinoffs
- Interest rates, other assumptions
- Default PBGC assumptions, 4044 allocation
- Anything else must be justified on the basis of
annuity purchase pricing - May be special features in plan that make group
annuity more or less expensive, or that would
give more weight to certain categories of
participants
74Spinoffs
- Mid-year considerations similar to merger
- Total of funding standard account entries should
be the same on a full-year basis as they were
before the spin-off - Dont forget to address the issue of excess assets
75Questions?