2006 Enrolled Actuaries Meeting Session 303 Mergers and Spinoffs: Applying Rules under 414lC

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2006 Enrolled Actuaries MeetingSession
303Mergers and Spinoffs Applying Rules under
414(l)(C)
March 27, 2006
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Agenda

• Applying the rules of 414(l)
• Funding rules after mergers and spinoffs
• IRS Perspective

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Mergers and Spinoffs Applying Rules under 414(l)

• Lonie A. Hassel
• Groom Law Group, Chtd.
• 2006 Enrolled Actuaries Meeting
• March 27, 2006

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Section 414(l)

• Legal Requirements
• Agency Enforcement
• Applying the Rules

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414(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)

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Internal 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

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Pension 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

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Pension 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

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Pension 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

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Pension 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
  

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Department 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

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Allocating 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

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Allocating 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

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Allocating 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

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Allocating 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

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Allocating 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

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Allocating 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

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Allocating 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

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Full 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

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Undoing 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

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Funding Rules after Mergers and Spinoffs

• Tom Swain, F.S.A.
• Bryan, Pendleton, Swats McAllister, LLC
• 2006 Enrolled Actuaries Meeting
• March 27, 2006

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DB 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

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DB 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

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Mechanics 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

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Mechanics 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

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Mergers Focus on Funding Issues

• Rev. Proc. 2000-40
• General concepts
• Types of Mergers covered
• Areas without guidance
• Examples

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Mergers 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

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Mergers 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

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Mergers 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

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Mergers 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

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Rev. 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

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De 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

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Mid-Year De Minimis Merger


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Mid-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

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Simple 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

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Simple 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

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Simple 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

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Simple 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

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Simple Merger Funding Example
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MergerTransition 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

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MergerTransition 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

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MergerTransition 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

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MergerTransition 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

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MergerTransition 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

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MergerTransition period up to 12 months

• Plan A Funding standard account

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MergerTransition period up to 12 months
Example (contd) Reconcile with full-year totals
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MergerTransition period up to 12 months
Example (contd)
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MergerTransition 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

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MergerTransition 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

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Rev. 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

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Spinoffs Focus on Funding Issues

• General concepts
• Planning Issues
• Types of Spinoffs

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Spinoffs 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

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Spinoffs 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

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Types of Spinoffs

• De Minimis
• Beginning of Year
• Mid-Year
• Simple Spinoff
• Mid-Year Spinoff

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De 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

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De 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

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De Minimis Mid-Year Spinoff


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De 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.

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Simple 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

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Simple 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

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Simple 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

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Simple Spinoff

• Rev. Rul. 81-212

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Simple Spinoff

• Rev. Rul. 86-47

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Mid-Plan Year Spinoff

• Valuation date first day of plan year
• Spinoff occurs during the plan year of the
  continuing plan

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2006 EA Meeting

• Session 303
• Mergers and Spinoffs IRS PerspectiveCarol
  Zimmerman, F.S.A.
• March 27, 2006

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When 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

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What 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

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What 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

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What 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

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Other 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

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Other 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

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Other 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

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Spinoffs

• 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

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Spinoffs

• 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

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Questions?