Rev. Rul. 89-60,
1989-1 C.B. 113, 1989-18 I.R.B. 6.
Internal Revenue Service
Revenue Ruling
ALLOCATION OF ACCRUED BENEFIT BETWEEN EMPLOYEE AND EMPLOYER CONTRIBUTIONS
Published: May 1, 1989
26 CFR 1.411(c)-1 Allocation of accrued benefits between employer and employee contributions.
Allocation of accrued benefit between employee and employer contributions. Guidance is provided as to the effect on section 411(c) of the Code of changes made by section 9346 of the Pension Protection Act (part II of title IX of the Omnibus Budget Reconciliation Act of 1987). Rev. Ruls. 76-47 and 78-202 amplified.
ISSUE
(1) What interest rates are used to determine an employee's 'accumulated contributions' under section 411(c)(2) of the Internal Revenue Code, as amended by section 9346 of the Pension Protection Act ('PPA'), part II of title IX of the Omnibus Budget Reconciliation Act of 1987, Pub. L. No. 100-203?
(1) If a plan distributes the employee's accumulated contributions with interest as a single sum at termination of employment before normal retirement age, what is the amount of the remaining vested accrued benefit in the form of a single life annuity commencing at normal retirement age that satisfies section 411(c)?
FACTS
Employer X maintains a qualified defined benefit plan that required mandatory employee contributions for 1987 and prior years, but not for years after 1987. The plan year is the calendar year. The plan provides for a normal retirement age of 65, and 100-percent vesting in the employer-derived portion of a participant's accrued benefit after 5 years of service.
The terms of the plan provide that a participant who terminates employment with X prior to attaining normal retirement age may elect, among other optional forms of benefit, to receive one of the following distributions as an alternative to an annual single life annuity commencing at normal retirement age:
1) A single-sum distribution of his or her accrued benefit upon termination of employment. The plan provides that the single sum is calculated using the UP-1984 Mortality Table with a 1-year age set-forward and interest at the applicable rates described in section 417(e) of the Code.
2) A single-sum distribution of his or her employee contributions as of the date of termination of employment, credited with interest to the date of distribution ('determination date') at the rate specified in section 411(c) of the Code, and a distribution of the remainder of his or her vested accrued benefit in the form of an annual single life annuity commencing at normal retirement age.
A, an unmarried participant terminated employment with X on July 1, 1988, at age 50 with 7 years of service. A's total accrued benefit under the plan in the form of an annual single life annuity commencing at age 65 is $2,949 per year. As of December 31, 1987, A's total accumulated mandatory employee contributions to the plan, including interest compounded annually at 5 percent, equaled $3,021. On January 1, 1988, 120 percent of the federal mid-term rate under section 1274 of the Code was 10.61 percent.
LAW AND ANALYSIS
Section 411(a)(1) of the Code provides that an employee's rights in the employee's accrued benefit derived from the employee's own contributions must be nonforfeitable.
Section 411(a)(2) of the Code provides that an employee's rights in the employee's accrued benefit derived from employer contributions must be nonforfeitable in accordance with one of the vesting schedules described in section 411(a)(2).
Section 411(c)(1) of the Code provides that an employee's accrued benefit derived from employer contributions is the excess, if any, of the employee's accrued benefit over the employee's accrued benefit derived from contributions made by the employee.
Section 411(c)(2)(B)(i) of the Code provides that, in the case of a defined benefit plan providing an annual benefit in the form of a single life annuity (without ancillary benefits) commencing at normal retirement age, the accrued benefit derived from employee contributions is the annual benefit equal to the employee's accumulated contributions is the annual benefit equal to the employee's accumulated contributions multiplied by the appropriate conversion factor. Section 411(c)(2)(B)(ii) of the Code provides that the appropriate conversion factor is the factor necessary to convert an amount equal to the accumulated contributions to a single life annuity (without ancillary benefits) commencing at normal retirement age, and that this factor shall be 10 percent if the normal retirement age is 65.
Prior to the enactment of section 9346 of the PPA, section 411(c)(2)(C) provided that the term 'accumulated contributions' was defined as the sum of (1) mandatory contributions made by the employee; (2) interest under the plan (if any) to the end of the last plan year to which section 411(a)(2) does not apply; and (3) with respect to each subsequent plan year, interest on the amounts determined under (1) and (2) at the rate of 5 percent. Section 9346(b) of the PPA amended section 411(c)(2)(C) by replacing 5 percent with 120 percent of the federal mid-term rate as in effect under section 1274 of the Code for the first month of the plan year ('mid-term AFR'). Section 9346(c) of the PPA provides that the amendments made by section 9346 are effective for plan years
beginning after December 31, 1987.
Section 411(c)(2)(E) of the Code provides that the accrued benefit derived from employee contributions shall not exceed the greater of the employee's accrued benefit under the plan, or the accrued benefit derived from employee contributions accumulated using an interest rate of zero.
Section 411(c)(3) of the Code provides:
ACTUARIAL ADJUSTMENT. -- For purposes of this section, in the case of any defined benefit plan, if an employee's accrued benefit is to be determined as an amount other than an annual benefit commencing at normal retirement age, or if the accrued benefit derived from contributions made by an employee is to be determined with respect to a benefit other than an annual benefit in the form of a single life annuity (without ancillary benefits) commencing at normal retirement age, the employee's accrued benefit, or the accrued benefits derived from contributions made by an employee, as the case may be, shall be the actuarial equivalent of such benefit or amount determined under paragraph (1) or (2) [of section 411(c)].
Section 1.411(c)-1(e) of the Income Tax Regulations provides that the actuarial equivalent of the employee's accrued benefit under section 411(c)(1) and the actuarial equivalent of the accrued benefit derived from employee contributions under section 411(c)(2)(B) of the Code shall be as determined by the Commissioner.
Rev. Rul. 76-47, 1976-1 C.B. 109, provides that a benefit in a form other than the normal form of benefit shall not be less than an actuarial equivalent of the normal form of benefit, using the actuarial assumptions or actuarial table prescribed by the plan or by any insurance or annuity contracts used to provide benefits under the plan ('plan assumption'). Rev. Rul. 76-47 also states that, notwithstanding that the benefit must be actuarial equivalent of the normal form of benefit using plan assumptions, the amount of benefits under any form of retirement benefit other than the normal form of benefit shall not be less than the benefit that would be derived from employee contributions if such benefit were the normal form of benefit. Rev. Rul. 76-47 provides appropriate conversion factors to determine the minimum accrued benefit derived from employee contributions when the normal retirement age is not 65. It also sets forth the actuarial adjustment required when the normal form of benefit is other than a single life annuity (without ancillary benefits).
Rev. Rul. 78-202, 1978-1 C.B. 124, requires, generally, that if a benefit derived from employee contributions is payable other than at normal retirement age, the benefit must be at least the actuarial equivalent of the employee- derived benefit payable at normal retirement age, based on the same actuarial assumptions required by section 411(c) and Rev. Rul. 76-47 to be used to determine the accrued benefit derived from employee contributions at normal retirement age. Rev. Rul. 78-202 provides methods for determining a single sum that satisfies this requirement.
Thus, a benefit derived from both employee and employer contributions that is to be distributed in a form other than a single life annuity commencing at normal retirement age must satisfy two requirements. First, the amount of the employee's accrued benefit must be the actuarial equivalent of his or her accrued benefit in the form of a single life annuity commencing at normal retirement age. For this first requirement, the actuarial equivalence is determined using plan assumptions, subject to the interest rate limitation described in section 417(c) of the Code. Second, the amount of the benefit must not be less than the actuarial equivalent of the employee-derived accrued benefit payable in the form of a single life annuity commencing at normal retirement age. For this second requirement, the actuarial equivalence is determined using the actuarial assumptions and factors specified in section 411(c)(2) and Rev. Rul. 76-47, taking into account the principle illustrated in Rev. Rul. 78-202.
Generally, section 411 of the Code provides that an employee's rights in the portion of his or her accrued benefit that is derived from employee contributions must be nonforfeitable (vested) at all times, and that the employee's rights in the portion of his or her accrued benefit that is derived from employer contributions become vested in accordance with one of various schedules. Section 411(c) sets forth the requirements for allocating an employee's total accrued benefit between employee and employer contributions.
To comply with the requirements of section 411(c), the plan must first determine an employee's vested accrued benefit in the form of an annual single life annuity commencing at normal retirement age. Generally, this amount is determined by converting the accumulated contributions to a benefit and adding the vested percentage of the remainder, if any, of the employee's total accrued benefit.
Under section 411(c)(2)(C), accumulated contributions are all mandatory contributions made by the employee and interest on such contributions until the employee attains normal retirement age. The interest rate for all plan years beginning on or after the effective date of section 411(a)(2) and before January 1, 1988, is 5 percent. For each plan year beginning after December 31, 1987, the interest rate is 120 percent of the mid-term AFR for the month that includes the first day of that plan year that includes the determination date is also used for the entire period from the determination date to the date on which the employee would attain normal retirement age.
Accordingly, for plan year 1987 and each prior plan year, A's accumulated contributions are credited with interest at 5 percent. For plan year 1988 and all subsequent plan years up to and including the plan year in which A would attain normal retirement age, A's accumulated contributions are credited with interest, compounded annually, at 120 percent of the mid-term AFR on January 1, 1988, i.e., 10.61 percent. (If A were to terminate employment on July 1, 1989, instead of 1988, A's accumulated contributions would be credited with interest at 10.61 percent for 1988 and, because 120 percent of the mid-term AFR on January 1, 1989, was 11.11 percent, interest at 11.11 percent for the 1989 plan year and all subsequent plan years up to and including the plan year in which A would attain normal retirement age.)
SINGLE LIFE ANNUITY COMMENCING AT NORMAL RETIREMENT AGE
If A elects to receive A's accrued benefit in the form of an annual single life annuity commencing at A's normal retirement age, A's benefit would be determined as follows:
(1) Determine A's total accrued benefit in the form of an annual single life annuity commencing at normal retirement age under the plan's formula ($2,949 per year payable at age 65).
(2) Determine A's accumulated contributions with interest to normal retirement age using, for years prior to January 1, 1988, 5-percent interest (which compounds to $3,021 as of December 31, 1987, in this example) and, for the 1988 plan year until normal retirement age, 10.61-percent interest ($14,420).
(3) Determine the accrued benefit derived from A's contributions by multiplying A's accumulated contributions determined in step (2) by the conversion factor specified in section 411(c)(2)(B)(ii) ($14,420 x 10 percent = $1,442 per year) and then limiting the result as required by section 411(c)(2)(E) to the greater of A's accrued benefit under the plan or the employee's accrued benefit derived from the employee's mandatory contributions, without crediting interest.
(4) Determine the accrued benefit derived from employer contributions by subtracting the accrued benefit derived from employee contributions from the employee's accrued benefit under the plan, but in no event is the accrued benefit derived from employer contributions less than zero ($2,9496-$1,442 = $1,507 per year).
(5) Determine the vested percentage of the accrued benefit derived from employer contributions under the plan's vesting schedule (100 percent).
(6) Determine the vested accrued benefit derived from employer contributions by multiplying the accrued benefit derived from employer contributions by the vested percentage ($1,507 x 100 percent = $1,507 per year).
(7) Determine A's vested accrued benefit in the form of an annual single life annuity commencing at normal retirement age by adding the accrued benefit derived from employee contributions and the vested accrued benefit derived from employer contributions ($1,442 + $1,507 = $2,949 per year).
SINGLE SUM DISTRIBUTION UPON TERMINATION OF EMPLOYMENT
If A elects to receive A's accrued benefit as a single sum at termination of employment on July 1, 1988, the vested accrued benefit payable as a single sum as of July 1, 1988, is determined as follows:
(1) Determine A's vested accrued benefit in the form of an annual single life annuity commencing at normal retirement age ($2,949 per year; see steps (1) through (7) under 'Single Life Annuity Commencing at Normal Retirement Age').
(2) Determine the single sum as of July 1, 1988, that is the actuarial equivalent of the vested accrued benefit using the plan interest rate ($7,108).
(3) Determine the accrued benefit derived from A's mandatory contributions as of July 1, 1988, in the form of an annual single life annuity commencing at normal retirement age ($1,442 per year; see step (3) under 'Single Life Annuity Commencing at Normal Retirement Age').
(4) Determine the single sum as of July 1, 1988, that is the actuarial equivalent of the amount in step (3), following the rules of Rev. Rul. 78-202 and using the interest rate specified in section 411(c)(2)(C)(iii), a conversion factor of 10 percent, and the adjustment factors specified in Rev. Rul. 76-47 ($3,177).
(5) A's vested accrued benefit payable as a single sum upon termination of employment is the greater of (A) the single sum as determined in step 2, or (B) the single sum determined in step (4) ($7,108).
SINGLE SUM DISTRIBUTION OF ACCUMULATED CONTRIBUTIONS UPON TERMINATION OF EMPLOYMENT AND DEFERRED ANNUITY OF EMPLOYER CONTRIBUTIONS
If A elects to receive A's employee contributions with interest as a single sum at termination of employment on July 1, 1988, and the remainder of A's accrued benefit as an annual single life annuity commencing at normal retirement age, section 411(c)(3) of the Code is not satisfied unless the single sum and the deferred annuity are the actuarial equivalent of A's vested accrued benefit in the form of an annual single life annuity commencing at normal retirement age. The plan assumptions, including the interest rates described in section 417(e) of the Code, are used to determine this actuarial equivalence. Also, section 411(c)(3) is not satisfied unless the single sum and the deferred annuity are at least as great as the actuarial equivalent of the accrued benefit derived from A's contributions, using the actuarial assumptions and factors specified in section 411(c)(2) and Rev. Rul. 76-47.
Because A's accrued benefit must be the actuarial equivalent of the accrued benefit in the form of a single life annuity commencing at normal retirement age, the minimum deferred annuity is determined as follows:
(1) Determine A's vested accrued benefit in the form of a single-life annuity commencing at normal retirement age ($2,949 per year; see steps (1) through (7) under 'Single Life Annuity Commencing at Normal Retirement Age').
(2) Determine the amount of A's single-sum distribution by crediting A's accumulated contributions with interest to the date of distribution, using 5 percent for years prior to 1988, and 10.61 percent for January 1, 1988, to July 1, 1988 ($3,177).
(3) Using the plan assumptions, including the section 417(e) interest rates, determine the benefit in the form of an annual single life annuity commencing at normal retirement age that is the actuarial equivalent of the single-sum distribution determined in step (2) ($1,339 paid annually commencing at age 65 is the actuarial equivalent of A's accumulated contributions with interest to the determination date).
(4) Determine the minimum benefit payable at normal retirement age that is necessary to satisfy the requirement that A's accrued benefit be the actuarial equivalent of A's accrued benefit in the form of a single life annuity commencing at normal retirement age. This determination is made by reducing A's vested accrued benefit in the form of an annual single life annuity commencing at normal retirement age by the annuity determined in step (3) that is equivalent to the single-sum distribution ($2,949 - $1,339 = $1,610 per year). The minimum benefit cannot be less than zero.
The requirement that the amount of A's benefit not be less than the actuarial equivalent of the employee-derived accrued benefit payable in the form of a single life annuity commencing at normal retirement age is satisfied without regard to the amount of the deferred annuity, because A will receive a single- sum distribution of A's accumulated contributions with interest at the section 411(c) rates, as illustrated in this ruling. However, if the plan distributes to A a single sum that is less than A's accumulated contributions with interest at the section 411(c) rates, additional steps would be needed to determine whether the single sum and deferred annuity meet this requirement.
The above examples address situations where the participant is fully vested. Similar rules apply with respect to a nonvested participant.
HOLDINGS
(1) Under section 411(c)(2), an employee's accumulated contributions are determined using 5-percent interest for all plan years beginning on or after the effective date of section 411(a)(2) and before January 1, 1988. For plan years beginning after December 31, 1987, the rate to be used is 120 percent of the mid-term AFR for the month that includes th first day of the plan year. The interest rate for the plan year. The interest rate for the plan year that includes the determination date is also used for the period from the determination date to the date on which the employee attains normal retirement age.
(2) If the employee's accumulated contributions with interest are distributed as a single sum at termination of employment before normal retirement age, the annuity commencing at normal retirement age must be at least as great as the annuity determined by (a) using the plan interest rate, subject of the section 417(e) limitation, and plan assumptions to convert the single sum previously distributed to the employee to an actuarially equivalent single life annuity commencing at normal retirement age, and (b) subtracting the resulting annuity from the total vested accrued benefit, expressed as a single life annuity commencing at normal retirement age.
EFFECT ON OTHER REVENUE RULINGS
Rev. Rul. 78-202, 1978-1 C.B. 124, and Rev. Rul. 76-47, 1976-1 C.B. 109, are amplified to reflect the application of the new interest rate contained in section 411(c)(2)(C)(iii) of the Code, as explained in this ruling.
DRAFTING INFORMATION
The principal author of this revenue ruling is James E. Holland, Jr. of the Employee Plans Technical and Actuarial Division. For further information regarding this revenue ruling, please contact the Employee Plans Technical and Actuarial Division's taxpayer assistance telephone service between the hours of 1:30 and 4 p.m. Eastern time, Monday through Friday on (202) 566-6783/6784 (not a toll-free telephone number). Mr. Holland's telephone number is (202) 535- 6768 (also not a toll-free telephone number).
Rev. Rul. 89-60, 1989-1 C.B. 113, 1989-18 I.R.B. 6.