Ea-2F - Spread Gain Funding Methods

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The spread gain funding methods (which can be used for funding multiemployer plans) are:

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Aggregate

Individual aggregate

Frozen initial liability

Attained age normal

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The basic formula for determining normal cost in a spread gain funding method is:

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NC = (PVFB – Actuarial assets - Unfunded liability) ÷ Temporary annuity

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PVFNC

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(PVFB – Actuarial assets - Unfunded liability)

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The temporary annuity is either equal to

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- the present value of a level $1 per year (if the benefit is not based on salary, also known as the level dollar approach)

- or the ratio of PVFS to salary (if the benefit is based upon salary, also known as the level percent of salary approach). You will be told in a question if this rule is not to be followed.

Note that when you are amortizing as a level percent of salary, the implicit interest rate is equal to j, where j = [(1+i)/(1+s)] – 1 (i is the assumed interest rate, and s is the assumed salary scale).

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The benefits of retired and vested terminated participants are

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included in the total of the present value of future benefits. However, retired and vested terminated participants are not included in the temporary annuity factor.

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The most common adjustments to benefits of non-retired participants are made based upon the following table. Note that i' and s' are the actual interest earnings rate and the actual rate of salary increase, and the adjustments assume no change in the plan population.

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True (see next cards)

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PVFB adjustment

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× (1 + i), × (1 + s')/(1 + s), × new retirement benefit rate/old retirement benefit rate, × new maturity value/old maturity value

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Assets

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× (1 + i' ), + contribution  (1 + i' )*, - benefit payments (1 + i' )*

*Note that the interest is pro-rated for the portion of the year that the contribution or benefit payment was actually made. Also note that the actual salary increase has no effect on the adjustment of the temporary annuity.

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PVFS

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-salary,×(1+i),×(1+ s')/(1+s)

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Salary

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×(1+ s')

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Temporary annuity

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(a(n) (annuity due) - 1) × (1 + i)/(1 + s)

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Spread gain methods that use an unfunded liability must

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keep that unfunded liability maintained. This is accomplished by accumulating from valuation date to valuation date as follows.

ULt = [(ULt-1 + NCt-1) × (1 + i)] - [Contributiont-1 × (1 + j)], where j is the pro-rated interest rate at the valuation rate from date of deposit of the contribution to the current valuation date. Contributions deposited after the current valuation date receive no interest. Interest can be pro-rated either using simple interest or compound interest.

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Aggregate Funding Method

The following are special characteristics of the aggregate funding method.

UL

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The aggregate funding method has no unfunded liability. Therefore, the unfunded liability portion of the normal cost formula mentioned in the previous section does not apply.

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Aggregate Funding Method

The following are special characteristics of the aggregate funding method.

Amort Bases

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2. The aggregate funding method could have amortization bases due to a waived funding deficiency or due to a switchback base from the alternative funding standard account (from years before 2008). If that is the case, then the outstanding balance of these bases are added to the actuarial value of assets for purposes of determining the normal cost for IRC section 431. They are not added to the assets for purposes of the IRC section 404 normal cost, as they are not amortization bases under IRC section 404. Alternatively, rather than including the outstanding balance as part of the assets, the outstanding balance can be thought of as the “unfunded liability” for the plan and subtracted from the present value of future benefits.

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Aggregate Funding Method

The following are special characteristics of the aggregate funding method.

CB

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The credit balance in the funding standard account is subtracted from (and the prior funding deficiency is added to) the assets for purposes of the IRC section 431 normal cost. Similarly, any undeducted contributions are subtracted from (and receivable contributions not yet used for minimum funding purposes but already deducted are added to) the assets for purposes of the IRC section 404 normal cost. Undeducted contributions are not increased with interest.

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Note that due to items 2 and 3, the aggregate funding method can yield different

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normal costs for purposes of IRC section 404 and 431. Also note that per Revenue Ruling 2000-20, the aggregate funding method does not maintain amortization bases due to the OBRA’87 full funding limitation (which could have been established prior to 2004).

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Individual Aggregate

This is identical to the aggregate method except that

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normal costs are calculated on an individual basis. The same three points mentioned concerning the aggregate method apply to the individual aggregate method.

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Individual Aggregate

The following rules apply regarding the allocation of assets to the individual participants.

Assets

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The assets of a plan that used the individual aggregate method in the prior year are allocated proportionally to each active participant based upon the prior year normal cost and asset allocation.

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Individual Aggregate

The following rules apply regarding the allocation of assets to the individual participants.

PVVAB

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2. The present value of vested accrued benefits is subtracted from the assets for retired and vested terminated participants before they are allocated to the active participants.

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Individual Aggregate

The following rules apply regarding the allocation of assets to the individual participants.

asset allocation first year

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3. For plans changing to the individual aggregate method from another actuarial cost method, the assets are allocated in a reasonable manner (e.g., in proportion to the present value of accrued benefits) for that first year.

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Frozen Initial Liability

This method is similar to the aggregate method with the exception of

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an unfunded liability, which is initially equal to the entry age normal accrued liability. A description of the entry age normal accrued liability is discussed in that section of this outline.

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Frozen Initial Liability

The following are other special points of interest concerning this funding method.

Assets

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The assets are not adjusted by the credit balance, funding deficiency, and undeducted contributions (as is the case with the aggregate and individual aggregate methods). As a result, the IRC section 404 and 431 normal costs are the same.

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Frozen Initial Liability

The following are other special points of interest concerning this funding method.

NC

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2. The normal cost is not affected by the amount of the contribution for the prior year. This is because the contribution increases the assets by the same amount as it reduces the unfunded liability. That causes the same reduction in the present value of future benefits in the normal cost formula regardless of the contribution.

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Frozen Initial Liability

The following are other special points of interest concerning this funding method.

NC first year

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3. The normal cost in the first year that the funding method used is frozen initial liability is the same as the normal cost under the entry age normal method. This is due to the fact that the initial past service liability under FIL is identical to that under the entry age normal method. In addition, the normal cost in each subsequent year will continue to be the same as the normal cost under the entry age normal method provided that there have never been any experience gains or losses.