As we know that Under DB pension plans, Employer has
to contribute towards the plan, so today we are going to see how much an
employer has to contribute and up to how much employer can avail the Tax
benefit.
Let’s Start with basic terminologies:
1.Stabilized
rates: Pension regulators has set the
Segmented interest rates that we can use to calculate our Liability.
2.NonStabilized
rates: Nonstabilized rates are lower than
stabilized rates, so technically Liability will be higher under nonstabilized
rates.
3.FT=
Funding Target, it means the liability of
a plan calculated using 3 segment stabilized interest rates.
4.FT(max)
= Funding Target, it means the liability of
a plan calculated using nonstabilized interest rates.
5.TNC
= Target Normal Cost = Present value of
benefits accruing during the plan year.
6.EIR
= Effective
interest rate; it is the single rate of interest which is used to determine the
PV of plan’s accrued benefit, would result in an amount equal to the Funding
target of the plan for such plan year.
7.AVA
= Actuarial
Value of Assets
8.COB
= Carryover Balance: Continuation of Plan’s
Credit balance as of the end of 2007 plan year.
9.PFB
= Prefunding Balance: Balance due to excess of
contributions made in 2008 and subsequent plan years
10.MRC= Minimum
Required Contribution
11.MDC = Maximum
Deductible Contribution
12.SAC=
Shortfall
amortization charge
13.WAC = Waiver
Amortization Charge
14.Segment Yield Curve
= these are the 24 month rates in to 3 segments: 05 years, 520 years and then
thereafter
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Calculation of MRC (Minimum Required
Contribution):
· It
is the amount that employer has to pay in quarterly instalments. Before start
with its calculation let’s understand the meaning of Funding Shortfall. It means where the plan’s assets are not enough
to cover liabilities.
· FS
= FTNA; NA means Net Assets. And FS cannot be negative, it is either zero or
positive.
· Net
Assets= AVACOBPFB
· But
COB, PFB balance cannot be used to reduce MRC if there is a binding agreement
with PBGC not to use it.
· So,
if funding shortfall is greater than Zero, then calculation of MRC is MRC=
TNC+SAC+WAC
· If
Funding Shortfall is Zero, then calculation of MRC is MRC = TNC(Net AssetsFT)
3 points
to remember:
1.If NA>FT+TNC, then funding
shortfall =0 and MRC = 0
2.If FT<NA<FT+TNC, then FS = 0
and MRC = TNC+FTNA
3.If FT>NA, then FS>0 and MRC =
TNC+SAC+WAC
Let’s understand the concept of SAC:
· Here
we set up a SAI (Shortfall
amortization instalments) to amortize each SAB
(shortfall amortization base) in level instalments over a period of 7 years and
must use yield curve segment rates for the next 7 years (it will be 9 or 15
years if Pension Relief Act 2010 is used)
· Note
to test if SAB base is exempted or not, check the calculation of AVAPFB, if it
is greater than FT , then it will not apply; which further means SAC will not
be included in the calculation of MRC.
· Let’s
see the Calculation of SAC:
1. Calculate the SAB, which is equal to the Funding Shortfall
2.Subsequesnt years SAB = FTPV of remaining amortization payments
3. For calculating PV, current year segment rates will be used.
4. In any year , if FS = 0, then SAB are considered Fully Amortized.
5. Now SAI = SAB/SAF; where SAF is Shortfall amortization factor
6. SAC = sum of SAI
7. SAI = now suppose if amortize for 7 years, then it is the sum of discounting
back of segment rates of first 7 years from now onwards.
8. MRC
= TNC+∑SAI
· But
we cannot use PFB to satisfy MRC, if it was not used in the shortfall
amortization base exemption test. We can only use COB or PFB if the plan was at
least 80% funded in the prior year.
· (AVAPFB)/FT
>=80%, then MRCCOBPFB
Maximum
Deductible Contribution:
It is the maximum amount upto which an employer gets Tax
deduction.
The MDC is greater of
1. MRC
2. At risk FT+At risk TNC – AVA
3. FT(max)+Cushion amount (which is 50% of FT(max)) +
TNC – AVA
Let’s see an Example:
Given: FT = 18,957,466 FT(max)= 23,961,983 TNC = 160,000 AVA = 18,347,261 COB = PFB = 0.
PPA segment rates are 4.16% for
5 years, 5.72% for other 15 years and 6.48% thereafter.
Solution:
· Let’s
calculate FS= FTAVA = 18957466(1834726100) = 610205
· So,
our funding shortfall is $610,205 which is our SAB (shortfall amortization
base) too.
· SAC
= ∑SAI
· SAI=
SAB/SAF
· So
let’s calculate SAF =
·
Year

Segment rates

Discounting back

1

1.0416

1

2

1.0416

0.960061444

3

1.0416

0.921717976

4

1.0416

0.884905891

5

1.0416

0.849564028

6

1.0572

0.757206316

7

1.0572

0.716237529


Total

6.089693183

· Now
SAI = 610205/6.0896 = 100,203
· So,
SAC = $100,203
· Now
let’s calculate MRC = TNC+SAC+WAC = 160,000+100,203+0 = $260,203
Let’s Calculate MDC:
FT(max)+TNC+ Cushion amountAVA = 23,961,983+160,000+50%(23,961,983)18,347,261
= 17,755,713.50
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