How to Calculate Minimum Required Contribution that has to be paid by Employer to fund the Plan
 Get link
 Other Apps
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.
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
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
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.
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
Follow us on LinkedIn : Actuary Sense
Follow me on LinkedIn: Kamal Sardana
 Get link
 Other Apps
Popular posts from this blog
Role of Generalised Linear Model in Non Life Pricing  Phase1
We will cover a series of topics relating to how Non Life Pricing is done through GLM.
But first let's see what is GLM
Generalised Linear Model Before Jumping on to what is GLM, let’s see what is Linear models 1.Linear Models:
Let’s take the example of Weight (Y) and Height (X). The aim of linear models is to find the line of best fit through the data points.
Here is your X axis is Height and Y axis is your Weight. Y = B0 + B1x
Line of Best Fit is B0 + B1x where B0 is intercept on Y axis and B1 is the gradient.
Now the question is how that line comes?
Well, line is chosen in such a way to minimize the sum of squared error terms where error terms are distances from data points to straight line, error terms are normally distributed with mean 0 and variance σ2.
2.Multiple Linear Regression:
We can extend our model to allow for other predictive variables. For example, we can decide that Weight can depend on height and calories consumed per day both. So here we cannot find the line of b…
But first let's see what is GLM
Generalised Linear Model Before Jumping on to what is GLM, let’s see what is Linear models 1.Linear Models:
Let’s take the example of Weight (Y) and Height (X). The aim of linear models is to find the line of best fit through the data points.
Here is your X axis is Height and Y axis is your Weight. Y = B0 + B1x
Line of Best Fit is B0 + B1x where B0 is intercept on Y axis and B1 is the gradient.
Now the question is how that line comes?
Well, line is chosen in such a way to minimize the sum of squared error terms where error terms are distances from data points to straight line, error terms are normally distributed with mean 0 and variance σ2.
2.Multiple Linear Regression:
We can extend our model to allow for other predictive variables. For example, we can decide that Weight can depend on height and calories consumed per day both. So here we cannot find the line of b…
CFM vs UDD vs Balducci
Life Tables: It is a computational tool based on a specific survival model. Our
task is to generate a survival model and our output will be a life table. Life
table is based on Unitary method. lx= Expected no. of lives at age x dx= Expected no. of deaths between exact age x and exact
age x+1 NOTE: We call it expected and not actual because most of the values
will be in decimal too, so how can it be actual.
But there is a limitation of Life Tables: It is defined only for integer ages. If we have to calculate probability of death/survival at any noninteger age we will use 3 assumptions: 1.CFM= Constant Force of Mortality 2.UDD= Uniform Distribution of death 3.Balducci assumption
1.CFM ·It assumes that the force of mortality is constant, i.e. ux+t = ux ·If the force of mortality of a newborn is constant, it means that the expected future lifetime of this life is 1/μ no matter what age he is in. ·Survival Function in this case will decrease exponentially. ·If 0<s<t<1 then tspx+s = tpx/spx …
But there is a limitation of Life Tables: It is defined only for integer ages. If we have to calculate probability of death/survival at any noninteger age we will use 3 assumptions: 1.CFM= Constant Force of Mortality 2.UDD= Uniform Distribution of death 3.Balducci assumption
1.CFM ·It assumes that the force of mortality is constant, i.e. ux+t = ux ·If the force of mortality of a newborn is constant, it means that the expected future lifetime of this life is 1/μ no matter what age he is in. ·Survival Function in this case will decrease exponentially. ·If 0<s<t<1 then tspx+s = tpx/spx …
MWRR vs TWRR which is better and Why ?
We can decide between various projects that which one
is better and which one is not on the basis of different criteria such as: NPV, IRR, DPP But how can we measure the investment performance?
Well, there are basically three measures of investment performance: 1.Money
Weighted rate of return (MWRR) 2.Time
Weighted rate of return (TWRR) 3.Linked
internal rate of return (LIRR)
Follow us on LinkedIn : Actuary Sense Follow me on LinkedIn: Kamal Sardana
It is necessary to measure the performance of a fund which can be a pension fund, funds of an insurance company or funds of an asset management company. It is important for those who are responsible for the investment funds for example: trustees in case of pension fund will monitor how fund is performing i.e. they find out the rate of return of the fund and then compare it with performance of other funds. Before looking at different measures, let’s see some definitions: a.)Income generate by fund: it includes interest payments, dividends received fr…
Follow us on LinkedIn : Actuary Sense Follow me on LinkedIn: Kamal Sardana
It is necessary to measure the performance of a fund which can be a pension fund, funds of an insurance company or funds of an asset management company. It is important for those who are responsible for the investment funds for example: trustees in case of pension fund will monitor how fund is performing i.e. they find out the rate of return of the fund and then compare it with performance of other funds. Before looking at different measures, let’s see some definitions: a.)Income generate by fund: it includes interest payments, dividends received fr…
Comments
Post a Comment