Automatic Approval for Change in Funding Method Under Rev. Proc. 2017-56
The IRS has finally issued an updated revenue procedure providing automatic approval for certain changes in funding method for single-employer plans that reflects the provisions of the Pension Protection Act of 2006 (PPA) and IRC § 430.
Rev. Proc. 2017-56 replaces Rev. Proc. 2000-40, and formally states that Rev. Proc. 2000-40 approvals do not apply to plans that are subject to § 430.1 This article will discuss certain aspects of Rev. Proc. 2017-56, but interested readers can read the entire revenue procedure here.
In general, Rev. Proc. 2017-56 provides automatic approval for three asset valuation method changes, two valuation date changes, changes in the plan’s actuary, changes in software, and changes for fully funded terminated plans. There are other changes approved as well (such as in connection with mergers and a change in the treatment of insurance contracts). The revenue procedure contains general restrictions on its use in section 6, but also contains restrictions specific to each approval. A key restriction for some (but not all) approvals is that there was not a change in the preceding four years. Rev. Proc. 2000-40 had a similar requirement. Other restrictions will be discussed as needed.
Rev. Proc. 2017-56 is effective for plan years commencing on or after Jan. 1, 2018. However, taxpayers may elect to apply the revenue procedure for earlier plan years.2
Asset Valuation Changes
In general, section 3.013 provides approval to one of three asset valuation changes:
1. A change to “a method that determines the value of the plan assets as fair market value, as defined in § 1.430(g)-1(c)(2)(iii) of the regulations” (emphasis added).
2. A change to a method that determines the value of plan assets as the average of the fair market value on the valuation date and the adjusted fair market value determined for one or more earlier determination dates, as described in the IRC, the regulations, and Notice 2009-22 (with asset value restricted to a 10% corridor around the fair market value).
3. A change to a method that applies a phase-in for the determination of plan assets as the average of the fair market value (as described in more detail in section 3.01(3) of Rev. Proc. 2017-56) with a three-year phase-in period.
The asset valuation changes approved would seem to be straightforward, but some caution is needed. Consider, for example, the approval for a change to fair market value. The approval uses the term “a method” that determines fair market value. How many methods are there that determine plan assets as fair market value? On the one hand, you can think of some humorous (almost ridiculous) ideas. For example, this year I determined the value of the bonds first, and then the stocks, but last year I determined the value of the stocks first, and the bonds second. Is that a change in the way I determined fair market value? One hopes the answer is a resounding “no.”
On the other hand, if there are hard-to-value assets, such as real property or limited partnerships, there is more than one way to determine the fair market value of those assets. A change from one year to the next in the way the fair market value of those assets is determined would be a change in the method to determine fair market value and be subject to the restriction of no changes in the prior four years. So there would need to be consistency in the way the fair market value is determined.
Similar comments apply to the average of fair market value approvals. Note that the phase-in method approval requires that the phase-in must be carried through in years 2 and 3, and that the approval cannot be used to merely restart the method.
Valuation Date Changes
Section 3.02 provides approval for either of two changes in valuation date, provided there was no change in valuation date in the four preceding plan years. The two changes are:
1. A change in the valuation date to the day that is the first day of the plan year.
2. A change in the valuation date to the last day of the plan year, if there was a change in the plan year and the valuation date for the prior plan year was the last day of that plan year.
These are more routine changes, and the approval to the change to the first day of the plan was provided in the past. It is disappointing that no approval is provided for a change to last day of the plan year, especially in view of the approval (discussed below) for takeover plans.
Section 4.01 provides a new approval for takeover plans. The approval in section 4 replaces the approvals provided in IRS Announcements 2010-3 and 2015-3 (collectively, “the announcements”) starting for plan years beginning on after Jan. 1, 2018. Thus, for 2017 plan years there is a choice. The announcements can be used, or approval of section 4 can be used.
Section 4 provides approval for a change in funding method, including a change in the valuation date to the last day of the plan year (without regard to whether there is also a change in the plan year) or a change in software, if all of these four conditions are satisfied:
1. Both the enrolled actuary for the plan and the business organization providing actuarial services to the plan have changed. (emphasis added)
2. The new method is substantially the same as the method used by the prior enrolled actuary and is consistent with the description of the method contained in the prior actuarial report or prior Schedule SB (disregarding any difference attributable to a change in funding method for which automatic approval is provided without regard to this section 4.01).
3. The funding target and target normal cost (without regard to any adjustments for employee contributions and plan-related expenses), as determined by the new enrolled actuary as of the valuation date for the prior plan year (using the actuarial assumptions of the prior enrolled actuary and using the data elements and valuation software of the new enrolled actuary), are both within 3% of those values as determined for that prior plan year by the prior enrolled actuary.
4. The actuarial value of plan assets, as determined by the new enrolled actuary as of the valuation date for the prior plan year (using the actuarial assumptions of the prior enrolled actuary), is within 2% of the value for that prior plan year as determined by the prior enrolled actuary.
Alternatively, the comparisons in conditions 3 and 4 may be made on the basis of the current plan year, provided that the prior enrolled actuary has issued an actuarial report that includes the results for the current plan year (or has provided a signed Schedule SB to the new enrolled actuary for the current plan year, to the extent guidance issued by the IRS would permit the new enrolled actuary to revise those entries on that Schedule SB). For this purpose, an actuarial report must be signed by the enrolled actuary for the plan and must meet the applicable standards of performance under regulations issued by the Joint Board for the Enrollment of Actuaries. In addition, for purposes of this section 4.01, the current plan year means the first plan year for which a Schedule SB is signed by the new enrolled actuary, and the prior plan year means the plan year that immediately precedes the current plan year.
The use of the 3% and 2% thresholds in conditions 3 and 4 are a reduction from the 5% thresholds provided in the announcements. Apparently, with a prescribed methods for valuing liability and assets, the IRS believed there was room for variation and that it wanted to review situations where the variation exceeded the lower thresholds. Of course, the announcements can still be used for takeovers in 2017.
The new approval for takeovers creates an uneven playing field (yes, I like the sports analogy) with respect to the valuation date. It permits a plan sponsor to change the valuation date to the end of the plan year by switching actuarial firms (more about that aspect below) with automatic approval. However, the automatic approval for a valuation date change cannot be made by the current prior actuarial firm. There appears to be little justification for the difference. Furthermore, the difference in treatment for takeovers adds fuel to the controversy discussed below.
The first condition for takeover plans, is that both the enrolled actuary for the plan and the business organization providing actuarial services to the plan have changed. There is some disagreement as to what that means. What is the business organization providing actuarial services to the plan?
To illustrate the disagreement, consider a common situation. The plan sponsor has engaged a third party administrator (TPA) firm to administer the plan, prepare Form 5500 filings, file for determination letters, etc. The TPA firm does not have an enrolled actuary on staff. The TPA firm may have staff that uses actuarial software (including through a license with the typical vendors) and then sends the Schedule SB to an outside enrolled actuary for review and signature. Alternatively, all of the actuarial work may be performed by the outside actuary. The plan sponsor neither contracts with nor separately pays the outside actuary for his or her work. The only contact is with the TPA firm.
The TPA firm changes the outside actuary with whom it contracts. This change can even take place because the first outside actuary is retiring (or has passed away). Assume that the new outside actuary is in a different firm then the first outside actuary. (The term “firm” as used here includes self-employment.) So now the question arises: Has there been a change in the “business organization providing actuarial services” to the plan? Some have said “yes” because they are only looking at the employer of the actuary. Others say “no” because the plan sponsor has contracted for all services (including actuarial services) with the TPA firm.
I side with those who say “no,” and there is another factor that I consider. It concerns disaster relief. In Notice 2017-49, the IRS provided disaster relief for funding for “Affected Plans.” The definition of Affected Plans included a plan for which the office of the “enrolled actuary or other advisor that previously had been retained by the plan or the employer to make funding determinations or certifications…” was in the Affected Area. (emphasis added) Clearly (at least to me), the relief contemplated that an advisor other than an enrolled actuary could be retained to make funding determinations. It appears that the express intent was to provide relief in situations where the TPA firm was in the Affected Area but the enrolled actuary was elsewhere.
What is the difference between the “business organization providing actuarial services” to the plan and the “other advisor” that had been retained by the plan to make funding determinations? I see no real distinction in the situation of the TPA firm illustration. In both cases, it is the TPA firm that has been retained by the employer to provide actuarial services and the actuary is not in contact with the employer. If one takes the view that the business organization has changed because the actuary has changed (thus enabling a change in valuation date to the end of the plan year), then the how can the “other advisor” be the TPA firm?
Also, I have seen situations where the actuary’s signature on the TPA firm’s letterhead. As far as I know, there is no ERISA or IRC provision prohibiting such an arrangement. Furthermore, you have the question as to whether the enrolled actuary is an employee of the TPA firm or an independent contractor. It will make things more complicated if that question needs to be resolved to see if there is a takeover. However, if one considers the change in valuation software approval, there is an alternative that may avoid the issue.
So far there has been no clarification from the IRS with respect to the controversy. Given the focus on tax reform efforts that are currently taking place, it is likely that any clarification from the IRS will come informally. In the meantime, be careful of the interpretation you make and consider the impact in all situations.
Change in Valuation Software
Section 4.02 provides approval for a change in valuation software if these five conditions are satisfied:
1. The enrolled actuary for the plan is the same as the enrolled actuary for the plan for the prior plan year, or the business organization providing actuarial services to the plan is the same as the business organization that provided actuarial services to the plan for the prior plan year. (Accordingly, the approval under section 4.01 of this revenue procedure is not available.)
2. The new method is substantially the same as the method used for the prior plan year (disregarding any difference attributable to a change in funding method for which automatic approval is provided without regard to this section 4.02).
3. The new valuation software generally will be used by the enrolled actuary for the single-employer plans to which the enrolled actuary provides actuarial services.
4. For either the prior plan year or the current plan year, the funding target, target normal cost (without regard to any adjustments for employee contributions and plan-related expenses) and actuarial value of assets determined under the new valuation software are each within 1% of the respective values determined under the valuation software used for the prior plan year (all other factors being held constant). However, the 1% threshold is increased to 2% of the respective values if the approval under this section 4.02 was not used in the prior year.
5. The modifications to the computations in the valuation software or the use of a different valuation software system are designed to produce results that are no less accurate than the results produced prior to the modifications or change.
The conditions for approval of a change in valuation software are similar to those in the announcements, but there are some changes in wording. The wording of the first condition is different but the result is the same. Announcement 2010-3 had stated condition 1 in the negative, with language stating, “There has not been both a change in the enrolled actuary for the plan and a change in business organization” (emphasis added). Thus, either the enrolled actuary or the business organization can change, but not both, or neither could change. Condition 1 of § 4.02 states things in the positive in the enrolled actuary is the same or the business organization is the same (and implicitly allow both to be the same). Same result, just said differently.
The thresholds in condition 4 have been lowered to 1% from the 2% level in Announcement 2010-3. However, if there was no change in valuation software for the prior year for which § 4.02 of Rev. Proc. 2017-56 approval was used, then the 1% is increased to 2%. Because of the specific reference to § 4.02, it appears that a change in valuation software for 2018 will have a 1% threshold even though there was no change in the software for 2017.
With respect to condition 1, there is the same question of what is meant by the business organization providing actuarial services to the plan. The example of the TPA firm and the outside actuary exists for the enrolled actuary. If the business organization is the TPA firm, then the valuation software change easily applies, and there is no need to seek other approval (such as through a “class ruling” request4) for changing systems. The only downside concerns a change in the asset valuation method (which can be made separately, if no change in the prior four years) and the change in valuation date (which may not be desired anyway).
In any case, care in interpretation is needed, and can have other impact. Again, IRS clarification may be needed.
Rev. Proc. 2017-56 introduces a new concept referred to a “data elements.” While the regulations before and after PPA state that each specific method of computation is part of the funding method, the regulations did not elaborate upon the statement. Rev. Proc. 2017-56 does elaborate upon the statement (nor does Rev. Proc. 2017-57). Any change in data elements is a change in funding method.
Examples of data elements include the method for determining plan compensation, the method for determining dates of birth, and using assumed data rather than actual data. Thus, for example, a change from assuming that spouses were three years younger than the plan participant to using the actual age is a change in data elements. (See section 3.02 of Rev. Proc. 2017-57, and also note there is a distinction between assumptions and methods.)
Section 4.03 of Rev. Proc. 2017-56 provides automatic approval for a change in data elements if conditions are satisfied. As an example, a change from determining compensation using the prior year’s actual compensation with an adjustment to the current year to using the current year annual rate of pay is approved. The conditions for approval are:
1. The enrolled actuary for the plan is the same as the enrolled actuary for the plan for the prior plan year or the business organization providing actuarial services to the plan is the same as the business organization that provided actuarial services to the plan for the prior plan year.
2. Other than the change in data elements described in this section 4.03, the new method is the same (disregarding any difference attributable to a change in funding method for which automatic approval is provided without regard to this section 4.03).
3. The funding target and target normal cost (without regard to any adjustments for employee contributions and plan-related expenses) determined using the all of the new data elements (for either the current plan year or the prior plan year) are each within 1% of the respective values determined using the prior data elements (with all other factors being held constant).
4. The use of any new data element is designed to produce results that are no less accurate than the results produced prior to the modifications or change.
It would not be surprising if many are dismayed that the IRS has now focused on the data elements. However, another view is that IRS has actually helped enrolled actuaries to avoid a trap for the unwary. The statements in the regulations were there before the PPA, which had the potential of an agent claiming there was a change without approval (even though it is unlikely that an agent would understand that level of detail). With the approval provided by § 4.03, a change can be made without having that potential. It is important to consider that there is no condition that looks at whether a change in data elements was made in prior years. Thus, there can be changes in data elements for successive years.
Fully Funded Terminating Plans
Section 4.04 provides for approval of certain changes in funding method for fully funded terminated plans. The changes approved by § 4.04(1), if the conditions in § 4.04(2) are met, are:
1. The asset valuation method may be changed to a method that determines the value of plan assets as the fair market value of assets, even if that change does not otherwise satisfy the conditions of section 3.01 of this revenue procedure.
2. For a plan that is eligible to designate any day during the plan year as its valuation date pursuant to § 430(g)(2)(B), the valuation date may be changed to the date of termination or the first day of the plan year, even if the change does not otherwise satisfy the conditions of section 3.02 of the revenue procedure.
3. The funding method may be changed as a result of a change in both the enrolled actuary for the plan and the business organization providing actuarial services to the plan, even if the change does not otherwise satisfy the conditions of section 4.01 of this revenue procedure.
4. The funding method may be changed as a result of a change in the valuation software, even if the change does not otherwise satisfy the conditions of section 4.02 of this revenue procedure.
5. The funding method may be changed as a result of a change in the data elements, even if the change does not otherwise satisfy the conditions of section 4.03 of this revenue procedure.
The conditions on the approvals that are set forth in § 4.04(2) are:
A. As of the date of termination, the assets of the plan (exclusive of contributions receivable) are sufficient to satisfy all benefit liabilities (whether or not the corresponding benefits are vested). (emphasis added)
B. If applicable, a timely notice of intention to terminate was filed with the Pension Benefit Guaranty Corporation pursuant to section 4041(b)(2)(A) of ERISA.
The approval for the change in method for fully funded terminated plans is similar to that found in previous revenue procedures. However, there has been confusion with the approval for the change in valuation date provided by the final regulations that were issued in 2015. The regulations provide approval for a terminating plan to change the valuation date from the last day of the plan year to any date from the first day of the plan year through the plan termination date. The approvals in section 4.04 do not negate the approval in the regulations, but provide additional approvals for situations where the regulations do not apply.
Consider a plan with a beginning of the plan year valuation date. The plan sponsor decides to terminate the plan part way through the year. On the proposed termination date, the plan assets are sufficient to provide all benefits, but at the beginning of the plan year the assets were not sufficient. Section 4.04 provides approval to change the valuation date from the beginning of the plan year to the termination date, and to also change the asset valuation method to market value. In addition, rather than projecting accruals for the year to the termination date, the actual accruals can be used. The regulations did not apply because the valuation date was prior to the termination date, but the revenue procedure does.
Note the emphasized wording in condition A. The word “receivable” means contributions to be made in the future as opposed to contributions received, which have already been made. The condition assures that, as of the termination date, the plan already has enough assets to provide the benefits. Arguably, in the context of PPA, that condition is no longer needed, but the IRS wanted to continue it because of prior revenue procedures. The reason the condition is no longer needed is that the basic funding method will not change and the target normal cost can be determined reflecting the plan termination even if the plan is not fully funded at the termination date (but a commitment has been made for the contribution needed to fund the benefits.). In other words, the context has changed and the size of the plans that can use a valuation date other than the first day of the plan year had decreased. The need for full funding could be dropped with no significant adverse policy impact.
The issuance of Rev. Proc. 2017-56 has provided needed automatic approvals for single-employer plans under PPA. This article has highlighted some key aspects especially for small plans. There are important approvals that were not discussed (for example, mergers), and perhaps they be the subject of another article. Also, this article did not go through the restrictions in section 6 on using the revenue procedure, which also can be the subject of a separate article.
1. See § 8 of Rev. Proc. 2017-56.
2. See § 7 of Rev. Proc. 2017-56.
3. Unless otherwise stated, all section references are to sections in Rev. Proc. 2017-56.
4. See Revenue Procedure 2017-57.
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