One of the most challenging things enrolled actuaries face is the takeover of a defined benefit plan. A takeover in this context is typically defined as a change in both the enrolled actuary and the business organization providing actuarial services.
Once we get beyond the initial stage of reviewing plan documents and gathering all the historical data, we arrive at the point of checking benefits and actuarial values and compare to what was reported by the prior actuary. One of the first steps we take is to rerun the prior year valuation and compare our results to the prior year certified Schedule SB. We do this to confirm that we in compliance with the rules found in IRS Announcement 2010-03, “Automatic Approval for Takeover Plans.”
In a nutshell, Announcement 2010-03 requires that our methodology be substantially the same as the prior actuary’s. Automatic Approval is granted as long as we are within a 5% range of the prior actuary’s calculated Funding Target (FT) and Target Normal Cost (TNC). These are checked separately, not as a single sum. If you find that your methodology is different, but you are within the 5% threshold, you will check Line 25 of the current Schedule SB as a ‘Yes’ and do an attachment referencing compliance with Announcement 2010-03.
There was an expansion to 2010-03 with Announcement 2015-03, which allows the takeover actuary to check the actuarial values using a signed valuation report that was issued in the current year (instead of a comparison to the prior year). Announcement 2015-03 also addresses a takeover for a plan that filed a 2013 Schedule SB without the use of the HATFA funding rates. It gives the takeover actuary approval to amend the 2013 Schedule SB to incorporate the HATFA rates while leaving all other assumptions and funding methods the same.
With these takeover thresholds, keep in mind that if the prior actuary had errors, such as incorrect participant benefits, you will run the 5% test using the same benefits they used. The purpose of the 5% is not to check the accuracy of the prior work but instead to check that the methodology we are employing in calculating liabilities is similar enough that the 5% threshold is met.
If the benefits match, the right assets were used and you are within the 5% threshold noted above, then you’re ready to move on to the current year. But that would be an easy takeover, which many are not.
Unfortunately you will sometimes find that the prior actuary or the firm doing the actuarial calculations made mistakes in calculating participant benefits. It could be from incorrectly coded software, misreading of the benefit formula or data entry errors. If this is what you’re up against, it’s clear that you or the prior actuary needs to revisit the prior year (or years) to determine the impact of the corrections to the data.
The most important thing is to confirm whether there are any issues with minimum funding being met and/or the accuracy of prefunding balance amounts. How far back you need to go depends on how far back the errors occurred.
The IRS has indicated that it is not necessary to amend a Schedule SB when the changes have no impact on minimum funding (without regard to the HATFA issues addressed above). Things can get sticky if the plan was adding excess contributions to the prefunding balance and/or applying funding balances to meet minimum funding. Once you or the prior actuary have reworked the years in question, you must consider any changes to the prefunding balance when determining that minimum funding was met in those prior years. If the plan has no issues with minimum funding but does have changes to funding balances, consideration must be given to all the parts that may be impacted by such changes. That would include AFTAPs, 101(j) notices, funded ratios (if balances used to reduce minimum funding) and more.
If you’re lucky enough to have no material issues other than a change in the prefunding balance, these changes can be reported on the current year Schedule SB. Changes to the balance amount as of the beginning of the prior plan year will create a need for a “Line 7 – Explanation of Discrepancy in Prior Year Funding Standard Carryover Balance or Prefunding Balance” for the current year SB. This is described in the Schedule SB instructions. A change to the prior year excess contribution amount reported on Line 38 of the prior year Schedule SB will impact Line 11 of the current Schedule SB. Although a Line 11 attachment is not specifically addressed in the Schedule SB instructions, my experience has been to submit it as an ‘other attachment’ with Line 11 referenced in the heading. Both a Line 7 and Line 11 attachment should provide a brief explanation on why the balances were adjusted as well as a statement that the adjustments to the prior work had no impact on satisfaction of required minimum funding in that year.
Conversely, if you do find that there are issues with minimum funding in a prior year, you or the prior actuary will need to certify and file (if applicable) an amended Schedule SB. There may be other situations where you will want to amend the Schedule SB even when that particular year has no problem with minimum funding. For example, assume that you take over a DB plan for the 2014 calendar year. In the takeover process you find errors and correct them. It turns out the plan had a funding deficiency for the 2012 plan year. The sponsor funded enough to satisfy minimum funding in 2013 including the 2012 unpaid minimum. In my practice, I would advise that an amended SB is needed for both the 2012 and 2013 plan years, whether by me or the prior actuary. A Form 5330 would need to be filed (albeit late) for the 2012 year.
When you have a takeover with problems in prior years, common sense goes a long way. Make the effort to contact the prior actuary to discuss the problems that you have found. Give them the opportunity to explain — there may be data that you are missing! Or give them the opportunity to correct if that’s what makes sense. And remember, it goes both ways. Treat others the way you want to be treated. Be aware of our ethical and professional duties and follow those rules accordingly. Having a spirit of cooperation is something that goes both ways — and goes a long way.
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