The IRS has issued Notice 2004-78 (from Benefitslink.com), providing guidance with respect to a change to section 415 of the Code which was tucked away in the Pension Funding Equity Act of 2004 (“PFEA”). The change affects all defined benefit plans and has to do with the actuarial assumptions that must be used to adjust a benefit payable in a form other than a straight life annuity.
Prior to its amendment by PFEA, section 415(b)(2)(E))(ii) provided that, for purposes of adjusting any benefit payable in a form that is subject to the minimum present value requirements of section 417(e)(3) of the Code, the interest rate assumption could not be less than the greater of the applicable interest rate (as defined in section 417(e)(3)) or the rate specified in the plan.
PFEA amended section 415(b)(2)(E)(ii) of the Code to provide that the interest rate assumption must not be less than the greater of the applicable interest rate (as defined in section 417(e)(3)) or the rate specified in the plan, except that in the case of plan years beginning in 2004 or 2005, 5.5 % is used in lieu of the applicable interest rate.
The Notice makes it clear that the changes made to section 415 of the Code by PFEA will be effective for plan years beginning on or after January 1, 2004, but that the changes will not apply to plans that terminated prior to April 10, 2004, the date of enactment of PFEA. Also, the Notice provides that a plan won’t violate section 411(d)(6) of the Code or section 204(g) of ERISA if the plan is amended on or before the last day of the first plan year beginning on or after January 1, 2006 and the plan is operated in the meantime as though the amendment were in effect during the period beginning on the date the amendment is effective.
What is the financial effect of this change? The Notice provides as follows:
. . . [W]here a plan’s interest rate is 5%, the applicable interest rate under § 417(e)(3) is 5.25%, and where the plan uses the applicable mortality table for determining actuarial equivalence, the effect of section 101(b)(4) of PFEA ’04 would be to require the conversion of a single-sum distribution paid during the plan year beginning in 2004 to an equivalent straight life annuity using 5.5 % rather than the applicable interest rate of 5.25% as under prior law. In such a case, to satisfy the limitations of section 415 of the Code, the maximum single-sum distribution for a participant who is age 65 in 2004 would be $1,866,645 calculated using 5.5% as required by section 101(b)(4) rather than $1,905,638 calculated using 5.25% as required under prior law.