On August 17, the President signed into law the Pension Protection Act of 2006. Most of the changes in the PPA address the funding and disclosure requirements for traditional defined-benefit (DB) plans.
Factors that prompted the passage of the PPA include the artificially low interest rates used for discounting traditional pension valuations and the numerous corporate failures in the past decade that resulted in the dissolution of employees’ pension plans.
The PPA will bring about significant changes in the valuation of lump sum distributions. These changes include new interest rates and new mortality tables that will ultimately cause a reduction in the General Agreement on Tariffs and Trade treaty limitation.
The GATT treaty imposed a limitation on qualified DB plans, including 412(i) plans, specifying how much can be distributed as a lump sum. This limitation does not affect annuitized distributions. If the lump sum distribution exceeds the GATT limit at the time the participant takes it, the participant will not receive the amount in excess of the GATT limit. An article detailing the GATT limit on lump sum distributions from qualified defined benefit plans appeared in the June 12, 2006, issue of National Underwriter.
Clients Have a Lot to Lose
Monitoring GATT limits on DB and 412(i) plans can protect clients from losing a significant portion of an anticipated lump sum distribution. In the example below based on current law, a 55-year-old male with a 412(i) plan who plans to retire at 65 with $3.3 million in cash available at retirement but with nearly $2.1 million available as a lump sum could lose roughly $1.3 million of the cash value/benefit where the GATT limit is exceeded (see chart).
PPA Changes the Valuation of Lump Sum Distributions
The PPA introduces a new pension funding model. Lump sum distributions from DB plans will be valued using a 3-segment yield curve, which is based on the rates for the month before the distribution, rather than on the 24-month average used for the plan’s funding.
GATT Limitations Reduced on Lump Sum Distributions