Rev. Rul. 81-13

Advice has been requested as to the circumstances under which an accrued liability can be directly calculated under the funding method used for a plan for purposes of section 412(c)(7) of the Internal Revenue Code and section 302(c)(7) of the Employee Retirement Income Security Act of 1974 (ERISA), Pub. L. 93-406, 1974-3 C.B. 1, 41.

Section 412(c)(7) of the Code and section 302(c)(7) of ERISA state that the term "full funding limitation" means the excess (if any) of (A) the accrued liability (including normal cost) under the plan over (B) the lesser of the fair market value of the plan's assets or the value of such assets determined under section 412(c)(2). The accrued liability is determined under the method used to determine costs if the accrued liability can be directly calculated or under the entry age normal funding method if such accrued liability cannot be directly calculated under the funding method used for the plan.

Section 3(29) of ERISA defines the term "accrued liability" as the excess of the present value, as of a particular valuation date of a pension plan, of the projected future benefit costs and administrative expenses for all plan participants and beneficiaries over the present value of future contributions for the normal cost of all applicable plan participants and beneficiaries.

For purposes of section 412(c)(7) of the Code and section 302(c)(7) of ERISA, an accrued liability can be directly calculated under the funding method used for the plan if the following three conditions are met:

(1) the accrued liability may be determined solely from the computations with respect to the liabilities (without reference to plan assets);

(2) the accrued liability is an integral part of the funding method used; and

(3) the accrued liability satisfies the definition of section 3(29) of ERISA.

In order for the accrued liability to be an integral part of the funding method used for the plan, such accrued liability or both the present value of future benefits and the present value of future normal costs must be calculated as part of the funding method and must be used to determine plan costs.

In order to satisfy the definition of section 3(29) of ERISA, the accrued liability must be equal to the present value of future benefits less the present value of future normal costs. The normal costs that are so used are the plan's anticipated future normal costs under the funding method as of the valuation date.

Prior to the publication of this revenue ruling, the full funding limitation under some funding methods (for example, methods B and C below) has been determined for some plans by using an accrued liability (including normal cost) which satisfies conditions (1) and (2) above but not condition (3). In order to limit any adverse retroactive effect on those plans, pursuant to section 7805(b) of the Code, for plans years ending on or prior to December 31, 1980, the full funding limitation under such funding methods may be determined using either the accrued liability which satisfies conditions (1) and (2) or the accrued liability under the entry age normal method. (In the case of methods B and C, the individual level premium accrued liability satisfies conditions (1) and (2).) However, for subsequent plan years, in accordance with section 412(c)(7) of the Code and section 302(c)(7) of ERISA, the full funding limitation is to be calculated using the accrued liability under the entry age normal method for methods that do not satisfy all three conditions.

The text of this revenue ruling is illustrated by the following examples:

Example 1

Funding method A is the individual level premium method. Experience gains and losses are separately determined and amortized. The accrued liability under the individual level premium method is the present value of future benefits less the present value of future normal costs. Such accrued liability is determined solely from the computations with respect to the liabilities, is an integral part of the individual level premium funding method, and satisfies the definition of section 2(29) of ERISA. Accordingly, such accrued liability is directly calculated within the meaning of section 412(c)(7) of the Code and section 302(c)(7) of ERISA and must be used for determining the full funding limitation.

Example 2

Funding method B computes the normal cost of the plan as the sum of the normal costs computed separately for each participant for whom a normal cost is computed. A normal cost is computed for each participant currently employed in the service of the employer(s). The normal cost for such a participant is obtained by dividing the excess of the present value of that participant's future benefits over allocated adjusted assets by a temporary annuity factor from attained age to the assumed retirement age. Adjusted assets are allocated each year to these participants, only for purposes of computing the normal cost, in the proportion that the accrued liability under the individual level premium funding method for each such participant bears to the total for all such participants. The normal cost of the plan is not determined under the individual level premium funding method. Before the allocation of assets each year, the assets are adjusted by subtracting any credit balance in the funding standard account or adding any debit balance. If a plan retains the liability for benefits for individuals for whom a normal cost is not computed, the present value of such liability is subtracted from the adjusted assets prior to allocation.

Under funding method B the accrued liability under the individual level premium method is calculated solely from the computations with respect to the liabilities and is an integral part of the funding method. However, for funding method B the individual level premium accrued liability does not satisfy the definition of section 3(29) of ERISA because, although this accrued liability equals the present value of future benefits less the present value of future individual level premium normal costs, the future individual level premium normal costs are not the plan's anticipated future normal costs under funding method B. Also, no other accrued liability is directly calculated under funding method B. Accordingly, the accrued liability (including normal cost) under the entry age normal method must be used to determine the full funding limitation.

Example 3

Funding method C computes the normal cost of the plan in the aggregate for all participants. The normal cost is obtained by dividing the excess of the present value of future benefits for all participants over the adjusted assets by a weighted average temporary annuity factor. The weighted average temporary annuity factor is computed by dividing the present value of future normal costs under the individual level premium method (often called tabular normal costs) by the current normal cost under the individual level premium method. (The normal cost of the plan is not determined under the individual level premium funding method.)

Funding method C is often viewed as computing the normal cost of the plan by multiplying the current individual level premium cost by an adjustment factor. For funding method C the adjustment factor is determined by dividing the excess of the present value of future benefits over adjusted assets by the present value of future normal costs under the individual level premium method.

Under funding method C, both the present value of future benefits and the present value of future individual level premium normal costs (tabular costs) are calculated. Such tabular normal costs are not dependent on the plan assets. The difference between the present value of future benefits and the present value of future individual level premium normal costs is the accrued liability under the individual level premium funding method. Both the present value of benefits and the present value of future normal costs are computed solely from the computations with respect to the liabilities and are an integral part of the funding method. However, the accrued liability under the individual level premium method does not satisfy the definition of section 3(29) of ERISA because, although this accrued liability equals the present value of future benefits less the present value of future individual level premium normal costs, the future individual level premium normal costs are not the plan's anticipated future normal costs under funding method C. Also, no other accrued liability is directly calculated under funding method C. Accordingly, the accrued liability (including normal cost) under the entry age normal method must be used to determine the full funding limitation. Example 4

Funding method D computes the normal cost as the product of the accrual rate and the current compensation of the plan participants. The accrual rate equals a fraction whose numerator is the excess of the present value of benefits over the adjusted assets and whose denominator is the present value of future compensation of plan participants. In determining the present value of future benefits, the actuary separately itemized the present value of future benefits accrued to date and the present value of future benefits not yet accrued.

Under funding method D the present value of future benefits accrued to date is determined solely from the computations with respect to the liabilities (without reference to the assets). However, this determination is not an integral part of the funding method; it is not separately used at any stage of the valuation to influence costs. In addition, this accrued liability does not satisfy the definition of section 3(29) of ERISA and no other accrued liability is directly calculated under funding method D. Accordingly, an accrued liability within the meaning of section 412(c)(7) of the Code and section 302(c)(7) of ERISA is not directly calculated under funding method D, and the accrued liability (including normal cost) under the entry age normal method must be used to determine the full funding limitation.