DB Training Material

Build Domain Training Session - I
Topics to be covered:
Introduction to DB Plans
Introduction to DB Plan Types & Formulas
Introduction to Service & Eligibility
Introduction to Estimates
Introduction to Compensation
Introduction to Protection of Benefit
Introduction to DB Plans
Market/Division/Tier 3 (Optional) | Practice Group/Tier 4 (Optional)

Proprietary & Confidential (Optional) | Date (Optional) 2
DB Plan
- Defined by a mathematical formula based upon a combination of age

and/or service and/or pay levels, or may be a guaranteed flat benefit
amount
- Aims at replacing a portion of an employees’ pre-retirement income
- Aims at providing economic security to participants and their families

during retirement years
- Rewards long term service
- Helps companies remain competitive in the market place

Companies
- Invest their retirement contributions in one pension trust for all

employees
- Can generate profit or incur losses through the invested trust fund
- Can use the interest earnings to offset future contributions
- Employees are not impacted by the pension trust investment

performance

Actuary
- Estimates employer contributions to DB Plans
- Estimates the cost to the company
- Designs formulas to calculate pension amounts

Government ensures that DB Plans
- Have enough assets to meet future obligations
- Do not discriminate amount plan participants
- Communicate appropriately to plan participants
- Pay as promised to the employees

PBGC
- It is a federal agency that guarantees benefits from qualified DB

Plans
- Employers pay annual fee PER PARTICIPANT for insurance under

the PBGC
- If company is unable to pay benefits, PBGC will pay monthly

retirement benefits, UP TO a guaranteed maximum, to participants
- Employers are required by law to establish a pension trust or trust

fund so that pension funds are protected and retirement benefits are
still paid in circumstances like bankruptcy

Introduction to DB Plan Types and
Formulas

– There are two broad categories of Defined Benefit Plans:
Qualified
Nonqualified
– Most participants belong to a qualified plan and enjoy the

tax advantages it offers.
– Only select, high-income participants belong to a

nonqualified plan, where there are few government
restrictions.

Qualified Pension Plans
– Governed by IRC Section 401 (a)
– Provide tax advantages to Participants, Plans & Employers
– Adhere to government rules in their design and administration
– Guarantee promised benefits to the participants & have the plans

explained to them in writing
– Require to have mandatory insurance coverage governed by PBGC

Qualified Pension Plans Contd.
 Employers –
- Employers are obligated to make sure they pay the promised amount to
participants
- Employers can deduct plan contributions from their federal taxes
- Employers remain exempt from paying taxes on the interest their
contributions earn
 Participants –
- Participants are guaranteed to receive the promised retirement benefits and
to have qualified plans explained to them in writing
- Participants receive tax advantages by paying taxes on the employer-
provided benefits when they receive them, not during their employment
- Participants would be covered by insurance (PBGC) if a company did not
have the money to pay for retirement benefits
- Qualified plans do, however, limit the maximum benefits higher paid
employees receive

Non- Qualified Pension Plans
- Do not meet all the all the government rules as Qualified Plans do
- No tax advantages for participants or employers
- Not offered to everybody – only to select participants who need to receive benefits in
excess of the government limited amount that can be paid from the Qualified Plan
- Provide supplemental benefits in addition to the limited benefits from the Qualified
Plans
- Do not guarantee their employees a right to benefits
- Offer flexible ways of paying balances to employees
- Favor some employees over the others

 There are six types of pension plans with all of them derived from
formulas based on an employee’s compensation and years of
service:
Final Average Pay (FAP) Pension Equity Plan
Career Average Pay (CAP) Dollar Times Service
Plan
Cash Balance Plan Employee Contributory
Plan
 FAP is the most common type of retirement plan for large

employers and its formula averages the highest consecutive or
nonconsecutive years of a participant's pay.

Final Average Pay
- Averages the highest consecutive or nonconsecutive years of

participant’s pay
- Post –retirement income is based on pre-retirement earnings
- Considers an employee’s years of service and compensation history
- Rewards long-term service employees
- Normal form of payment is typically an Annuity
- No portability of benefits – benefit must remain in the plan until the

participant reaches some form of retirement eligibility

Final Average Pay Contd..

Career Average Pay
- Benefits accrue based on a percent of the employee’s entire pay

history
- Post-retirement income is based on the pre-retirement earnings over

the entire career (versus a highest average)
- Lower cost alternative to a FAP
- Rewards long-term service employees
- Considers an employee’s years of service and entire compensation

history

Career Average Pay Contd..

Cash Balance
- Designed to provide benefits for short-term employees
- Hybrid pension plan – having the attributes of both a traditional pension

plan and a Defined Contribution (DC) plan
- Contributions into a participant’s account are usually defined
- Employers calculate the accruing benefit monthly, quarterly, or annually
- Participants can take their accrued benefit when they leave the company
- No reduction for early retirement

Cash Balance

Pension Equity Plan
- Participant’s benefits are expressed as a lump sum value equal to a multiple of Final
Average Pay
- For each year worked, employees are credited with a percentage of pay that will be
applied to their final average compensation
- Benefits under this plan are defined in terms of a current lump sum amount
- Easy for employees to understand and calculate the benefit
- Unlike Cash Balance, the account grows with salary increases rather than interest
credits
- Aims at providing benefit to mid-career hires
- Hybrid pension plan, having attributes of both traditional DB Plan and DC Plan

Pension Equity Plan

Dollar Time Service
- Participants receive a specified dollar amount times the number of

years of service
- Sometimes used as a minimum comparison to the FAP, whichever is

more generous
- Easy for employees to understand
- Mostly offered to union employees
- Low-cost employer provided benefit
- There is a reduction for early commencement

Dollar Time Service

Employee Contributory plan
- Allows employees to make contributions to their pension plan
- Subject to special or complex government regulations
- Raises awareness of retirement, and makes employees responsible for part of their
retirement savings
- Employees become part of the retirement planning process, increasing their

understanding and appreciation
- Participant makes after-tax contributions to the plan, which earns interest
- Employee contributions generally mean less pension benefit contribution from the
employer
- Fewer employers offer these plans

Employee Contributory plan Contd..
- Following one of the two approaches :
Offset Approach
 Retirement Benefit = Annual Benefit (employee provided portion +

Employer provided portion)
Add-on Approach
 Retirement Benefit = Annual Benefit + Employee Contrbution +

Interest

Dollar Time Service

Introduction to Service and
Eligibility

Introduction to Service and Eligibility
 Service means a period of employment. Companies
use the plan rules to describe how service is measured
 First, you have to work to qualify to enter the

pension plan (Eligibility Service)
 Second, you have to work to be entitled to receive all or a

portion of the retirement benefit (Vesting Service)
 Finally, once you qualify to enter and get eligible, service

earned from right after the waiting period till the retirement is
used to calculate the pension benefit (Credited Service)
Employee Retirement Income Security Act
 Specifies the maximum participation requirements. A plan

CANNOT be more restrictive than ERISA rules
 The minimum standard for participation set by ERISA dictate to

have the employee reach the age of 21, AND complete one year
of service with the company

Computation Period
 There are 3 types of computation periods:
 Calendar Year – From January 1 to December 31 of the

same year
 Plan Year – The plan may determine any start date within a
calendar year and end date that is the day before the
following year (e.g. June 1 to May 31)
 Anniversary Year – This is one full year beginning on the

date of hire each year (e.g. Date of hire is March 3.
Anniversary Year would be from March 3 to March 2 of the
following year)

Methods to Count Service
 There are three types of Methods to Count Service :
 Hours of Service – Counts actual hours worked and paid in

a computation period
 Hours Equivalency – It is based on a set number of hours

for a specified period of time worked
 Elapsed Time Method – Counts the total period of time that

lapses while the employee is employed, regardless of the
actual number of hours of service completed.

Methods to Count Service
Hours of Service Method
 Counts actual hours worked and paid in a

computation period

Hours Equivalency Method
 Considers a set number of hours for a specified time period of

employment
 This set time period may be Daily/Monthly, etc
 Certain number of EQUIVALENT hours are assigned to such

period

Elapsed Time Method
 Counts the total period of employment that elapses while the

employee is employed, regardless of the number of hours worked.
 Service is counted from the starting point to an ending point
 Eligibility/Participation Date is usually the starting point for

earning benefit service
 Date of Termination is the ending point for the period of service
 To determine the amount of lapsed time, you have to subtract

DOH (Date of Hire) from the DOT (Date of Termination)
 Date Subtraction is rounded & Plan determines how rounding

works
Introduction to Estimates

Intro to Estimates
PROJECTION of what the participant would receive from the

Pension Plan when retired
- Plan rules specify when a participant can receive an estimate
- ERISA requires that a plan administrator provide a participant,

beneficiary or alternate payee with a statement of total or vested
accrued benefits once a year.
- IRC imposes certain limits that cannot be calculated until the

actual payments start. These limits (such as “pay cap” limits)
restrict the benefit payable from the qualified plan.

Intro to Estimates contd…
-Only projects the pay that is within the current pay cap limit
- Uses current rate of interest
- GATT is a law that defines the interest rates that should be used
- May reflect a total benefit with benefit amounts from both

qualified and nonqualified plans. However, in this case, the
actual retirement or commencement kit lists the portions from a
qualified and nonqualified plan separately
- May or may not be adjusted to reflect the QDRO

Who all can request for an Estimate –
- Employees :
 Active Employees who are participate in the plan
 Terminate Employees who are vested in the plan
- Beneficiaries :
 Can only receive an estimate once the participant dies
 Only if beneficiary is entitled to a benefit
- Alternate Payees

What do you need to perform an Estimate –
- Date of Termination
- Benefit Commencement Date
- Other Calculations (optional) – Beneficiary Birth Date, Pay

Growth Percentage, Beneficiary Relation Code, Base Pay Rate.

Introduction to Compensation

Intro to Compensation
 Compensation includes pay components that may or may not

be included in the definition of pay used to calculate retirement
benefits. For example, overtime may be included and
commissions may be excluded
-Definitions of pay may differ by plan or the same plan may use
different definitions for different reasons
-Major reasons for defining pay in more than one way include:
Legal requirements
Level of benefit company wants to provide
Available data
Safe Harbor Benefit Formula

 Factors that companies may consider when deciding the

definition of compensation :
Cost
Employee expectations and satisfaction
Impact and availability of nonqualified plans
- Bridging is a method by which periods of zero compensation are

ignored (bridged) when calculating a participant’s final average
pay. Service may also be bridged
- Pay caps limit the amount of annual compensation that can be

used to determine benefits for qualified plans. They were
implemented by federal government from 1989 plan year, and
can effectively reduce the benefits that plans can pay to highly
compensation employees
 No recorded pay is such pay which requires that participant

be deemed to receive compensation even if no compensation was
paid for Leaves of Absence like Disability leave, Military leave,
Jury Duty, Family Medical leave, etc.
- Trailing pay:
 Pay which is received months after it is earned
 Client must decide if trailing pay is applied to the
period in which it is earned or the period in which it is
received
 Safe Harbor pay definition requires that client must
count the trailing pay in the year in which the pay is
received
- Section 415 Limits of IRC limits the amount of annual benefits

that a qualified DB plan can provide
Safe Harbor Benefit Formula
- Mathematical test performed by a plan actuary to prove that the

benefits under the plan do not discriminate in favor of highly
compensated employees
- Plan administrators must perform nondiscrimination testing

each year to demonstrate the plan provides benefits fairly
- By using a Safe Harbor Benefit Formula, the plan may avoid

nondiscrimination testing
-By using the government definitions, a company is in a “safe

harbor” and will not be determined to discriminate in favor of
highly compensated employees

Introduction to Protection of Benefit

Intro to Protection of Benefit
 Federal law protects accrued benefits to ensure that benefits

already earned to not decrease even if laws changes or company
changes its plan design.
-Once a benefit is earned or accrued, or a right or feature

promised, then such benefit, right or feature cannot be taken away
-Two rules under Protection of Benefits –

oAnti-Cutback Rule:
oHighest Early Rule:
-Two key sources of change that affect pension plans due to plan
amendments :
Company driven plan design changes (usually reflect a
change in the corporate environment)
Government-driven legislative changes
Anti-Cutback Rule :
“You made a promise, you must keep it”
An accrued benefit may not decrease due to a plan amendment
The past is protected, but the future can be changed
The dollar amount of the accrued benefit is protected, but not the
actuarial equivalence
Benefit formula is protected from an amendment change, but not

the operation within the formula
Plan may not be amended to provide for a “significant reduction

in the rate of future benefit accrual” UNLESS participants are
notified of the amendment date and its effective date
Anti-Cutback Rule :
Written notice explaining the amendment and its effective date must be
provided after adoption of amendment and atleast 15 days before the
effective date
Written notice must be provided to each-

Participant
Beneficiary
Alternate Payee
Estate (employee organization representing participants)
Provides that a plan amendment may not :

Decrease the accrued benefit by changing a formula to a less
generous one
Reduce or eliminate early retirement benefit/subsidy by revising
early retirement factors
Eliminate an optional form of payment

Anti-Cutback Rule :
Exceptions of Anti-CutBack are (first three are IRS identified) :
Change due to statutory requirement
Changing a cash-out benefit (for involuntary cash-outs up to
$5,000)
Removal of middle J&S option or options
Changes in FAP, Social Security fluctuations and Covered
Compensation fluctuations
Grandfathering is the term applied to the protection of benefits, rights

or features. It prevents prohibited cutbacks due to plan amendments
Three commonly used types of grandfathering :

Wear-Away Method
No Wear-Away Method
Extended Wear-Away Method

Highest Early Rule :
“Don’t hurt someone who stays employed and helps you”
At normal retirement, the plan must pay the highest monthly
payment the participant could have received if they had retired
earlier
It is a win-win situation for both Employees and Employers :

Employees can continue to work without the risk of
reducing their retirement benefits
Employers gain from the experience of long-service
and/or older employees

Highest Early Rule :
“Need for Highest Early rule :
Decrease in FAP
Changes in Social Security Benefit (for plans with
Social Security offset formula, the plan benefit might
decrease as the Social Security benefit increases. This may
trigger Highest Early rule)
Changes in Covered Compensation (for plans with a
Social Security Covered Compensation excess formula,
the plan benefit might decrease as the Covered
Compensation amount increases)
Requires that multiple calculations be performed on and after the early

retirement date; may be performed on an ongoing basis or at retirement
Relevant regulations use annual examples, but there is nothing in the

law that says the calculations cannot be made more frequently

Comparision :

Introduction to Benefit Payments

Intro to Benefit Payments
 Monetary distributions from a pension plan
- Considered as income and are taxable
- In general, there are three types of payment (although we could

have a variety of combinations of possible forms of payments) :
 Life Annuity:
 Lump Sum
 Period Certain
-Life Annuity:
 Monthly payments to last the life of the participant and
possibly a spouse or beneficiary
 Takes life expectancy into account
 Cannot be rolled over to tax-deferred vehicles
Intro to Benefit Payments Contd…
 Lump Sum:
 Single payment that represents the entire value of a

participant’s pension
 Can be rolled over to tax-deferred vehicles
- Period Certain
 Guaranteed payments for a specific time period

 Not based on life expectancy
 If participants dies before receiving all payments, they
go to a beneficiary
 Period Certain payments less than 10 years can be
rolled over to tax-deferred vehicles

 Tax Characteristics :
- Lump sum cash-outs may be rolled over into a tax-deferred

vehicle
- Annuities are based on life expectancy and may not be rolled

over into tax-deferred vehicles
- Federal, state, and local withholding and other deductions may

be taken from the benefit payments
- Some plans allow employee contributions; if these contributions

were made after being taxed, they are not taxable when paid as
benefits

 Federal government prefers annuities because they

provide income to retirees and their spouses for the rest of
their lives
- There are no IMMEDIATE federal tax benefits for

retirees since regular wages and pension benefits are
taxed the same. However, once retired, some retirees may
fall into lower tax brackets when they’re not working
- Additionally, some states don’t tax pension benefits so

this could provide a tax benefit

 General flow of Basic Payment Process :
- Participant calls Service Center to initiate retirement
- Service Center sends retirement paperwork to the participant
- Participant calls the Service Center with his or her elections
- Service Center sends authorization for to the participant, which

must be signed and returned before benefits begin
- Service Center reviews the returned Authorization Form. The

Service Center may send a confirmation statement to the
participant

 Hewitt creates payment file and sends to the trustee or

checkwriter. Client teams typically send annuity and Lump Sum
payments on separate files to the trustee/checkwriter
- Hewitt sends instructions to the Checkwriter, reconciles the

accounts, and provides reports
- Checkwriter reconciles the same accounts, serving as a check

and balance system to verify Hewitt’s reconciliation
- Checkwriter verifies their results with Hewitt
- Checkwriter sends check or other type of payment to

participant, usually on a set schedule

Forms of Payment :
 Each plan may offer a variety of forms of payment, however,

they must offer a normal form of payment
- Normal form for single participants = Single Life Annuity
- Normal form for married participants = Qualified Joint &

Survivor Annuity (QJSA)
- The monthly amount payable for a J&S Annuity is less than an

SLA because benefits are payable for two people
- Marital status on the Annuity Start Date (ASD) determines the

type of required optional form
- IRC determines the rules for normal forms of payment

Forms of Payment :
 Any form of payment offered to participants other than the

normal form is defined as an optional form
- There must be spousal consent for a married participant to elect

an optional form
- Optional forms are available to the participants only if:

 They are listed in the Plan Document, and
 Participant waives the normal form and elects the
optional form, and
 Spouse of the married participant provides notarized,
written consent to the waiver, and election of the optional
form
-There is no legal requirement to offer an optional form of

payment and some plans do not offer them
Types of optional forms of payment –
 Joint & Contingent is a J&S annuity selected by a single

participant, who designates a beneficiary other than a spouse.
Since the normal form for a single participant is an SLA, selecting
this payment form is like choosing an optional form of payment
- Payment Certain provides a guaranteed number of monthly

payments to the participant, starting on the Annuity Start Date
(ASD)
- Certain and Life Payment provides monthly benefit for the life
of the participant with a specified number of guaranteed
payments. If participant dies before receiving all guaranteed
payments, the beneficiary receives payments until the guaranteed
period ends

 Joint & Contingent is a J&S annuity selected by a single

participant, who designates a beneficiary other than a spouse.
Since the normal form for a single participant is an SLA, selecting
this payment form is like choosing an optional form of payment
- Payment Certain provides a guaranteed number of monthly

payments to the participant, starting on the Annuity Start Date
(ASD)
- Certain and Life Payment provides monthly benefit for the life
of the participant with a specified number of guaranteed
payments. If participant dies before receiving all guaranteed
payments, the beneficiary receives payments until the guaranteed
period ends

 Lump Sum provides the entire benefit as a single payment to
the participant
-Cash Outs (Non-Elective Force Out)

 Government rule allows a plan to force a participant to
receive a one time lump sum payment when the amount is
less than or equal to $5,000
 Payouts from Nonqualified plans or to non-spouse
beneficiaries cannot be rolled over into a tax-deferred
vehicle
 Payouts can be directly paid out to the participants,
partly disbursed as a rollover and partly to the participant
 As per the regulations passed by the IRS in March,
2005, cashouts greater than $1,000 can be rolled over to
an IRA Account when participant does not make a
delivery election
 Level Income is an option for participants taking early

retirement
 Provides an increased amount of income to age 62 or
age 65 or whenever Social Security Benefits start
 It is then reduced by the estimated amount of Social
Security benefits
 This option is available only to participants who begin
receiving benefits before Social Security begins
 Benefits are paid for the life of the participants and stop
when participant dies
 No beneficiaries

 Relative Values –
- Government required calculation & helps employees compare

two different forms of payment
- Calculations use an interest rate and a mortality assumption to

convert all payments into a present value amount
- Result is a percentage that says – “this option is approximately

XX% of the value of the SLA or of a QJSA”
- Such information is communicated to the participants at

retirement & intends to assist in comparing the relative values of
the payment options available

 Actuarial Equivalence –
- Two different forms of payment have equal value under a set of

actuarial assumptions defined in a pension plan
- Actuaries calculate the value of a payment form based on plan

rules.

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Build Domain Training Session - I

Market/Division/Tier 3 (Optional) | Practice Group/Tier 4 (Optional)

- Defined by a mathematical formula based upon a combination of age

- Aims at replacing a portion of an employees’ pre-retirement income

- Aims at providing economic security to participants and their families

- Rewards long term service

- Helps companies remain competitive in the market place

Market/Division/Tier 3 (Optional) | Practice Group/Tier 4 (Optional)

- Invest their retirement contributions in one pension trust for all

- Can use the interest earnings to offset future contributions

- Employees are not impacted by the pension trust investment

Market/Division/Tier 3 (Optional) | Practice Group/Tier 4 (Optional)

- Estimates employer contributions to DB Plans

- Estimates the cost to the company

- Designs formulas to calculate pension amounts

Market/Division/Tier 3 (Optional) | Practice Group/Tier 4 (Optional)

- Have enough assets to meet future obligations

- Do not discriminate amount plan participants

- Communicate appropriately to plan participants

- Pay as promised to the employees

Market/Division/Tier 3 (Optional) | Practice Group/Tier 4 (Optional)

- It is a federal agency that guarantees benefits from qualified DB

- Employers pay annual fee PER PARTICIPANT for insurance under

- If company is unable to pay benefits, PBGC will pay monthly

- Employers are required by law to establish a pension trust or trust

Market/Division/Tier 3 (Optional) | Practice Group/Tier 4 (Optional)

Market/Division/Tier 3 (Optional) | Practice Group/Tier 4 (Optional)

– Most participants belong to a qualified plan and enjoy the

– Only select, high-income participants belong to a

Market/Division/Tier 3 (Optional) | Practice Group/Tier 4 (Optional)

– Governed by IRC Section 401 (a)

– Provide tax advantages to Participants, Plans & Employers

– Adhere to government rules in their design and administration

– Guarantee promised benefits to the participants & have the plans

– Require to have mandatory insurance coverage governed by PBGC

Market/Division/Tier 3 (Optional) | Practice Group/Tier 4 (Optional)

Market/Division/Tier 3 (Optional) | Practice Group/Tier 4 (Optional)

- No tax advantages for participants or employers

- Do not guarantee their employees a right to benefits

- Offer flexible ways of paying balances to employees

- Favor some employees over the others

Market/Division/Tier 3 (Optional) | Practice Group/Tier 4 (Optional)

 FAP is the most common type of retirement plan for large

Market/Division/Tier 3 (Optional) | Practice Group/Tier 4 (Optional)

- Averages the highest consecutive or nonconsecutive years of

- Post –retirement income is based on pre-retirement earnings

- Considers an employee’s years of service and compensation history

- Rewards long-term service employees

- Normal form of payment is typically an Annuity

- No portability of benefits – benefit must remain in the plan until the

Market/Division/Tier 3 (Optional) | Practice Group/Tier 4 (Optional)

Market/Division/Tier 3 (Optional) | Practice Group/Tier 4 (Optional)

- Benefits accrue based on a percent of the employee’s entire pay

- Post-retirement income is based on the pre-retirement earnings over

- Lower cost alternative to a FAP

- Rewards long-term service employees

- Considers an employee’s years of service and entire compensation

Market/Division/Tier 3 (Optional) | Practice Group/Tier 4 (Optional)

Market/Division/Tier 3 (Optional) | Practice Group/Tier 4 (Optional)

- Designed to provide benefits for short-term employees

- Hybrid pension plan – having the attributes of both a traditional pension

- Contributions into a participant’s account are usually defined