These proposed regulations are the third in a series of proposed regulations under new section 430.^[3] These proposed regulations would provide guidance on the determination of assets and liabilities for purposes of applying the new funding rules of section 430. The Treasury Department and the IRS intend to issue additional proposed regulations relating to other portions of the rules under section 430 (including sections 430(a), (c), and (j)) in the first part of 2008. It is expected that those regulations will be effective for plan years beginning on or after January 1, 2009.

Section 1.430(d)-1 would provide rules for determining the funding target and the target normal cost of a plan that is not in at-risk status (within the meaning of section 430(i)). The proposed regulations would provide that the funding target is the present value of all benefits that have been accrued or earned under the plan as of the first day of the plan year, and that the target normal cost for the plan year is the present value of all benefits that accrue or are earned (or that are expected to accrue or to be earned) under the plan during the plan year. Thus, if the actuarial valuation date for the plan year is not the first day of the plan year, the target normal cost will include the benefits actually earned during the year through the valuation date for the plan year plus a projection of benefits that will be earned through the rest of the plan year.

In order to determine the funding target and target normal cost, the future benefits to be paid from the plan must be allocated among prior plan years (in which case they will be taken into account in determining the funding target for the current year), the current plan year (in which case they will be taken into account in determining the target normal cost of the plan for the plan year), and future years. If the amount of a benefit that is expected to be paid is a function of the accrued benefit at the time the benefit is expected to be paid, then the amount taken into account in the funding target is determined by applying that function to the accrued benefit as of the beginning of the plan year and the amount of the benefit taken into account in the target normal cost is determined by applying that function to the increase in the accrued benefit for the plan year. If the amount of a benefit that is expected to be paid is not a function of the accrued benefit at the time the benefit is expected to be paid (for example, certain ancillary benefits), but is a function of the participant’s service at that time, then the amount taken into account for purposes of determining the funding target for a plan year is based on a participant’s service as of the first day of the plan year and the amount of the benefit that is taken into account in the target normal cost is the increase in that benefit for the plan year based on the additional year of service. If the amount of a benefit that is expected to be paid is neither a function of the accrued benefit at the time the benefit is expected to be paid nor a function of the participant’s service at that time, then the portion of the benefit taken into account for purposes of determining the funding target for a plan year is based on the proportion of a participant’s service as of the first day of the plan year relative to the service the participant will have when the participant meets the age and service eligibility requirement for the benefit, and the portion of the benefit that is taken into account in the target normal cost is the increase in the proportional benefit for the plan year.

The proposed regulations would provide that the determination of the funding target and the target normal cost for a plan year is not permitted to take into account any limitations or anticipated limitations under section 436. Also, the proposed regulations would provide that plan administrative expenses paid (or expected to be paid) from plan assets for a plan year are not taken into account in determining a plan’s target normal cost and funding target for that plan year. With respect to benefits provided by insurance, the proposed regulations would provide that, in general, a plan must reflect the liability for benefits that are funded through insurance contracts held by the plan in the plan’s funding target and target normal cost, and must include the value of the corresponding insurance contracts in plan assets. However, an alternative rule is provided in the case of benefits that are funded through certain insurance contracts purchased from an insurance company licensed under the laws of a State. Under this rule, a plan is permitted to exclude benefits provided under such contracts from the plan’s funding target and target normal cost and to exclude the corresponding insurance contracts from plan assets, but only to the extent that a participant’s or beneficiary’s right to receive those benefits is an irrevocable contractual right based on premiums paid to the insurance company prior to the valuation date under the insurance contracts.

The proposed regulations would provide that, except as provided in section 412(d)(2), the funding target and target normal cost are determined based on the plan terms that are adopted no later than the valuation date for the plan year and become effective during that plan year. Thus, the rules of Revenue Ruling 77-2, 1977-1 C.B. 120, would no longer apply. See §601.601(d)(2) of this chapter. For example, if an amendment that increases plan liabilities is adopted on or before the plan’s valuation date and is effective during the plan year that includes the valuation date, the full increase in liability with respect to the amendment is taken into account as of that year’s valuation date. However, with respect to the pre-PPA counterpart to section 412(d)(2) (section 412(c)(8) as in effect prior to amendments made by PPA ’06), Rev. Rul. 79-325, 1979-2 C.B. 190, provides that section 412(c)(8) applies to plan amendments made during the plan year (as well as to plan amendments made within 2¹/₂ months after the end of the plan year), and this same rule applies under the identical statutory provisions of section 412(d)(2). See §601.601(d)(2) of this chapter. Thus, if an amendment that increases plan liabilities is adopted after the valuation date for a plan year but the amendment is effective during that plan year, the full increase in liability will be taken into account as of the valuation date for that plan year if a section 412(d)(2) election is made, and none of the increase in liability will be taken into account as of the valuation date for that plan year if no section 412(d)(2) election is made. Regardless of whether a section 412(d)(2) election is made, the rules of section 436(c) must be applied in determining whether the amendment is permitted to take effect during the plan year. Section 430 does not contain a corresponding provision to former section 412(c)(12) under which the provisions of a collective bargaining agreement are taken into account for funding purposes before the corresponding plan amendments have been made.

The proposed regulations would require all currently employed plan participants, formerly employed plan participants (including retirees and terminated vested participants), and other individuals currently entitled to benefits under the plan to be included in the valuation. Unlike §1.412(c)(3)-1(c)(3)(ii), the proposed regulations would not permit exclusion from the valuation of those plan participants who could have been excluded from participation in the plan under the rules of section 410(a). However, the proposed regulations would continue to apply the rules of §1.412(c)(3)-1(c)(3)(iii) (relating to the exclusion of terminated employees who do not have a vested benefit under the plan but whose service might be taken into account in future years upon rehire) and the rules of §1.412(c)(3)-1(d)(2) (under which the future participation in the plan of current employees who are not yet participants is permitted to be anticipated).

Section 1.430(d)-1 of the proposed regulations would cross-reference other regulations for the details of the statutorily specified interest rates, mortality tables, and actuarial assumptions that apply to plans in at-risk status. With respect to the actuarial assumptions that are not specified by statute or regulations, the proposed regulations would require that the actuarial assumptions used to determine present value satisfy the section 430(h)(1) requirements to be individually reasonable (taking into account the experience of the plan and reasonable expectations) and, in combination, offer the plan’s enrolled actuary’s best estimate of anticipated experience under the plan.

The proposed regulations would provide that, once the actuarial assumptions for a plan year are established, they are not permitted to be changed for that plan year (unless the Commissioner determines that the assumptions are unreasonable). Similarly, the proposed regulations would provide that, once the funding method for a plan year is established, it is not permitted to be changed for that plan year (unless the Commissioner determines that the use of the funding method for the plan year is impermissible).

In general, the actuarial assumptions and funding method used by a plan for a plan year are required to be established not later than the due date (with extensions) for the filing of Form 5500, “Annual Return/Report of Employee Benefit Plan,” for that plan year (or not later than the last day of the seventh month after the end of the plan year in the case of a plan not required to file Form 5500). The proposed regulations would provide that the filing of the first actuarial report (Schedule SB) under section 6059 for a plan year that reflects the use of actuarial assumptions and a funding method is treated as the establishment of those assumptions and the funding method for that plan year.

In accordance with section 430(h)(4), the proposed regulations would provide that the plan’s actuarial valuation must take into account the probability that future benefits will be paid in optional forms of benefit under the plan, including single sum distributions, determined on the basis of the plan’s experience and other relevant assumptions. In addition, the plan’s enrolled actuary must take into account any difference in the present value of those future benefit payments that results from the use of actuarial assumptions in determining benefit payments in any such optional forms of benefit that are different from those prescribed by section 430(h).

In the case of a distribution that is subject to section 417(e)(3) and that is determined using the applicable interest rate and applicable mortality table under section 417(e)(3), the proposed regulations would provide that the computation of the present value of that distribution will be treated as having taken into account any difference in present value that results from the use of actuarial assumptions that are different from those prescribed by section 430(h) only if the present value of the distribution is determined by valuing the annuity that corresponds to the distribution using special actuarial assumptions. Under these special assumptions, for the period beginning with the annuity starting date, the current applicable mortality table under section 417(e)(3) is substituted for the mortality table under section 430(h)(3) that would otherwise apply. In addition, under these special actuarial assumptions, the valuation interest rates under section 430(h)(2) are used for all periods (as opposed to the interest rates under section 417(e)(3) which the plan uses to determine the amount of the benefit).

The proposed regulations provide two elective adjustments to this methodology for valuing distributions subject to section 417(e)(3). First, in determining the present value of such a distribution, if a plan uses the generational mortality tables under §1.430(h)(3)-1(a)(4) or under §1.430(h)(3)-2, the plan would be permitted to use a 50-50 male-female blend of the annuitant mortality rates under the §1.430(h)(3)-1(a)(4) generational mortality tables in lieu of the applicable mortality table under section 417(e)(3) that would apply to a distribution with an annuity starting date occurring on the valuation date. Second, a plan would be permitted to make adjustments to reflect differences between the phase-in of the section 430(h)(2) segment rates under section 430(h)(2)(G) and the adjustments to the segment rates under section 417(e)(3)(D)(iii).

In the case of a distribution that is subject to section 417(e)(3) but that is determined as the greater of the benefit determined using the applicable interest rate and the applicable mortality table under section 417(e)(3) and the benefit determined using some basis other than the section 417(e)(3) assumptions, the proposed regulations would provide that the computation of present value must take into account the extent to which the present value of the distribution is greater than the present value determined using the applicable interest rate and applicable mortality table.

In the case of an applicable defined benefit plan described in section 411(a)(13)(C) (such as a cash balance plan), the proposed regulations would provide that, if the distribution is determined under the rules of section 411(a)(13)(A), the amount of the future distribution must be determined by projecting the future interest credits or equivalent amounts under the plan’s interest crediting rules to the expected date of payment using reasonable actuarial assumptions. Thus, the present value of a future distribution is not necessarily the current amount of a participant’s hypothetical account balance.

The proposed regulations would provide that any reasonable technique can be used to determine the present value of the benefits expected to be paid during a plan year, based on the interest rates and mortality assumptions applicable for the plan year. For example, the present value of a monthly retirement annuity payable at the beginning of each month can be determined using the standard actuarial approximation that reflects 13/24ths of the discounted expected payments for the year as of the beginning of the year and 11/24ths of the discounted expected payments for the year as of the end of the year, or by assuming that the payment is made in the middle of the year.

The proposed regulations would also reflect the provisions of section 430(h)(5), requiring approval of the Commissioner for large changes in actuarial assumptions. In general, this rule applies where the application of the changes in actuarial assumptions results in a decrease in the plan’s funding shortfall for the current plan year (disregarding the effect on the plan’s funding shortfall resulting from changes in interest and mortality assumptions) that exceeds $50,000,000, or that exceeds $5,000,000 and that is 5 percent or more of the funding target of the plan before the change. Thus, for example, if a plan leaves at-risk status and consequently makes changes to its actuarial assumptions (including a return to previously used assumptions) that result in a reduction in the funding shortfall that exceeds $50,000,000, that change in actuarial assumptions would require approval of the Commissioner. In determining whether aggregate unfunded vested benefits exceed $50,000,000, the proposed regulations would provide that multiemployer plans and plans with no unfunded vested benefits are disregarded. In addition, the proposed regulations would provide that the aggregate unfunded vested benefits used to determine premiums for the current plan year (as determined under section 4006(a)(3)(E)(iii) of ERISA) are used for purposes of calculating whether unfunded vested benefits exceed $50,000,000.

Section 1.430(g)-1 would provide rules for a plan’s valuation date and the value of plan assets.^[4] Under the proposed regulations, except in the case of a small plan, a plan’s valuation date is the first day of the plan year. For this purpose, a small plan is defined as a plan sponsored by an employer that had 100 or fewer participants in defined benefit plans (other than multiemployer plans as defined in section 414(f)) sponsored by the employer or members of the employer’s controlled group, including active and inactive participants and all other individuals entitled to future benefits. A small plan is permitted to have a valuation date other than the first day of a plan year. The selection of a valuation date by a small plan is part of the plan’s funding method and, thus, is permitted to be changed only with the Commissioner’s consent. If a plan that was using a valuation date that was not the first day of the plan year is no longer eligible to use that date because the plan is no longer a small plan, the required change of the valuation date to the first day of the plan year is treated as automatically approved and no prior approval of the Commissioner is necessary.

The proposed regulations would provide that plan assets must be valued either at their fair market value on the valuation date or at the “average” value of assets on the valuation date. Under this average value, the value of plan assets is set equal to the average of the fair market value of assets on the valuation date and the adjusted fair market value of assets determined for one or more earlier determination dates. The proposed regulations would provide that the period of time between the valuation date and each of the earlier determination dates must be equal (with a period that is not more than 12 months), and the earliest of these determination dates cannot be earlier than the last day of the 25th month before the valuation date of the plan year. In a typical situation, the earlier determination dates will be the two immediately preceding valuation dates. The proposed regulations would provide that this average of fair market values is increased for contributions included in the plan’s asset balance on the current valuation date that were not included in the plan’s asset balance on an earlier determination date, and reduced for benefits and administrative expenses paid from plan assets during the same period.^[5] After these adjustments, as well as the adjustments described in the following two paragraphs, the resulting average value must be constrained so that it falls between 90 and 110 percent of the fair market value of plan assets.

The proposed regulations would implement the rules of section 430(g)(4) relating to the treatment of contributions for a prior plan year that are made after the valuation date for the current plan year. These rules work in conjunction with the rules of section 430(j)(2) in order to keep employers and plans neutral regarding the timing of contributions that are paid after the end of the plan year. Under section 430(j)(2), the amount of the contribution must be adjusted for interest at the effective interest rate under section 430(h)(2) in order to take into account the delay in contributions (including the period after the end of the year). For this purpose, section 430(g)(4) requires that only the present value of a prior year contribution paid after the valuation date be included in plan assets, so that the value of plan assets for the next plan year is not inflated by reflecting a delayed contribution at full value. This effectively means that the present value of the contribution is the same from the perspective of the employer and the plan, regardless of when it is made. Because the requirement to adjust contributions for delayed payment after the end of the plan year is first effective for plan years beginning in 2008 (except for certain plans with a delayed effective date), the corresponding requirement to include only the present value of a prior year contribution paid after the valuation date is not effective until the second plan year for which section 430 applies to the plan. Thus, this corresponding requirement will become effective in plan years beginning in 2009, except with respect to plans for which the effective date of section 430 is delayed.

The proposed regulations would specify the treatment of current year contributions that are made before the valuation date (which could only occur for small plans with valuation dates other than the first day of the plan year). These contributions, adjusted for interest at the effective interest rate under section 430(h)(2) for the plan year, must be subtracted from plan assets in determining the actuarial value of plan assets. This is similar to the pre-PPA ’06 requirement to subtract these contributions from plan assets after adjustment using the plan’s valuation interest rate.

The proposed regulations would incorporate the provisions of section 430(l) (involving qualified transfers to health benefit accounts under section 420).

Section 1.430(h)(2)-1 would specify the interest rates that are to be used to determine present value and to make other calculations under section 430. These rates are generally based on the 24-month moving averages of 3 separate segment rates for the month that includes the valuation date (the applicable month). The first segment rate, which is based on the portion of the corporate bond yield curve over the period from 0 to 5 years, applies for purposes of discounting benefits that are expected to be paid during the 5-year period beginning on the valuation date for a plan year. The second segment rate, which is based on the portion of the corporate bond yield curve over the period between 5 and 20 years, applies for purposes of discounting benefit payments that are expected to be paid at least 5 years after the valuation date, but before 20 years. The third segment rate applies to benefit payments that are expected to be paid at least 20 years after the valuation date. Thus, for example, if a series of monthly payments is assumed to be made beginning on the valuation date, the second segment rate will apply to the 61^st such payment and the third segment rate will apply beginning with the 241^st such payment.^[6] Except in the case of a new plan, a transition rule applies for 2008 and 2009 under which these segment rates are blended with the long-term corporate bond rate that applies under pre-PPA law.

The monthly corporate bond yield curve is, with respect to any month, a yield curve that is prescribed by the Commissioner for that month based on yields for that month on investment grade corporate bonds with varying maturities that are in the top three quality levels available. Notice 2007-81, 2007-44 I.R.B. 899, provides guidance on the monthly corporate bond yield curve and related interest rates used to make certain computations related to the funding requirements that apply to single employer defined benefit plans under section 430(h)(2), including a description of the methodology for determining the monthly corporate bond yield curve. See §601.601(d)(2) of this chapter.

The proposed regulations would reflect the special interest rate for determining a plan’s funding target in the case of airlines that make the 10-year amortization election described in section 402(a)(2) of PPA ’06, in accordance with section 6615 of the U.S. Troop Readiness, Veterans’ Care, Katrina Recovery, and Iraq Accountability Appropriations Act, 2007, Public Law 110-28 (121 Stat. 112). The special interest rate does not apply for other purposes such as the determination of the plan’s target normal cost.

The proposed regulations describe several elections a plan sponsor is permitted to make in order to use an alternative interest rate rather than the segment rates. These elections are made by providing written notification of the election to the plan’s enrolled actuary. Such an election is part of the plan’s funding method and, accordingly, may only be adopted or changed with the consent of the Commissioner. Under one such election, a plan sponsor that is using segment rates may elect the use of an alternative month as the applicable month, provided that the alternative month is one of the 4 months that precede the month that includes the valuation date for the plan year. Under another such election, the plan sponsor may elect not to apply the transition rule under which the segment rates are blended with the 30-year Treasury rate for 2008 and 2009. Under the third such election, for purposes of determining the minimum required contribution under section 430 (including the determination of shortfall amortization installments, waiver amortization installments, and the present value of those installments), the plan sponsor may elect to use interest rates under the monthly corporate bond yield curve — which is a set of spot rates for the month preceding the valuation date rather than a 24-month moving average for that month or an alternative applicable month — in lieu of the segment rates. The amount of the funding target calculated in accordance with any of these elections applies for all purposes, including determining the adjusted funding target attainment percentage under section 436 and the applicable limitations under section 404. In the case of the first plan year to which section 430 applies to a plan (the first plan year beginning in 2008 other than for a plan with a delayed section 430 effective date), any of these elections are treated as having been approved by the Commissioner and do not require the Commissioner’s specific prior approval.

In the case of a plan sponsor that has elected to use interest rates under the monthly corporate bond yield curve, if with respect to a decrement the benefit is only expected to be paid for one-half of a year (because the decrement was assumed to occur in the middle of the year), the proposed regulations would provide that the interest rate for that year can be determined as if the benefit were being paid for the entire year.

Under the proposed regulations, the effective interest rate determined under section 430(h)(2)(A) is the single interest rate that, if used to determine the present value of the benefits taken into account in determining the plan’s funding target for a plan year, would result in an amount equal to the plan’s funding target determined for the plan year under section 430(d) as described in §1.430(d)-1(b)(2) (without regard to calculations for plans in at-risk status under section 430(i)). The effective interest rate is used to adjust plan contributions made on a date other than the valuation date.

Under the proposed regulations, the interest rates used to determine the amount of shortfall amortization installments and waiver amortization installments are determined based on the dates those installments are assumed to be paid, using the same timing rules that apply for purposes of determining the target normal cost. Thus, for a plan that uses the segment rates, the first segment rate applies to the five shortfall amortization installments assumed to be paid during the first five years beginning on the valuation date for the plan year, and the second segment rate applies to the two shortfall amortization installments that are assumed to be paid after that period.

The proposed regulations would provide rules and assumptions for determining the funding target and making other computations for certain defined benefit plans that are referred to as plans in “at-risk” status due to their significantly underfunded status. These rules apply to single employer defined benefit plans (including multiple employer plans) but do not apply to multiemployer plans. The at-risk rules do not apply to small plans. For this purpose, a small plan is defined as a plan sponsored by an employer that had 500 or fewer participants (including both active and inactive participants) in defined benefit plans (other than multiemployer plans) sponsored by the employer or any member of the employer’s controlled group on each day during the preceding plan year.

In general, the proposed regulations would provide that a plan is in at-risk status for a plan year if the funding target attainment percentage (FTAP) for the preceding plan year is less than 80% (65%, 70%, and 75%, for plan years beginning in 2008, 2009, and 2010, respectively),^[7] and the at-risk FTAP for the preceding plan year is less than 70 percent. For this purpose, the proposed regulations would provide that a plan’s FTAP for a plan year is a fraction (expressed as a percentage) determined as: (i) the value of plan assets for the plan year after subtraction of the prefunding balance and the funding standard carryover balance under section 430(f)(4)(B)), divided by (ii) the funding target of the plan for the plan year (determined without regard to section 430(i) and these proposed regulations). The proposed regulations would provide that the at-risk FTAP of a plan for a plan year is determined similarly except that the denominator is the at-risk funding target of the plan for the plan year (but determined without regard to the loading factor discussed in the following paragraph). The proposed regulations would provide that, in the case of a newly established plan, this FTAP and at-risk FTAP determination are assumed to be 100% for years before the plan exists.

In general, in accordance with section 430(i)(1), the proposed regulations would provide that the at-risk funding target and the at-risk target normal cost of the plan for the plan year are generally determined in the same manner as for plans not in at-risk status but using special actuarial assumptions. In addition, the at-risk funding target and the at-risk target normal cost are increased to take into account a loading factor. In any case, the at-risk funding target and the at-risk target normal cost of a plan for a plan year cannot be less than the plan’s funding target and target normal cost determined without regard to the at-risk rules. This minimum value is determined on a plan-wide (rather than a participant-by-participant) basis.

The actuarial assumptions used to determine a plan’s at-risk funding target for a plan year are the actuarial assumptions that are applied under section 430, with certain modifications as set forth in the proposed regulations. Under these special actuarial assumptions, if an employee would be eligible to commence an immediate distribution upon termination of employment by the end of the plan year that begins 10 years after the end of the current plan year (that is, the end of the 11th plan year beginning with the current plan year), that employee is assumed to terminate and commence an immediate distribution at the earliest retirement date under the plan, or, if later, at the end of the current plan year. (However, the proposed regulations would provide that this special assumption does not apply to the extent the employee is otherwise assumed to retire during the current plan year. Thus, for example, if generally applicable retirement assumptions would provide for a 25% probability that an employee will retire during the current plan year, the special retirement age assumption would require the plan to assume a 75% probability that the employee will retire at the end of the plan year.) For this purpose, the proposed regulations would define the earliest retirement age under the plan as the earliest age at which a participant could terminate employment and receive an immediate distribution. In addition, the special actuarial assumptions in the proposed regulations would provide that all employees are assumed to elect the optional form of benefit available under the plan at the assumed retirement age that would result in the highest present value of benefits.

If a plan that is in at-risk status for the plan year has been in at-risk status for a consecutive period of fewer than 5 plan years, the plan’s funding target for the plan year is determined as a blend of the funding target determined as if the plan were not in at-risk status and the funding target determined as if the plan had been in at-risk status for each of the previous 5 plan years. For this purpose, the funding target determined as if the plan had been in at-risk status for each of the previous 5 plan years is determined without applying the loading factor if the plan has not been in at-risk status for two of the last four plan years. The increase in the funding target to reflect the at-risk rules is phased in over 5 years at 20% per year. The proposed regulations provide similar rules for determining the at-risk target normal cost of a plan that has been in at-risk status for fewer than 5 consecutive plan years.

For purposes of applying the rules under section 430(i), the proposed regulations set forth rules for making certain calculations with respect to the first plan year to which section 430 applies to the plan. These rules are generally the same as the rules that apply for that plan year for purposes of section 436.

There is no special rule for determining the at-risk funding target for the plan year preceding the plan year section 430 first applies to the plan. This is because, for a plan to which section 430 applies beginning in 2008, if the plan’s FTAP for the preceding plan year was less than the 65% needed to be in at-risk status (pursuant to the transition rule described in section 430(i)(4)(B)), then the at-risk FTAP would necessarily be below the 70% needed for the plan to be in at-risk status (because the at-risk funding target cannot be less than the funding target for a plan that is not in at-risk status). However, plans for which the effective date of section 430 is delayed will have to determine the at-risk funding target for the plan year that precedes the plan year for which section 430 is first effective with respect to the plan.

(a) In general—(1) Overview. This section sets forth rules for determining a plan’s target normal cost and funding target under sections 430(b) and 430(d), including guidance relating to the application of actuarial assumptions described in sections 430(h)(1) and 430(h)(4). Section 430 and this section apply to single employer defined benefit plans (including multiple employer plans as defined in section 413(c)) that are subject to section 412 but do not apply to multiemployer plans (as defined in section 414(f)). For further guidance on actuarial assumptions, see §1.430(h)(2)-1 (relating to interest rates) and §§1.430(h)(3)-1 and 1.430(h)(3)-2 (relating to mortality tables). See also §1.430(i)-1 for the determination of the funding target and target normal cost for a plan that is in at-risk status.

(2) Organization of regulation. Paragraph (b) of this section sets forth definitions of target normal cost and funding target. Paragraph (c) of this section provides rules regarding which benefits are taken into account in determining a plan’s target normal cost and funding target. Paragraph (d) of this section sets forth the rules regarding the plan provisions that are taken into account in making these determinations, and paragraph (e) of this section provides rules on which plan participants are taken into account for this purpose. Paragraph (f) of this section provides rules relating to the actuarial assumptions and the plan’s funding method that are used to determine present values. Paragraph (g) of this section contains effective/applicability dates and transition rules.

(3) Special rules for multiple employer plans. In the case of a multiple employer plan to which section 413(c)(4)(A) applies, the rules of section 430 and this section are applied separately for each employer under the plan, as if each employer maintained a separate plan. Thus, the plan’s funding target and target normal cost are computed separately for each employer under such a multiple employer plan. In the case of a multiple employer plan to which section 413(c)(4)(A) does not apply (that is, a plan described in section 413(c)(4)(B) that has not made the election for section 413(c)(4)(A) to apply), the rules of section 430 and this section are applied as if all participants in the plan were employed by a single employer.

(b) Definition of target normal cost, funding target, and funding target attainment percentage—(1) Target normal cost—(i) In general. For a plan that is not in at-risk status under section 430(i) for the plan year, the target normal cost of the plan for the plan year is the present value of all benefits that have accrued or have been earned (or that are expected to accrue or to be earned) under the plan during the plan year. See §1.430(i)-1(d) and (e)(2) for the determination of target normal cost for a plan that is in at-risk status.

(ii) Benefits accruing for a plan year. The benefits that have been accrued or have been earned (or that are expected to accrue or to be earned) under a plan during a plan year include any increase in benefits during the plan year that is a result of any actual or projected increase in compensation during the current plan year, even if that increase in benefits is with respect to benefits attributable to services performed in a preceding plan year.

(2) Funding target. For a plan that is not in at-risk status under section 430(i) for the plan year, the funding target of the plan for the plan year is the present value of all benefits that have been accrued or earned under the plan as of the first day of the plan year. See §1.430(i)-1(c) and (e)(1) for the determination of the funding target for a plan that is in at-risk status.

(3) Funding target attainment percentage. See §1.430(i)-1(b)(3) and §1.436-1(j)(2) for rules relating to the determination of the funding target attainment percentage under section 430(d)(2).

(c) Benefits taken into account—(1) In general—(i) Basic rule. The benefits taken into account in determining the funding target and target normal cost under paragraph (b) of this section are all benefits earned or accrued under the plan, including retirement-type and ancillary benefits.

(ii) Allocation of benefits—(A) Benefits that are based on accrued benefits. If the amount of a benefit that is expected to be paid is a function of the accrued benefit at the time the benefit is expected to be paid, then the amount of the benefit that is taken into account in the funding target is determined by applying that function to the accrued benefit as of the beginning of the plan year and the amount of the benefit that is taken into account in the target normal cost is determined by applying that function to the increase in the accrued benefit for the plan year. For example, a benefit that is assumed to be payable at a particular early retirement age in the amount of 90% of the accrued benefit is taken into account in the funding target in the amount of 90% of the accrued benefit as of the beginning of the plan year, and that benefit is taken into account in the target normal cost in the amount of 90% of the increase in the accrued benefit for the plan year.

(B) Benefits that are based on service. If the amount of a benefit that is expected to be paid is not a function of the accrued benefit at the time the benefit is expected to be paid, but is a function of the participant’s service at that time, then the portion of the benefit taken into account for purposes of determining the funding target for a plan year is determined by applying that function to the participant’s service as of the first day of the plan year and the amount of the benefit that is taken into account in the target normal cost is the increase in that benefit for the plan year based on the additional year of service. For example, if a plan provides a post-retirement death benefit of $500 per year of service, then the funding target is determined based on a death benefit of $500 multiplied by a participant’s service at the beginning of the year and the target normal cost is based on the additional $500 in death benefits earned for one more year of service.

(C) Other benefits. If the amount of a benefit that is expected to be paid is neither a function of the accrued benefit at the time the benefit is expected to be paid as described in paragraph (c)(1)(ii)(A) of this section nor a function of the participant’s service at that time as described in paragraph (c)(1)(ii)(B) of this section, then the portion of the benefit taken into account for purposes of determining the funding target for a plan year is based on the proportion of a participant’s service as of the first day of the plan year relative to the service the participant will have when the participant meets the age and service eligibility requirements for the benefit, and the portion of the benefit that is taken into account in the target normal cost is the increase in the proportional benefit for the plan year. For example, if a plan provides a Social Security supplement for a participant who retires after 30 years of service that is equal to a participant’s Social Security benefit, the funding target is determined based on the participant’s Social Security benefit as of the beginning of the plan year multiplied by a fraction, the numerator of which is the participant’s service as of the first day of the plan year and the denominator of which is 30 years. In such a case, the target normal cost is based on the increase in the proportional benefit taking into account one additional year of service and any changes in the participant’s Social Security benefit.

(iii) Application of section 436 limitations to funding target and target normal cost determination. The determination of the funding target and target normal cost of a plan for a plan year is not permitted to take into account any limitations or anticipated limitations under section 436.

(2) Payment of expenses from plan assets. Plan administrative expenses paid (or expected to be paid) from plan assets for a plan year are not taken into account in the determination of a plan’s target normal cost and funding target for that plan year.

(3) Benefits provided by insurance. A plan generally is required to reflect in the plan’s funding target and target normal cost the liability for benefits that are funded through insurance contracts held by the plan, and to include in plan assets the value of the corresponding insurance contracts. Alternatively, in the case of benefits that are funded through insurance contracts purchased from an insurance company licensed under the laws of a State, the plan is permitted to exclude benefits provided under such contracts from the plan’s funding target and target normal cost and to exclude the corresponding insurance contracts from plan assets, but only to the extent that a participant’s or beneficiary’s right to receive those benefits is an irrevocable contractual right, based on premiums paid to the insurance company prior to the valuation date under the insurance contracts. Thus, for example, in the case of a retired participant receiving benefits from an annuity contract in pay status under which no premiums are required on or after the valuation date, a plan is permitted to exclude the benefits provided by the contract from the plan’s funding target and target normal cost, provided that the value of the contract is also excluded from plan assets. Similarly, in the case of an active or deferred vested participant whose benefits are funded by a life insurance or annuity contract under which further premiums are required on or after the valuation date, a plan is permitted to exclude the benefits, if any, that would be paid from the contract if no further premiums were to be paid (for example, if the contract were to go on reduced paid-up status) from the plan’s funding target and target normal cost, provided that the value of the contract is excluded from plan assets. A plan’s treatment of benefits funded through insurance contracts pursuant to this paragraph (c)(3) is part of the plan’s funding method. Accordingly, that treatment can be changed only with the consent of the Commissioner.

(d) Plan provisions taken into account. Except as provided in section 412(d)(2), the determination of a plan’s funding target and target normal cost for a plan year is based on plan provisions that are adopted no later than the valuation date for the plan year and that become effective during that plan year. Section 412(d)(2) applies for purposes of determining whether a plan amendment is treated as having been adopted on the first day of the plan year (including a plan amendment adopted within 2¹/₂ months after the close of the plan year).

(e) Plan population taken into account—(1) In general. In making any determination of the funding target or target normal cost under paragraph (b) of this section, the plan population is determined as of the valuation date. The plan population must include three classes of individuals—

(i) Participants currently employed in the service of the employer;

(ii) Participants who are retired under the plan or who are otherwise no longer employed in the service of the employer; and

(iii) All other individuals currently entitled to benefits under the plan.

(2) Special exclusion for “rule of parity” cases. Certain individuals may be excluded from the class of individuals described in paragraph (e)(1)(ii) of this section. The excludable individuals are those former participants who, prior to the valuation date for the plan year, have terminated service with the employer without vested benefits and whose service might be taken into account in future years because the ‘rule of parity’ of section 411(a)(6)(D) does not permit that service to be disregarded. However, if the plan’s experience as to separated employees returning to service has been such that the exclusion described in this paragraph (e)(2) would be unreasonable, the exclusion would no longer apply.

(3) Anticipated future participants. In making any determination of the funding target or target normal cost under paragraph (b) of this section, the actuarial assumptions and funding method used for the plan must not anticipate the affiliation with the plan of future participants not employed in the service of the employer on the plan valuation date. However, any such determination may anticipate the affiliation with the plan of current employees who have not yet satisfied the participation (age and service) requirements of the plan as of the valuation date.

(f) Actuarial assumptions and funding method used in determination of present value—(1) Establishment of actuarial assumptions and funding method—(i) General rules—(A) Assumptions and method cannot be changed for a plan year once established. The determination of any present value or other computation under section 430 must be made on the basis of actuarial assumptions and a funding method. Actuarial assumptions established for a plan year in accordance with paragraph (f)(1)(ii) of this section cannot subsequently be changed for that plan year unless the Commissioner determines that the assumptions that were used are unreasonable. Similarly, a funding method established for a plan year in accordance with paragraph (f)(1)(ii) of this section cannot subsequently be changed for that plan year unless the Commissioner determines that the use of that funding method for that plan year is impermissible.

(B) Scope of funding method. A plan’s funding method includes not only the overall funding method used by the plan but also each specific method of computation used in applying the overall method. However, the choice of which actuarial assumptions are appropriate to the overall method or to the specific method of computation is not a part of the funding method.

(ii) Timing rule for establishing actuarial assumptions and funding method. The actuarial assumptions and the funding method used by a plan for a plan year must be established not later than the due date (with extensions) for the filing of Form 5500, “Annual Return/Report of Employee Benefit Plan,” for that plan year (or the last day of the 7th month after the end of the plan year in the case of a plan not required to file Form 5500). The filing of the first actuarial report (Schedule SB) for a plan year under section 6059 that reflects the use of actuarial assumptions and a funding method is treated as the establishment of those assumptions and the funding method for that plan year.

(2) Interest and mortality rates. Section 430(h)(2) and §1.430(h)(2)-1 set forth the interest rates, and section 430(h)(3) and §§1.430(h)(3)-1 and 1.430(h)(3)-2 set forth the mortality tables, that must be used for purposes of determining any present value under this section.

(3) Other assumptions. In the case of actuarial assumptions other than those specified in sections 430(h)(2), 430(h)(3), and 430(i), each of those actuarial assumptions must be reasonable (taking into account the experience of the plan and reasonable expectations), and the actuarial assumptions, in combination, must offer the plan’s enrolled actuary’s best estimate of anticipated experience under the plan. See paragraph (f)(4)(iii) of this section for special rules for determining the present value of a single sum and similar distributions.

(4) Probability of benefit payments in single sum or other optional forms—(i) In general. This paragraph (f)(4) provides rules relating to the probability that benefit payments will be paid as single sums or other optional forms under a plan and the impact of that probability on the determination of the present value of those benefit payments under section 430.

(ii) General rules of application. Any determination of present value or any other computation under this section must take into account—

(A) The probability that future benefit payments under the plan will be made in the form of optional forms of benefits provided under the plan (including single sum distributions), determined on the basis of the plan’s experience and other related assumptions; and

(B) Any difference in the present value of future benefit payments that results from the use of actuarial assumptions in determining benefit payments in any such optional form of benefits that are different from those prescribed by section 430(h).

(iii) Single sum and similar distributions—(A) Distributions using section 417(e) assumptions. In the case of a distribution that is subject to section 417(e)(3) and that is determined using the applicable interest rate and applicable mortality table under section 417(e)(3), for purposes of applying paragraph (f)(4)(ii) of this section, the computation of the present value of that distribution will be treated as having taken into account any difference in present value that results from the use of actuarial assumptions that are different from those prescribed by section 430(h) (as required under paragraph (f)(4)(ii)(B) of this section) if the present value of the distribution is determined in accordance with paragraph (f)(4)(iii)(B) of this section.

(B) Substitution of annuity form—(1) In general. Except as otherwise provided in this paragraph (f)(4)(iii)(B), the present value of a distribution is determined in accordance with this paragraph (f)(4)(iii)(B) if it is determined by valuing the annuity that corresponds to the distribution using special actuarial assumptions. Under these special assumptions, for the period beginning with the annuity starting date, the current applicable mortality table under section 417(e)(3) that would apply to a distribution with an annuity starting date occurring on the valuation date is substituted for the mortality table under section 430(h)(3) that would otherwise be used. In addition, under these special assumptions, the valuation interest rates under section 430(h)(2) are used for this purpose for all periods (as opposed to the interest rates under section 417(e)(3) which the plan uses to determine the amount of the benefit).

(2) Optional application of generational mortality. In determining the present value of a distribution under this paragraph (f)(4)(iii)(B), if a plan uses the generational mortality tables under §1.430(h)(3)-1(a)(4) or §1.430(h)(3)-2, the plan is permitted to use a 50-50 male-female blend of the annuitant mortality rates under the §1.430(h)(3)-1(a)(4) generational mortality tables in lieu of the applicable mortality table under section 417(e)(3) that would apply to a distribution with an annuity starting date occurring on the valuation date.

(3) Optional phase-in of section 417(e)(3) segment interest rates. In determining the pr