Actuarial and Funding Concepts for Defined Benefit Plans
What this domain tests
Actuarial and funding concepts for defined benefit plans test the link between plan formulas, actuarial assumptions, funding targets, and contribution rules. Expect calculations and questions about funding shortfalls, benefit restrictions, and PBGC premiums.
Core concepts
- Accrued benefit: the benefit earned to date under the plan formula, often based on final average pay and service.
- Funding target: present value of accrued benefits; target normal cost: present value of benefits accruing in the current year.
- Assumptions: discount rate, mortality, turnover, retirement age, and salary scale must be reasonable and consistently applied.
- Methods: unit credit and entry age normal allocate cost differently; the funding method must be permitted.
- Funding rules: minimum required contributions, quarterly contributions, amortization bases, and 436 benefit restrictions apply when funded status falls.
- PBGC: flat-rate and variable-rate premiums depend on participant counts and unfunded vested benefits.
Worked example
A plan formula is 1.5% of final average pay per year of service. A participant has 20 years and a final average pay of $120,000. The accrued annual benefit is 1.5% × 20 × $120,000 = $36,000. If the actuarial annuity factor at normal retirement is 14.0, the present value of the accrued benefit is $504,000. If assets allocated to the participant are $450,000, the funding shortfall is $54,000. Reasoning: the accrued benefit is valued using the plan's assumptions, not the participant's current salary alone.
Traps
Do not use current salary in a final average pay formula; do not ignore 436 restrictions when funded status is low; do not confuse the 404 deduction limit with the 412 minimum contribution; and do not omit mortality improvement in modern valuations.