401(a)(17) Comp. Limit

[Ken Davis]

Regarding a state DB plan with a 7/1-6/30 plan year.

When 401(a)(17) was amended in '93 by P.L. 103-66, I'm being told that state employees hired before 7/1/96 were grandfathered in with no compensation limit under 401(a)(17). But several IRS Notices since then, including the latest (IRS Notice 2002-71), apparently say that a compensation limit does apply to those employees. Notice 2002-71 says the limit for 2003 is $300K.

Which is correct? Pre-7/1/96 employees have no compensation limit, or the limit is $300K.

Thanks,

Ken Davis

[Guest Jose Rosario]

Is the grandfathered, pre-96 employee limit of 300K indexed at 5K increments annually?

[Carol V. Calhoun]

Essentially, for pre-1996 participants, the plan is to use the plan language that was in effect on July 1, 1993. If the plan, as in effect on July 1, 1993, did not impose any limit under section 401(a)(17), then no limit applies today for pre-1996 participants.

Conversely, in the case of a plan that, on July 1, 1993, imposed a limit equal to the 401(a)(17) limits as they might exist from time to time in the future, even pre-1996 participants are subject to current 401(a)(17) limits.

The IRS announcements deal with an intermediate situation. As of July 1, 1993, many governmental plans limited compensation to the 401(a)(17) limit that was in effect in 1993 (without regard to any later statutory changes), as adjusted for changes in the cost of living. In the normal course of events, the IRS would not have continued issuing cost of living adjustments to the old 401(a)(17) limits after such limits were adjusted by statute. However, because so many plan participants are grandfathered into the old 401(a)(17) limits, as adjusted, the IRS continues to issue cost of living adjustments to the old limit for that group of participants.

There is, by the way, considerable doubt as to how far the IRS announcements actually extend. Although they are based on the pre-1996 section 401(a)(17) limit, the cost of living adjustments they apply are based on the post-1996 formula for cost of living adjustments. Thus, to the extent that a governmental plan on July 1, 1993 incorporated by reference both the existing 401(a)(17) limits and the existing method for determining cost of living adjustments, the IRS announcements may not apply.

[MGB]

Just to extend what Carol is saying in the last paragraph:

The IRS announcements use the same 3rd quarter to 3rd quarter CPI methodology (and rounding) as current 401(a)(17) increases.

The actual methodology back in 1993 is a 4th quarter to 4th quarter CPI change and different rounding.

We have clients (very large states) that are using the 4th quarter calculation and ignore the IRS announcements.