415 Limit Calculation for Transferred Balance Into New DB Plan from DC Plan

[Guest mcohen]

A City is starting a new Defined Benefit Plan and giving all members their past service in exchange for their 401(a) DC balances being transferred into the new DB Plan. 415 DB limits will be relevant for the first few years. The DC transfer balances are made up of employer contributions, pre-tax and post-tax employee contributions, and gains. In calculating how much of a benefit is purchased with the transferred balance for the 415 calculation, which part of the transfered balance is used in the calculation.

[Mike Preston]

I'm not sure I understand exactly what is going on, but it is very possible that the answer is "none." See 1.415-7(e)-Example 4, paragraph (iii) and note the crossreference to 1.415-3.

[Guest mcohen]

Mike--

Thanks for your references. Your reference 1.415-7© Example 4 (iii) reads--

Even though J is subject to the limitations of section 415(e)

and this section, in computing the defined benefit plan fraction, the

special rule set forth in Sec. 1.415-3(b)(1)(iv) is applicable based on

the facts of this example. That rule provides that when there is a

transfer of assets or liabilities from one qualified plan to another,

the annual benefit attributable to the assets transferred does not have

to be taken into account by the transferee plan in applying the

limitations of section 415.

Hopefully, this still leaves only a problem that is unique to governmental plans -- 414(h)(2) employee contribution pick-ups. These pre-tax employee contribuitons are usually not allowed to offset 415 limits (the annual benefit attributable to the contribuions) . If this is true in this case then the annual benefit attributable to the all of the employee's assets transferred from the DC to the DB could be used to offset the 415 limits excluding the pre-tax employee contributions.

[Mike Preston]

I'm not sure I understand what your last paragraph is driving at. As an actuary, I deal better with numeric examples. Care to give one? Maybe that would clarify the issue. If not for me, then for somebody else.

[Guest mcohen]

Example of DC balance transfer.

A City is converting a DC Plan into a DB Plan and the Plan members are transferring their balances in the DC Plan into the DB trust. In lieu the members get their full past service. Note: the 10 year 415 limit phase-in rule applies to Participation in a DB Plan only --- the DC service does not count.

Example -- a member transfers a $100,000 DC balance to the DB trust. The $100,000 consists of 10,000 of pre-tax employee contributions, $5,000 dollars of after-tax employee contributions; 50,000 of employer contributions and the rest gains. The employee brings 20 years of service into a 3% accrual defined benefit plan. The employee is age 62 and the normal retirement age is 62. The benefit form is a single life annuity. The employee contributes $1,000 in pre-tax contributions to the DB Plan in the first 1 year of employment and retirees. The employees average final salary is $100,000. Thus a benefit of $63,000 per year. Now for the 415 limits -- since a 10 year phase the limit is 1/10 of 160,000 (assuming the retirement occured in 2003) or $16,000. But the benefit attributable to the transfer should offset some of the $63,000 benefit. What part of the transferred assets can be used in calculating the benefit attributable to the transferred assets that will not have to meet 415 limits.

[Mike Preston]

The one thing you have left out is the defined benefit "purchased" with the transfer. That is, the amount that the participant would be entitled to receive from the plan in the absence of future service, salary or contributions.

Assuming this individual's compensation rate did not increase in his final year, the benefit that was purchased with the transfer appears to be $60,000. As you can see, if the final benefit amount is only $63,000, the amount attributable to the one year of defined benefit participation is only $3,000, well below the $16,000 phase in.

I would think it reasonable to determine the amount subject to the 415(b) dollar limit as to final benefit offset by the amount of defined benefit "purchased" with the transfer.

I would feel comfortable with that as initial advice and caveat it by saying that the 415 limit should be laid out in the document and identify that the amount purchased is not considered as part of the limit. Then submit and let the IRS bless the whole thing.

[Guest mcohen]

Two points that I have a question on.

First, even if all the transferred funds can purchase the past service benefits; $100,000 dollars transferred buying over $600,000 (annuity factor of say 10 times the $60,000 benefit) seems at odds with the concept of purchasing at a rate that the IRS would allow in the calculation of the 415 limits.

Second -- back to my original problem -- could all the funds be used to purchase annuity benefits that would be excluded from the 415 calculation.l

[Guest mcohen]

The proverbial light just came on --- a call from a friend.

Please see if you agree with this analysis.

A DC Plan meets the 415 limits on a yearly basis. Employee pickups are treated as employer contributions in the yearly 415 testing. Assume that in all years of the DC Plan, the 415 DC limits were met. Then all funds transferred from the empluyees' DC Plans account balance to the DB Plan can be used to calculate the annuity benefit attributable to the transfer of funds. The calculated annuity benefit attributable to the transfer does not have to taken into account in the DB 415 limit testing.

One additional note -- I can find no IRS reference on what actuarial assumptions to use in the calculation of the annutiy benefit attributable to the transfer. There are IRS guidelines on rollovers and employee contributions made to the Plan but none for transfers. Do you or anyone agree on this?

[Mike Preston]

Well, I might agree that there aren't rules on what assumptions to use, but I won't agree that the absence of rules means that you can use any conversion factors you want. I think there has to be some relationship between the monies and the annuities and $100,000 buying $60,000/annum commencing immediately certainly won't cut it.

I don't know where you should draw the line, but when that line is drawn, that which it was reasonable to purchase with the DC monies will be exempt from 415. Anything else will essentially constitute a DB benefit subject to the DB limits.