DB/DC plan design after 12/31/99

[Guest Jim Berry]

I am hearing a lot of hype from the investment community about adding a DB plan to the retiremnt program for small closely held businesses for the plan year starting 1/1/2000. This sounds great for owners, another deduction for the DB plan in addition to the current 30k.

However, I thought the repeal of 415(e) was a benefit limit not a deduction limit. Does anyone know where the cross reference to give the needed releif to 404(a)(7) is?

I've not seen it and am afraid most of any new plans sold by these "investment guys" will end up with nondeductible contributions and 10% excise taxes a year later. Am i missing something?

[david rigby]

the repeal of 415(e) is indeed a change in the overall benefit limit, and is not a change in the deductible limit.

IRC 404(a)(7) (i think) is the cite for the deductible limit when a plan sponsor has at least one DB plan and at least one DC plan. This limit is still in place.

[Lorraine Dorsa]

There is no relief re the IRC 404(a)(7) limit on deductions when a company sponsors both a DB and DC plans, so you are right that you cannot simply add the DB on top of the existing DC plan without thinking.

[For those who are not familiar with 404(a)(7), it limits the maximum deduction in the case where an employer sponsors both a DB and a DC plan and there is overlapping participation to the greater of the amount needed to fund the DB plan or 25% of aggregate compensation. As a result, if the DB cost is greater than 25% there is no room for a DC contribution, or if there is a DC contribution there is only room for a DB contribution of 25% of aggregate compensation less the DC contribution.]

I do a lot of plan design for small companies, which means I do a lot of DB and cross-tested plans, so this is something that I face all the time. [i've also written an article for the Fall Issue of the Journal of Pension Benefits (which should be out in the next couple of weeks) discussing the impact of the repeal of IRC 415(e) which also addresses these issues.]

What I find is that for very small plans with older owners, the DB benefit/contribution is so much greater (often $75/80/90 and up) that the thing to do is to terminate the DC and replace it with a DB.

In slightly larger companies, or situations where it is important to have a 401k plan for the employees, it may be necessary to keep the 401k. In these cases, I suggest the only contributions to the 401k/PS be salary deferrals by the employees and the match (if any) and the remainder of the 25% maximum deduction be used for the DB plan.

Sometimes the demographics are such that the DB benefit/cost, while large for the older owner, is a fairly low percentage of aggregate compensation so there is room for both plans.

Conclusion--there is real opportunity in the repeal of 415(e), but not without careful analysis.

I've seen a dramatic increase in the number of DB plan in the last few years since 415(e) repeal was passed (plans being established in anticipation of the repeal, mostly to allow a full 10 years of participation by the owner so he will be eligible for the full 415(B) benefit when repeal becomes effective) and I expect to see a flood of DB plans next year.

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[SoCalActuary]

Remember that the 404 combined 25% limit only applies when participants are in both plans. If you have 40% coverage for 401(a)(26) in a separate DB plan, then you can keep the DC plan for the remaining 60% of the employees. Of course, other issues then arise, such as 410(B) ratios.