Does highest 3-year compensation figure of 415(b) have to be adjusted

[Guest shronesz]

I have a self-employed plan that we are funding for the maximum 415, high 3 year compensation. He has begun taking minimum distributions. Does his high 3 year comp have to be adjusted for the present value of these payouts for funding purposes? Please give me some references.

[Gary]

This is not something I have had to work with at a practical level. One good reference that might get you moving in the right direction is to start with the Defined Benefit Answer Book.

[Guest shronesz]

Thanks Gary, put the book doesn't help. I can't find anything in 415 either.

[rcline46]

You must look to the definition of compensation. Pension plan income would look like passive income. Under compensation you are looking for income in respect of services rendered, and pension distributions would not qualify.

[AndyH]

Shronesz, I have exactly the same situation. We don't have the answer, either. We're inclined to take the position that the current year's minimum would be included towards the 415 limit, but not prior distributions.

We have nothing concrete to point to, it just seems logical to us.

[Guest Mr. X]

Shronesz, are you asking if the 415 limits need to be reduced for the payments that have occured or if compensation includes the distributions made?

[Guest]

I agree with AndyH but I have to go one step further. I think that all prior distributions have to count against your current limit,because those minimums are actually partial lump sums,which represent a part of some benefit which will be fully distributed at some future date.This may lead to a nasty problem where a participant's benefit is governed by the 100% high-3 limit.Unlike the 415(B)(1) dollar limit the (B)(3) limit is absolute and not subject to

post-SSRA actuarial adjustment,so the value of his benefit is decreasing as he /she gets older. If the total value of the benefit is decreasing,and it's being further reduced by prior value received...

If I'm wrong I'd love to hear it,because I don't like my answer.

[Lorraine Dorsa]

Correct me if I misunderstand, but it sounds like we are talking about 3 issues--1) what is the participant's 415 limit? and2) what benefit can be funded for and 3) what distribution(s) can/should he receive if he takes 70.5 or other distributions after NRA?

The 415 limit question was originally phrased as "reducing 3 yr high average for distributions" but really the issue is computing the 415(B) limits which, assuming 3 yr avg compensation less than the dollar limit, is the 3 yr high average.

For funding, the 415(B) limit itself does not decrease for distributions, but the remaining benefit to be funded for is reduced by the value of the benefit(s) previously paid.

These two questions have relatively clearcut answers, but the question regarding the distributions allowable after NRA is a little murkier. The question revolves around whether a benefit which is delayed beyond NRA can increase to its actuarial equivalent if that actuarial equivalent is greater than the 3 yr high average compensation.

Example: If the 415(B) limit is $50,000/yr and NRA = 65, what is the maximum the participant can receive if he delays distribution to age 70.5? If the actuarial equivalent of $50,000/yr payable at 65 is $55,000/yr payable at 70, can he receive that benefit (or the pvab of that or a series of payments equivalent to that)? Or is his benefit "stuck" at $50,000/yr and therefore loses value each year he does not take it?

Is this the issue we are trying to resolve?

[AndyH]

Shronesz can correct me if I am wrong, but I think the question is how is the maximum lump sum determined for someone past 70 1/2 who has taken minimum distributions.

The circumstances are that the person's 415 limit is based upon a high 3 comp level below the dollar limit, therefore the actuarial value is decreasing each year because the person has a decreasing life expectancy.

If someone in such situation has a 415 limit of say, $50,000 and is receiving distributions solely to comply with 401(a)(9), do the distributions reduce the (principal) benefit?

If this was a retiree collecting monthly benefits, the principal benefit would not change. If an annuity were purchased, the entire benefit would need to be sold. Why would the lump sum value decrease, if it does?

If the lump sum benefit were to be decreased, would an annuity purchase be worth considering? (Sorry to extend the question further)

[AndyH]

I'll try to clarify my question.

Plan benefits provide for 10% of pay x years of participation, unlimited. Participant has 14 years of participation. Benefit is therefore 140% of average comp, but is restricted by the 415 limit. Hi 3 comp is around $100,000. This is less than the dollar limit.

Participant has received 3 years of minimum distributions, calculated based upon the actuarial equivalent of the accrued benefit divided by life expectancy. Participant is around 73-74.

Plan sponsor has been advised to terminate the plan for four years due to anticipation of current problem. Sponsor consciously ignored such advice (due to outside ill-advised ideas relating to estate tax issues). Sponsor now agrees to terminate. Ready to pay out. Assets exceed 415 limit (hi 3 unreduced by minimum distributions) by substantial amount. Does the amount payable have to be further reduced by prior minimum distributions?

Thanks for the patience and attempts to answer.

[AndyH]

Thank you.

A followup if I may: A minimum was paid 11/2000. A full distribution is intended to take place 12/2000. Should the full 12/2000 payment (at the 415 limit unreduced for prior year MRD's) be reduced for the 11/2000 MRD, since an alternative would have been to pay the full benefit and declare the MRD portion to be not available for rollover?

[AndyH]

8/26/28, calendar year.

By the way, we arrived at the same conclusion that you did, and for the same reasons. Having nothing to point to, though, it is very helpful to have another opinion.

We are inclined to believe, that the total final year distribution should be the 415 benefit only, because payment of that would have exhausted the liability.

[Guest shronesz]

Thank you all for your input. My self-employed person does not plan on retiring, so we are not worrieed about the lump sum. We want to be sure that we are not overfunding the plan by not reducing his 415(B)(high 3 comp). From the answers above, we can fund for the total 415(b)as long as it is less than the actuarial equivalent of his normal retirement benefit which is reduced for the distributions?

[AndyH]

That seems to be the consensus, as long as the minimums are true minimums (i.e. based upon act equiv of the benefit), not some other greater withdrawal schedule.

Sorry for taking over your question! I thought we had exactly the same situation. At least it was similar.

[Guest dsyrett]

I've got another of these types of situations:

75 year old retired former 5% owner. 2 DB plans of the same employer.

High 3 pay is $12,835 per month. Dollar limit is not a factor and can be ignored. Greater than 10 years of service.

Participant received (small) minimum distributions from each plan under the "account balance method" from age 71 onward.

First plan was terminated at age 73 and he received a rather large lump sum distribution much greater than his high 3 pay but well below his high 3 pay lump sum limit (under any reasonable interpretation).

Now the second plan has been terminated and he has an accrued benefit that is almost certainly above his remaining 415(b) limit.

The question is, what is that limit? Conceptually how is it computed and what interest rates come into play from among 7%, the "applicable interest rate" and the 2004/2005 5.5% under the "Pension Funding Equity Act")?

The plan basis is 7% and IAM71. Normal form of the underlying accrued benefit is 10YC&L.

The plan is overfunded and the excess will be rellocated to other participants so the upside and the downside on my question are important.

Any takers?

[FAPInJax]

Well, I will take a shot!

I believe the IRS is going to require that prior distributions be brought forward using the current GATT rate. This produces a current lump sum value already received.

Now, compute the current 415 limit and lump sum based on the 5.5%. Subtract the prior lump sum values and that is the lump sum that he can now receive.

[SoCalActuary]

I hold to the theory that prior lump sums offset the 415 dollar limit, adjusted for age and actuarial equivalence, but not the 100% of pay limit.

One of the earlier posts noted that a person at the pay limit who retired, taking their allowed payments each year, would have accumulated past benefits that would not be offset against their current benefit. Consider all past lump sum payments that do not exceed the accumulated payments at 100% of pay. I don't understand why these would be used to now reduce the benefit below 100% of pay in the future.

[Blinky the 3-eyed Fish]

I agree the past payments that didn't exceed the 100% of Hi-3 limit are not used to offset the maximum lump sum if at a Hi-3 lump sum limit. So the amount of the payment received from the terminated plan in excess of the 100% of Hi-3 would be the only amount in this case that offsets that Hi-3 lump sum limit.

So the question on how to do that is one in which you will get varying opinions. Personally, I would convert it to a benefit payable at the current age under the current plan's actuarial equivalents and use that benefit to reduce the Hi-3. For example:

Hi-3: 12,835 monthly = 154,020 annually

Lump sum received from terminated plan = 300,000

So convert 145,980 to an annuity under 71IAM 7% at current age of 75.

Reduce 154,020 by that amount.

Determine lump sum by mulitplying reduced benefit * lesser of APR 7% 71IAM or 5.5% 94GAR.

Frank, note that you still need to factor in the plan's AE, not blanketly determine the lump sum based on 5.5%

[Guest dsyrett]

Thanks for the comments.

Frank, do you have some "inside knowledge" on which way the IRS is leaning on this?

Blinky, under your thinking, the participant gets no prospective 415 credit for having taken less than his 100% of high three limit in one or more past years? I saw a post on PIX a few years ago where former IRS actuary Kathy Marticello put forth the idea that the pres val of the high three pay gets anchored to the year of first distribution. The value of distributions are then offset against this. This would seem to allow for these credits.

[Blinky the 3-eyed Fish]

Correct that no prospective credit is provided for taking less than the 415, but that too would be the same in your example. Why is the first year of distribution the beginning of the anchor? No prospective credit is given in years where no distribution took place. Under that logic an client that had a very early NRA in the plan and who took out $1 each year would have a much larger Hi-3 LS than a client that didn't take out the $1.

I have always understood the Hi-3 LS limit to be potentially decreasing in value so I don't have an issue with not providing "credit" when payments were not utilized in full (or at all).

[Guest Ron Sevcik]

Blinky,

Wouldn't is make more sense to convert the 145,980 at age 73 based on the annuity that was used to determine the 300,000? This way you would determine a reduced hi3 limit which will not change each year. Using your suggested method, the reduced hi3 limit is lower at 75 than it was at 74 and will be lower at 76.

Also, in determining the lump sum, I believe that Frank was correct is stating that he would use the 5.5% GAR94 factor. Based on question 16 from the 2005 Graybook, the 'plan rate' is the lessor of AE or GATT, and then the maximum lump sum is the larger of the 'plan rate' or 5.5%.

[Blinky the 3-eyed Fish]

I don't think not having it change each year is the criterion. But like I said, different people have different opinions on this subject and there is no clear guidance. Your method is one for which I think an argument can be made.

As for the PFEA lump sum, no that is not correct. While I don't have access to the Gray Book, I can assure you your AE do not allow you to provide a greater lump sum than 5.5% and 94GAR. I am pretty sure the confusion lies in how the question is presented and answered, but if you post it, I or someone can walk you through it.

[SoCalActuary]

I agree with Blinky, since the regulations say the interest rate is the lesser of plan or 417, but not greater than 5.5% (roughly, not precise). Thus the APR is the greater of plan or 417, but not greater than the APR on 5.5%.

[Guest Ron Sevcik]

Ooops! The confustion lies in how I wrote my last sentence. What my last sentence was supposed to say was that the interest rate used to calculate the maximum lump sum was the larger of 'plan rate' or 5.5%. So, for the plan in question, the minimum lump sum would be based on 7% 71IAM or 4.86% 94GAR (assuming a calendar year). The 4.86% would produce the larger lump sum and this would be compared to the lump sum produced by the 94GAR, which would be less. Thus I believe Frank's statement that he would use 5.5% 94GAR for this plan is correct.

[Blinky the 3-eyed Fish]

No, that is not correct. PFEA replaced the consideration of 417(e) rates for lump sums for 2004 & 2005. While I didn't pull up the tables I am betting that 71IAM at 7% will yield a lower lump sum than 5.5% 94GAR. See Notice 2004-78. It has a good explanation of the application of the law change.