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Guest shronesz

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

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Guest Ron Sevcik

Here is Question 16 from the 2005 Graybook:

PFEA provides that for 2004 and 2005 (ignoring the 2004 transition rules), the lump sum limit under IRC 415 is determined using the greater of 5.5% and the plan rate. Absent PFEA, the rule was the greater of the Applicable Interest Rate (AIR) and the plan rate.

a) For a plan that determines lump sums solely using the AIR, what is the correct interest rate to use for 2005?

b) A plan provides that lump sums are determined using the lesser of the 417(e)(3) interest rate and 7.5%. Assume the AIR for a 2005 distribution is 5.8%. Is the 415(b) limit adjusted for the lump sum form of payment using 7.5%, even though it was not used in the calculation (because the "plan rate" disregards 417(e)(3) rate), or using 5.8% (because the "plan rate" reflects the 5.8% applicable interest rate)?

RESPONSE

a) The AIR is the plan rate. The greater of 5.5% or the AIR should be used.

b) 5.8% because that is the plan rate used to determine the lump sum.

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I have no issues with a) but I think b) warrants a different response depending on the finer points of how a plan is drafted. There seems to be confusion on what is defined as the “plan rate”. (This is a poorly drafted question in that there is also no mention of a mortality table but I digress.) If the plan’s AE are defined for a lump sum as the lesser of 7.5% or the AIR, then I agree that the AIR is indeed a plan rate. However, if the document is drafted so 7.5% is AE, but of course there is the overriding 417(e) AIR for minimum lump sums, well then I do not hold that the AIR is a plan rate.

Consider this wording from Rev. Rul. 98-1:

Q-8. How is section 415(b)(2)(B) applied to a benefit under a defined benefit plan that is in a form of benefit subject to section 417(e)(3)?

A-8. If a defined benefit plan provides a benefit in a form that is subject to section 417(e)(3), the determination of the equivalent annual benefit is the same as in Q & A-7, Step 1, except that, under section415(b)(2)(E)(ii) , the applicable interest rate is substituted for the 5 percent interest rate under section 415(b)(2)(E)(i). Thus, the equivalent annual benefit must be the greater of the equivalent annual benefit computed using the plan rate and plan mortality table (or plan tabular factor) and the equivalent annual benefit computed using the applicable interest rate and the applicable mortality table.

See the bolded part. If the plan rate included the AIR, this would be clearly redundant. Also, 417(e) cannot be a tabular factor, so that too eliminates it for consideration as a plan rate.

Now let’s look at the change to 415(b)(2)(E) made by PFEA:

(4) LIMITATION ON CERTAIN ASSUMPTIONS.-- Section 415(b)(2)(E)(ii) of such Code is amended by inserting ", except that in the case of plan years beginning in 2004 or 2005, `5.5 percent' shall be substituted for `5 percent' in clause (i)" before the period at the end.

Here it is after being inserted into the Code:

(ii) For purposes of adjusting any benefit under subparagraph (B) for any form of benefit subject to section 417(e)(3), the applicable interest rate (as defined in section 417(e)(3)) shall be substituted for `5 percent' in clause (i), except that in the case of plan years beginning in 2004 or 2005, '5.5 percent' shall be substituted for '5 percent' in clause (i).

That's the only change to 415(b)(2)(E).

So my conclusion is that for maximum lump sums PFEA only changed 417(e) rates with 5.5% and 417(e) is not inherently a plan rate unless specifically included in AE.

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The new proposed 415 regs just came out, as has been rumored for months. The run 75 pages on my printer. The new regs address adjusting the 415 limit for prior distributions, and my quick scan indicates they lack thoughtful analysis with respect to the Hi-3 100% comp limit. The new regs appear to adjust for prior distributions by carrying forward the a.e. of prior distributions to the "current determination date" for adjustment of both the $ limit and 100% limit. Lack of special adjustment of the 100% limit ignores that, under the Code, it is not adjusted for age of commencement. Hopefully this will be corrected in the final regs.

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