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Guest M. Fox

How do you calculate the covered compensation amount that is used in a

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Guest M. Fox

The plan formula reads "1.2% of your average earnings up to your covered compensation plus 1.6% of your average earnings above your covered compensation times your years of credited service." If the benefit is to be frozen as of June 30,2001, what covered compensation amount should be used? Will the amount be the same for every Participant or will it vary depending upon when each Participant reaches age 65? Also, is a frozen accrued benefit calculated as though the Participants terminated their employment, or do other rules apply to this situation?

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As often, the answer is "what does the plan say?"

The plan should define the CC. Many plans define it as the amount in effect at the "date of determination." If the plan is frozen, use that date as date of determination.

But read the plan definition carefully.

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Also, since this is a defined benefit plan make sure the Enrolled Actuary responsible for the Schedule B is aware of what is happening because cost and many other values are going to change, depending on year end of the plan.

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Guest M. Fox

This is the definition for Covered Compensation in the plan document. "the amount of taxable wages with respect to which old-age and survivors insurance benefits would be provided under the Social Security Act (as in effect for the year in which the Employee's Severance from Service Date occurs) computed as though for each year until the Employee reaches age sixty-five (65) the Employee's annual Compensation is at least equal to the taxable wage base. Where appropriate for purposes of benefit calculation, Covered Compensation shall be reduced to the monthly equivalent of the applicable yearly figure considered the maximum amount of taxable wages for such year." Can anyone put this definition into an understandable calculation?

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Well....

That definition is probably "old". The correct definition probably should refer to the year in which the participant attains Social Security Normal Retirement Age, rather than the year the employee reaches age 65.

For those born before 1938, SSRA = 65.

For those born 1938-1954, SSRA = 66.

For those born after 1954, SSRA = 67.

However, the plan should also define how it is used. Perhaps a more useful question would be to ask how you, M.Fox, are using this information. In other words, can you express your question with regard to how you are going to use the information you receive? (No value in explaining things that won't be useful to you.)

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Guest M. Fox

I want to make sure that the correct covered compensation amount is used in the formula to calculate my frozen accrued benefit. As the covered compensation amount goes higher, the pension benefit goes lower. The plan language regarding the definition of covered compensation is all that is mentioned in the plan. Someone thinks it should be the average of the 35 years of the taxable wage bases up to and including the plan year. Others think it should be the average of the 35 years of the taxable wage bases beginning with the participant's year when he or she reaches age 65 and working back 35 years.

Covered compensation is also referred to as permitted disparity. I think that the amount of covered compensation in the formula I originally mentioned above should be the exact same amount for each participant in 2001 -- and that the only variable in the pension plan formula should be the final average earnings.

An example: Assume a covered compensation amount is $30,000; final average earnings of $45,000 and years of service 32 and age 58.

.012 x $30,000 = $360.00

.016 x $15,000 = $240.00

$360 + $240 = $600 x 32 years = $19,200/yr. or $1,600/mo.

if covered comp is $40,000:

.012 x $40,000 = $480.00

.016 x $5,000 = $80.00

$480 + $80 = $560 x 32 years = $17,920/yr. or $1,493.33/mo.

That is why I want to know how the definition of covered compensation in our plan can be interpreted into the way that amount is to be calculated.

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Whether Soc Sec Av Max Tax Wage (SSAMTW before TRA 86) or SS COv Com (Since TRA 86), the value depends on the YEAR the participant attains 65 (before) or SSRA (after). Unless everyone in the plan was born in the same year, it is different for everyone.

If the plan formula was NOT updated to the TRA 86 Safe Harbor rules, then the table MAY have been fixed - such as 1983 Table I or 1984 Table II or something. Of course the plan then needs to be tested for non-discrimination.

If updated for TRA 86, there are two options - floating table and jumping table (Covered Compensation). If floating table then it changes each year to the table in effect at the beginning of the the year. If jumping table then it changes every 5 years. You DO NOT HAVE ANY OTHER CHOICES.

I would STRONGLY urge you to get to an Enrolled Actuary or someone with strong DB experience to do the calculations. The chance of making a mistake here is high and costly.

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I volunteer to help, but I think the plan sponsor owes a complete explanation. My preference is that explanation should be in the form of a benefit calculation. To me, such includes a statement of all relevant data: DOB, DOH, average comp, Covered Comp, years of service, etc. Then the calculation should show how the benefit formula is applied using this data.

For M.Fox, take note that the CC is probably based on the 35-year average, such 35-year period ending in the year of attaining SSRA. However, note that the definition you quoted above does not include the word "average".

In the section of the plan document where the formula is given, does it also identify the appropriate CC? For example, does it say something like "1.6% of average compensation that exceeds Covered Compensation, where the CC is the amount in effect at the date of the employee's severance of employment"?

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Guest M. Fox

The Basic Formula for Retirement is written in the Plan as:

"The monthly amount of basic retirement income payable in a five-year Certain and Life Benefit form to a Participant who retires from active Service under the Plan on or after October 1, 1984 is determined as follows:

1.2% of his Average Earnings up to his Covered Compensation plus 1.6% of the portion of his Average Earnings in excess of his Covered Compensation, multiplied by his years of Credited Service."

That is all it has. And can anyone tell me if a frozen accrued benefit is calculated the exact same way as if I will be retiring from active Service -- when in fact I will continue to work for the new company under their pension plan and no prior service under the old plan will be carried forward with me.

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Oh, that sounds different. When you say "frozen" are you referring to a plan amendment that formally "freezes" the plan, or are saying that it is frozen because you are leaving the employ of this company?

The result of the plan may be the same for you, but this is just clarification. If the latter, you should not worry that the changing CC (between now and actual retirement) will cause your benefit to go down. It will not. Yes, CC will change each year (unless you are already over SSRA), but from the plan's point of view, once you sever employment (that is, death, retirement, disability, or other termination), then the benefit is fixed. With some very unusual exceptions, the plan will calculate your benefit as of your date of severance of employment.

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