Cash Balance Plans and Retroactive Application of 401(a)(17)

[Scott]

Notice 2001-56 provides that if a plan uses annual compensation for periods prior to January 1, 2002 to determine accruals for a plan year that begins on or after January 1, 2002, the plan is permitted to apply the $200,000 EGTRRA limit for such prior periods in determining such accruals. The notice gives an example of how the retroactive application of Code Section 401(a)(17) can be used with a traditional formula plan with a benefit based on "high 3-year average compensation."

An employer's cash balance plan credits each participant on December 31 with 3% of the participant's compensation for the year. Can the $200,000 limit be applied retroactively for years prior to 2002?

[david rigby]

Q&A 28 from the 2002 Gray Book:

QUESTION 28

Retroactive Increases to Reflect EGTRRA Pay Cap

IRS Notice 2001-56 explained that it is acceptable to take into account earnings of a participant up to $200,000 in periods prior to 2002 for purposes of determining benefit accruals for plan years beginning on or after January 1, 2002. An example in the notice demonstrates this for a final average pay plan. Can an accumulation plan, including a cash balance plan, provide additional accruals on incremental pay up to the new limit for past years?

May additional accruals be provided to active employees in the first year the EGTRRA change is effective even if the employee does not otherwise accrue additional benefits under the plan's benefit formula (for example, due to a failure to complete 1000 hours of service)?

RESPONSE

A plan sponsor is not precluded from creating any particular plan formula effective for plan years beginning on or after January 1, 2002, as long as it specifies that pay for the current or any prior year in excess of the new limit is not considered. Thus, an accumulation plan, including a cash balance plan, can be amended to provide that a participant's accrued benefit as of the beginning of the 2002 plan year is equal to the benefit that would have resulted had the compensation limit been $200,000 for 1994 through 2001. The difference between this amount and the accrued benefit as of the end of the 2001 plan year (based on compensation limited to $150,000, as indexed) is treated as an accrual during 2002. The modified formula must also meet any additional applicable qualification rules. For nondiscrimination testing, for example, all the additional accruals need to be tested in the current year, based on the usual testing options of annual, accrued-to-date or projected testing.

Employees currently providing services to the employer may be included when providing these additional accruals even if they would not otherwise accrue benefits under the existing plan formula. As a result, these current employees would be "benefiting" and would be considered as such in applying all relevant coverage, nondiscrimination and minimum participation requirements.

If the individual is no longer providing services after the effective date of the new limit, then the individual is consider a "former employee" and separate testing under the rules for former employees is required if additional accruals of any type, including accruals to take into account the additional compensation, are provided.

See Question 27 for additional information on minimum participation, coverage and nondiscrimination rules applicable to these accruals.