Accrual of Maximum Benefit

[Guest PensionNW]

I'm polling people on their approach to accruing a benefit limited by section 415.

Suppose the participant will have 12 years of participation in a DB plan, retirement age is 62. She has 10 years of service prior to entering the DB plan.

She earns $240,000 per year and the benefit formula produces an unlimited benefit of $240,000 at retirement in 12 years. The benefit will accrue over years of plan participation.

Do you calculate her accrued benefit at the end of year 1 to be $240,000 x 1/12 = $20,000 and then limit this to $16,000 ($160,000 x 1/10) or do you calculate her accrued benefit as $160,000 (the $240,000 benefit limited) accrued over 12 years to arrive at $13,333?

Which way do you think is correct and why?

[mwyatt]

What does your document say? Do you limit the projected benefit first to the 415 limit and then apply accrual rules or do you calculate all the way through and then apply 415 limits to the accrual. Corbel (or should I say Relius - showing my age) says their document argues for the second approach. Your document will spell out how the calculation should be performed.

[Blinky the 3-eyed Fish]

The benefit will accrue over years of plan participation.

I assume this means it is fractional accrual. If so, I agree with what mwyatt says.

[MGB]

I can't imagine why anyone would write a document in the second way, nor have I ever seen a document that does it that way. (I only work with individually designed plans, so I don't know what standard volume submitter language is.)

The main thing here is "what does the document say?"

It ought to say that the accrued benefit is limited to the 415 limit, not some projected benefit that has no relation to any rule in the law, accrual, benefit limits, etc.

[mwyatt]

Certainly the accrued benefit is limited to the IRC 415 limit. However (and this happened to us about 15 years ago in the midst of a messy professional corporation "divorce") unless your definition of accrued benefit explicitly states that the projected benefit will be limited to the IRC 415 limit prior to application of whatever your accrual ratio is, the interpretation that will stand up is blind calculation through accrual, and then application of the IRC 415 limit to the accrued benefit.

[MGB]

As stated earlier, the key to applying a calculation one way or the other is the exact, specific language in the plan. Here is Holland's description of this issue (it is in the context of early retirement factors, but equally applies to any other calculation), from the 2002 EA Meeting, "Dialogue With the IRS."

"MR. SEGAL: Okay. I'm going to ask a question that was sent in. The plan formula provides for a benefit of $200,000 payable at normal retirement age 65. The formula could be, for example, 100 percent of pay. Can the plan provide a payment of $160,000 at age 62? Let us assume the early retirement reductions were one-fifteenth/one-thirtieth.

MR. WELLER: This is one of the questions that Mr. Holland always likes to answer, which is are you going to be able to withstand an ERISA lawsuit from the participant who says "The plan formula is $200,000. I want my plan formula. I don't care if your plan is disqualified for paying me my promised benefit."

MR. HOLLAND: The long answer is that, first of all, we all understand you can't write a plan that will give you $200,000 at 65. Now the trick here is...

MR. WELLER: You can't write a qualified plan.

MR. HOLLAND: I'm making the assumption they want a qualified plan, but Mr. Weller is correct. But you can write...the trick in this question is the words "plan formula." Now the bottom line is you have to pay very close attention to your drafting. You can write a plan that says the benefit at 65 is $200,000 under some plan formula, but in no event can this benefit exceed what is allowed by IRC section 415. So the benefit at age 65 is really then the maximum allowed by Section 415. You will clearly have to do that to be qualified.

Now let's go to early retirement. Now you're really talking about what is the interaction of this benefit formula with the section 415 limits? How do these two parts of the plan look together? There are two ways to write a plan. Let's just take this one-fifteenth/one-thirtieth early retirement reduction.

There are two ways that I can write it. One, I could say I will take the plan benefit at age 65 and reduce it by one-fifteenth/one-thirtieth. That would mean I would take the section 415 limit at age 65 and reduce it by one-fifteenth/one-thirtieth. Another way to write your document is to have your early retirement benefit be the benefit described under Section X of the plan that has $200,000 in it, reduce that by one-fifteenth or one-thirtieth and then further constrain that to say this benefit cannot exceed what is allowed by Section 415. In essence then you would have a subsidized early retirement benefit versus what's payable at normal retirement age.

That can be done and, in fact, in one of the first talks I ever gave on Section 415 probably almost 20 years ago, I did an illustration of how that could be done. I think it was ASPA in 1983. It was almost 20 years ago. Anyway, you really have to pay very careful attention to drafting. What you have to make sure is that your accrued benefit at any point in time is limited to what can be provided by Section 415. Otherwise you will run into the situation where you can't forfeit the benefit in order to meet Section 415 and you can't pay the benefit because it violates Section 415.

So the trick is it's very careful drafting and this is something that would have to be done under plan terms. I've seen some people able to do it and I've seen that some people have not been able to do it. "