PRE-ERISA LIMITATIONS ON SALARY DEFERRALS

[Guest JennaJones]

I am researching the limitations on salary deferrals prior to the establishment of ERISA. I understand the limitations went through a few changes prior to ERISA. Any information would be greatly approciated. Thanks.

[Guest b2kates]

My recollection is that pre ERISA, there were no deductible salary deferrals, only nonqualified deferrals.

[Harwood]

My Fourth Edition Pension Answer Book [1987] indicates that cash or deferred arrangements were permitted under The Revenue Act of 1978.

[MGB]

That is not true. They have been around since the 1950s.

There were quite a few cash-or-deferred arrangements (CODAs) at large companies. Most were focused on the profit sharing contribution at the end of the year, rather than a salary deferral. For example, all of the big auto companies were doing this. The profit sharing was allowed to be taken in cash or deferred, thus the origin of the "CODA" moniker. However, salary reduction was beginning to show up, too.

Here is an exerpt from Chapter 11, "Cash of Deferred Plans Under Section 401(k)", Legislative History of CODAs, pg. 186, from Pension Planning, by Allen, Melone, Rosenbloom and VanDerhei, 8th Edition, Irwin Publisher:

"Before 1972, the IRS provided guidelines for qualifying cash option CODAs in a series of revenue rulings. In essence, more than half of the total participation in the plan had to be from the lowest paid two-thirds of all eligible employees. If this requirement was met, employees who elected to defer were not considered to be in constructive receipt of the amounts involved, even though they had the option to take cash. Salary reduction plans satisfying these requriements also were eligible for the same favorable tax treatment.

In December 1972, the IRS issued proposed regulations stating that any compensation that an employee could receive as cash would be subject to current taxation even if deferred as a contribution to the employer's qualified plan. Although primarily directed at salary reduction plans, the proposed regulations also applied to cash option profit sharing plans.

As the gestation period for ERISA was coming to an end, Congress became increasingly aware of the need to devote additional time to the study of the CODA concept. As a result, ERISA included a section providing that the existing tax status for CODAs was to be frozen until the end of 1976. Plans in existence on June 27, 1974, were permitted to retain their tax-favored status; however, contributions to CODAs established after that date were to be treated as employee contributions and, as a result, were currently taxable.

Unable to meet its self-imposed deadline, Congress extended the moratorium on CODAs twice; the second time, the deadline was extended until the end of 1979.

The Revenue Act of 1978 enacted permanenet provisions governing CODAs by adding Section 401(k) to the IRC, effective for plan years beginning after December 31, 1979. In essence, CODAs are now permitted, as long as certain requirements are met.

This legislation, in itself, did not result in any significant activity in the adoption of new CODAs. It was not until 1982, after the IRS issued proposed regulations in late 1981, that employers began to respond to the benefit-planning opportunities created by this new legislation. By providing some interpretive guidelines for Section 401(k), and by specifically sanctioning salary reduction plans, the IRS opened the way for the adoption of new plans and for the conversion of existing, conventional plans."

(I get really irked every time I hear that "the father of the 401(k)" created the first CODA in 1982...many of us worked on them long before that.)

[Harwood]

Superb information MGB. I hope you didn't have to type it all yourself.

[david rigby]

Similar, perhaps identical, language is included on page 228 of the Seventh Edition of the same book (1992).

[mbozek]

There were no limits on salary deferral in qualified plans pre ERISA because there was no 415 limit. The only limit on salary deferral was the exclusion allowance for contributions to a 403(b) plan which limited all contributions, including salary deferral, to 20% of the compensation after reduction for elective contributions. See IRC 403(b)(2) repealed effective 1/1/02.

[Kirk Maldonado]

I know an attorney that had a client that once made a $200,000 contribution to a money purchase pension plan before the enactment of ERISA. The client made $800,000 that year and the plan's formula required a contribution of 25% of compensation.

[MGB]

Note from the historical development that CODAs originated with the profit sharing contribution at the end of the year. That is why 401(k) ended up as a feature within profit sharing plans and is not applicable to other qualified plans.

[TCWalker]

I worked with a CODA that was established in 1955. As said, the Plan provided an election for cash or deferral of year-end profit sharing bonus. The plan worked exceptionally well it's 200 participants in an environment where all employees qualified for year-end bonuses. ERISA, then 401(k), frustrated the purpose of the plan and non-d deferral testing issues argued for it to be converted to a garden variety salary reduction arrangement in the late '80s.