Another 404(a)(7) question

[Guest Mike Spickard]

I’m sure that many other actuaries are dealing with this problem and as a result, may not have the time to answer my questions, but here they are:

My client has 2 DB plans – one union and one non-union. Union minimum contribution is $750k, max is $3.3mil (UCL). Nonunion plan minimum is $0, max is $800k (UCL). Client also sponsors a 401(k) plan in which both union and nonunion participate and there are matching contributions. Total eligible payroll is about $5 million.

To shore up the FAS87 reporting and avoid additional liability, they need to contribute $3 mil to the union plan and $700k to the nonunion plan. They are ready to do this, but these amounts in total are more than 25% of payroll. If the DB plans were the only plans, I don’t think there would be any deduction problem.

Since the DB’s are not the only plans, I think I have a problem in that the 401(k) match would not be deductible though I am wondering if I still have some deductibility “room” since I did not fund up to my full deductible limit in the DB plans.

My questions are: Which 404 limit trumps the other? Is 404(a)(1)(D) an absolute override to determine the deductibility ceiling? Or does it not even apply (God forbid) in an overlapping plan situation? Theoretically, I could put up to $4.1 million in the DB plans, but only need to put in $3.7 million. Is it reasonable to assume that the remaining deductible amount could be used for the 401(k) match?

If we can deduct just the DB max’s (driven by the UCL amounts), my client can live with about $150,000 in nondeductible matching contributions if necessary. I am hoping that we at least retain the 401(a)(1)(D) higher deductible limit even where there is a 401(k) plan into which DB participants contribute.

[Blinky the 3-eyed Fish]

Hope is lost. 404(a)(1)(D) will not transfer to any contributions in the DC plan because the full DB limit is not used. 404(a)(7) will still apply and the employer contributions in the plan will be nondeductible. At least there is no excise tax up to 6% of comp ($300,000), so maybe hope is restored, if only a little bit.

[Guest Mike Spickard]

But I can still contribute and deduct up to the UCL's in the DB plans, right?

[Blinky the 3-eyed Fish]

(7) Limitation On Deductions Where Combination Of Defined Contribution Plan And Defined Benefit Plan

(A) In General

If amounts are deductible under the foregoing paragraphs of this subsection (other than paragraph (5)) in connection with 1 or more defined contribution plans and 1 or more defined benefit plans or in connection with trusts or plans described in 2 or more of such paragraphs, the total amount deductible in a taxable year under such plans shall not exceed the greater of--

(i) 25 percent of the compensation otherwise paid or accrued during the taxable year to the beneficiaries under such plans, or

(ii) the amount of contributions made to or under the defined benefit plans to the extent such contributions do not exceed the amount of employer contributions necessary to satisfy the minimum funding standard provided by section 412 with respect to any such defined benefit plans for the plan year which ends with or within such taxable year (or for any prior plan year). A defined contribution plan which is a pension plan shall not be treated as failing to provide definitely determinable benefits merely by limiting employer contributions to amounts deductible under this section. For purposes of clause (ii), if paragraph (1)(D) applies to a defined benefit plan for any plan year, the amount necessary to satisfy the minimum funding standard provided by section 412 with respect to such plan for such plan year shall not be less than the unfunded current liability of such plan under section 412(l).

Yes. Here is 404(a)(7). Note the highlighted portion. (1)(D) is 404(a)(1)(D).

[Guest Mike Spickard]

Thanks Blinky. I have been trying to find out what interest rate must be used for purposes of determining the UCL as of the end of the year. The regs. state "using the current liability interest rate" which can be within the range that the IRS publishes. Do you use the interest rate at the top of the range when determining the UCL? Or can you use the bottom of the range? I have not seen anything that prohibits one from using the lowest rate to create the largest deduction possible. Of course, almost all of my clients are happy to use the top of the range.

[Mike Preston]

I think the IRS is on record saying you can use any rate in the range. I usually take the position that the rate you use is the rate you publish on the Schedule B.