Present Value of Future Salaries

[ishi]

Under the Individual Level Premium funding method, in calculating the temporary annuity factor (PVFS / current salary) in order to calculate the normal cost, can the following projected salaries be used:

2004 $500,000

2005 500,000

2006 500,000

2007 100,000

2008 100,000

2009 100,000

at 6%, this would produce a factor of 3.309186. Is this allowed?

Thanks in advance.

[david rigby]

Does those future salaries match your assumption for future salary?

If your question is about comp that exceeds the 401(a)(17) limit, then whether you include it is a part of your method.

[ishi]

We are in the design phase for a sole proprietor, who gave us the projected salaries shown. If we use current salary with some sort of salary scale, the contributions in the later years will exceed the corresponding salary for that year. If we the projected salaries shown, the normal costs will be higher when the current salaries are higher, and lower later. I think this is OK, but wasn't sure if there was some arcane rule out there that would preclude the method. (I always look to you, Pax, and others for these arcane rules)

[david rigby]

I'm not aware of any requirement that a salary assumption must always be in the form of X% per year. Although usually trouble than it is worth, there is no theoretical reason that the salary assumption could not be "select and ultimate." Still have the requirement of IRC 412©(3).

[MGB]

I've worked on many large plans that use very complex age/service based salary increases, with no fixed rate involved. In fact, one that I did was such a scale with inflation stripped out. The assumption for inflation was then factored back in each year's valuation as a separate assumption and changed from time to time.

The real issue here is whether the IRS accepts a decreasing salary pattern. I could see Jim H. immediately saying absolutely not because it produces an unreasonable allocation of costs. Just think about this scenario: my salary is 200,000 this year, and I will only take a salary of 1 for the next 9 years. Therefore, I can fully fund my full 415 limit benefit this year.

This seems to open up way too much gamesmanship that I am sure Jim H. wouldn't accept.

[ishi]

I agree that it smells a bit funny. Where would "unreasonable allocation of costs" be defined?

It's interesting to note that even though the contributions are much larger in certain years, they still remain the same percentage of that years salary, which is quite reasonable to me.

Thanks for the posts!

[MGB]

"Unreasonable allocation of costs" is like pornography; no clear definition, but I know it when I see it.

The Rev Procs on changing a funding method give some insight as does reg 1.412©(3)-1.

[ishi]

Thanks ... that made my day.