415 and Prior Plan

[pookah]

Suppose a non-PBGC DB plan terminates with less than 100% funding. Assets were allocated per section 4044 of ERISA. Suppose the same sponsor subsequently established a new DB plan. What benefit is credited under the prior plan to each employee under the new DB plan? Is it the benefit previously accrued or the benefit previously paid? (If an employee had a $10,000 annual benefit accrued under the plan, but was paid the equivalent of a $6,000 benefit do we take $6,000 or $10,000 into account in determining what the current plan's 415 limitation is?) Is there support for your conclusion?

Thanks.

[Mike Preston]

It is a sad world when the answer to questions such as this one are not obvious. But the fact is that some IRS folks have, indeed, put forth the theory that the appropriate measure of the prior benefit is $10,000, not $6,000.

They are wrong, of course.

And no amount of hand-waving and gesticulating about the "accrued benefit" being $10,000 makes any sense at all.

If the benefit paid was $6,000 then the benefit to offset against the current limitation is that $6,000 benefit.

Why? Because if the $10,000 was the true "accrued benefit" then the plan would not be a qualified plan if it were to pay something less. Something about an "impermissible forfeiture" comes to mind.

However, one never knows if the next "crazy" idea (such as this) will gain traction with some faction at the IRS or the Treasury and we will find ourselves having to respond to a formal challenge along these lines. What a waste.

[JAY21]

You might get some different opinions on this one as to my knowledge there isn't any definite statute, reg, rev-ruling, or other guidance on this (not sure if this is a EA mtg grey book item where IRS has provided a non-binding opinion or not). This issue has been around for a while not only for subsequent (2nd) DB plans by the same employer, but under old IRC 415(e) how much the terminated DB plan impacted the future DC contribution accumulation (if any) if the DB plan was under funded when terminated. That was the same issue before 415(e) was repealed for 2000 and beyond. Our firm has always used the "distributed" benefit (the $6,000 in your example) but I can't provide any strong support for or against this position.

[David MacLennan]

In Citrus Valley the court opined that 415 does not limit accruals, only actual distributions. I guess that does not give anyone reliance, but it is one more argument to bolster the position that the actual distribution governs. I reproduce below an excerpt (the "respondent" is the IRS):

* * * * * * * *

. . . . This argument, however, relies on the proposition that section 415 limits accruals.

In support of this contention, respondent refers us to section 1.415-1(d)(1), Income Tax Regs. That section requires that the plan provisions of a qualified plan:

preclude the possibility that the limitations imposed by section 415 will be exceeded. For example, a plan may include provisions which automatically freeze or reduce the rate of benefit accrual * * * to a level necessary to prevent the limitations from being exceeded with respect to any participant.

* * *

Respondent concluded that this language indicates that Congress intended section 415 to limit the accrual of benefits. We disagree.

There is nothing in section 415 indicating that Congress intended section 415 to limit the accrual of benefits, and the regulation respondent cited does not compel such a result. The regulation's suggestion on how to prevent the plan from paying benefits in excess of the section 415 limits cannot create a limitation on the accrual of benefits that Congress did not expressly enact. Furthermore, we held that all of the plans, except perhaps Fox, funded no more than an amount which would be payable if the plan terminated immediately; therefore, no forfeiture could occur.

[David MacLennan]

I would like to add that how you determine the offset to the 415 limit for the prior distributions is also not a straightforward issue. This is addressed in the proposed 415 regs but most feel the IRS really got it wrong and hopefully the final regs will provide more acceptable guidance. Common methods used by actuaries in the past also lead to unacceptable head-scratching type results.

I wrote a paper in which I (hopefully) gave the correct mathematical approach for adjusting the 415 limits, which you can find on the Society of Actuaries web site (pension section news, Jan 2006). I have to add that I have had zero feedback on my paper from other actuaries, so whether the methods I advocate will gain acceptance by the actuarial profession is not at all clear at this point! Comments, anyone, please!

[ak2ary]

It is a sad world when the answer to questions such as this one are not obvious. But the fact is that some IRS folks have, indeed, put forth the theory that the appropriate measure of the prior benefit is $10,000, not $6,000.

They are wrong, of course.

Mike-

I think the proposed regs and Hollands public statements make it clear that, while the Service has no concept of the application of 415 in the case of MASDs, where an offset is warranted they want to offset by actual amounts paid going forward and not reference the benefit accrued....which is nice

[AndyH]

Would you clarify/amplify that? I have one where the benefit might be $1.7 million at NRA 65 but the principal received $300K 15 years ago in a prior plan that had a NRA of 55 (rough numbers and years but real situation).

What do you mean by "they want to offset by actual amounts paid going forward"? Is there some new thinking on how to handle such a situation? (Not that there is much consistent old thinking).

[David MacLennan]

Andy, if I can answer for ak2ary, I think he/she was just pointing out that the proposed 415 regs reference prior distributions, not accrued benefits (which may be larger than the actual distribution), when adjusting for prior distributions.

I can outline the mathematically correct method to determine the 415 dollar and compensation limit offsets for the 300K prior distribution, if you provide the following:

1) In what year did the prior distribution of 300K occur, and what was his/her age at that time?

2) What is his/her hi-3 comp average for the 415 compensation limit, and which 3 years are these?

3) For what year is the ajusted 415 limit to be determined?

[AndyH]

Thanks, Dave:

The person received $331,472 in 1991 at age 50.

He established a new plan several years ago (has 10+ yop aggregated) and has always been above the 401(a)(17) comp limit.

He wishes to collect the maximimum in 2006 when he attains age 65. The benefit formula would provide for a payment well above the 415 limit.

He wishes to know what his maximum lump sum would be as well as the maximum annuity. (His wife is considerably younger than him so I cannot readily dismiss the 415 value of a J&100 in such case, but that is an aside).