PPA 06

[Effen]

I would like to confirm my interpretation of the new 404(a)(7)©(iii). The way I read this is that if the DC contribution is 6% or less, than the 404(a)(7) limit (25% comp) doesn't apply, but if it is > 6%, the 404(a)(7) limit applies.

When I read some of the summaries I got the impression that you could ignore DC contributions up to 6% of comp, thus increasing the combined limit from 25% to 31%, however I do not think this is correct. Basically the way I read it now is that if the DB contribution is 50% of comp, you would be allowed DC contributions up to 6%, but the penny over 6% triggers this limit and would make any amount over 6% non-deductible. So if your db contribution was 15%, you could only put 10% into the DC without hitting the limit.

Agree?

404(a)(7)© PARAGRAPH NOT TO APPLY IN CERTAIN CASES. --

* * *404(a)(7)©(iii) LIMITATION. --

In the case of employer contributions to 1 or more defined contribution plans, this paragraph shall only apply to the extent that such contributions exceed 6 percent of the compensation otherwise paid or accrued during the taxable year to the beneficiaries under such plans. For purposes of this clause, amounts carried over from preceding taxable years under subparagraph (B) shall be treated as employer contributions to 1 or more defined contributions to the extent attributable to employer contributions to such plans in such preceding taxable years.

[SoCalActuary]

* * *404(a)(7)©(iii) LIMITATION. --

In the case of employer contributions to 1 or more defined contribution plans, this paragraph shall only apply to the extent that such contributions exceed 6 percent of the compensation otherwise paid or accrued during the taxable year to the beneficiaries under such plans. For purposes of this clause, amounts carried over from preceding taxable years under subparagraph (B) shall be treated as employer contributions to 1 or more defined contributions to the extent attributable to employer contributions to such plans in such preceding taxable years.

The trick here is the final interpretation of "apply to the extent that such contributions exceed 6 percent"

I hold that their intent was to move 25% to 31%, and apply the non-deductible portion only on the amount that exceeded 6%. But we don't have guidance yet. If you are correct, then someone who intended to use a 6% limit but made a mistake (counted incorrect compensation for example) would lose the entire dc deduction.

But these are just interpretations until the IRS tells us otherwise.

[ak2ary]

Mu understanding is slightly different than each of yours

Consider 2006

Assume the max deduction absent the DC is the amount necessary to bring the plan to 150% of CL

Assume that amount is 75% of pay

Assume the DB minimum 22% of pay

If the DC contribution is 6% or less, 404(a)(7) does not apply, the 6% is deductible and the max DB contribution is 75% of pay

If the DC contribution is 8% of pay, 404(a)(7) applies, 2% of the 8% applies in the 404(a)(7) calculation making the maximum DB deduction 23% of pay

If the DC contribution is 10% of pay, 404(a)(7) applies 4% of the 10% applies in the 404(a)(7) calculation, the maximum DB is 22% of pay (to meet min funding), the max DC deduction is 9% out of the 10% to satisfy 404(a)(7)

But, yes, we need guidance

[Guest Carol the Writer]

I admit that it has been a few days since I read it, but I read the (increased) limits for the DC to apply to matching contributions only. Therefore, if you have a 40% of payroll DB plan, and a 401(k) profit sharing plan with no overlapping plan participants in the er "profit sharing" contrib. - a "carve-out" arrangement - then you could add a safe harbor match for the common members and have it tax deductible. The SH match would be less than 6% of payroll. And, the way these plans had been working, the employer wasn't getting a full deduction for any SH matching contributions that he was making to his "overlapping" plan members. (Presumably he wasn't contributing a SH match for himself, because the match wasn't deductible. Now he can contribute and deduct the SH match.)

Any thoughts out there on this? Am I right or wrong on this analysis?

Carol Caruthers, MSPA, EA

Consulting Actuary

for E. Dominic Firmani

[ak2ary]

I believe that you are looking at Section 803(b) of the Act rather than Section 803(a). Section 803(b) deals with excise taxes on non deductible (as a result of 404(a)(7)) matching contribs...Section 803(a) changes the the 404(a)(7) calc itself and does not distinguish between PS contribs and matches

[ak2ary]

oops I mean you were looking at 803©

[SoCalActuary]

Thanks to ak2ary for your review. I agree with your position.

[Effen]

ak2way, I'm sorry, but I'm a bit dense this late on Friday....

If the DC contribution is 8% of pay, 404(a)(7) applies, 2% of the 8% applies in the 404(a)(7) calculation making the maximum DB deduction 23% of pay

Because 23 + 2 = 25?

If the DC contribution is 10% of pay, 404(a)(7) applies 4% of the 10% applies in the 404(a)(7) calculation, the maximum DB is 22% of pay (to meet min funding), the max DC deduction is 9% out of the 10% to satisfy 404(a)(7)

So taking your first example a little futher, you would say that the max DB is 22% of pay (to meet min funding), the max DC is 8% and the entire 30% DB/DC contribution would satisify 404(a)(7)?

So basically you are saying db + dc - 6% m/b < 25%, ie: they raised the limit to 31%.

[ak2ary]

Yes but the key is that under 6% 404(a)(7) doesn't apply at all, so on the DB side you are not limited to the 22% min or 31%-DC contrib...if the DC is 6% or less you can deduct the DB max,,,in this case 75%

[Penman2006]

Also, under the new law, effective in 2008, if the DB plan is covered by the PBGC it can be ignored for the 404(a)(7) combined plan deduction limit.

[Effen]

I've been wondering how long it will be before some otherwise exempt group asks to be covered by the PBGC. Does anyone know if it is possible?

[david rigby]

Asks to be covered? Seems undesirable from the sponsor's viewpoint. Also, I doubt it is possible, due to statutory language.

Besides, isn't that a perfect example of anti-selection?

[SteveH]

Ok so plan design gurus out there, how will you be using this new feature?

I sort of think what Carol was mentioning that the 6% was INTENDED to allow matching contributions so that a plan sponsor with employees that has a DB plan can also contribute to a 401(k) plan. The past 6 or 7 years the Adminstration and Congress has really been pushing for people to be more responsible for their own retirement and they have been pushing that with changes to 401(k) plans. Catch up contributions, deferrals not counting towards the deduction limit, safe harbor 401(k) plans, etc. I think this 6% provision is another example of trying to increase participation in 401(k) plans.

But...

I'm not sure if that is how it will be used. For instance I don't think it says how the 6% would need to be allocated. It doesn't say that you would have to allocate 6% to each participant. It doesn't say that you could not allocate it like a new comp formula. I think this will make DB/DC combo plan designs work very well. Design a max funded DB plan for an owner. Cover the employees at 0.5% unit credit formula. Then allocate the entire 6% of compensation to the employees in the DC plan with none for the owner. Let's say that ends up giving them a 7.5% of pay allocation in the DC portion. Test the plans together and you pass gateway, 410(b), 401(a)(4) and 401(a)(26). So you will see 55+ owners running around receiving DB allocations of $170,000+ and then employees getting somewhere between 7-10% of pay.

This could cause a deductible contribution between both plans that is 50% of pay, and the owner is getting a huge proportion of it. The DC plan contribution will be right at 6% of eligible payroll so that we don't cause the 25% deduciton limit to kick in.

Anyone agree or think that this can not be done with PPA'06?

[SoCalActuary]

Ttott - I read PPA as you do. 6% has no requirement attached to it in the law, so it can be a safe harbor match, or a shnec, or a tiered allocation.

[John Feldt ERPA CPC QPA]

Effen: "I've been wondering how long it will be before some otherwise exempt group asks to be covered by the PBGC. Does anyone know if it is possible?"

According to Brian Graff and Judy Miller from yesterday's ASPPA Webcast, the answer is no, it is not possible to voluntarily become subject to coverage by the PBGC.

[Guest lerieleech]

In the same webcast, they indicated that if you go over the 6% DC contribution, you lose the entire 6%.

I still want to see the regs before I conclude anything.

[Kevin C]

Now there are conflicting opinions from ASPPA.

The ASPPA ASAP for 9/14/2006 (No. 06-30) says that if the DC contribution exceeds 6%, only the contribution in excess of 6% counts towards 404(a)(7).

I hope some guidance is issued soon.

[SoCalActuary]

The people who wrote this include Judy Miller of Senate Finance Committee. Hopefully, the reg's will be written by people who actually talk with the authors to check their intent.

I believe that the latest ASPPPPPPA item contradicts prior opinion, and we don't yet have the definitive answer.

For safety sake, be very careful if dc plan contributions could exceed 6% of participant pay when you have combined plans.

[Mike Preston]

Remember that it is 6% of those who participate in the DC plan. Anybody in neither plan or in only the DB wouldn't have their compensation included.

[Guest Jeff Hartmann]

Consider 2006

Assume the max deduction absent the DC is the amount necessary to bring the plan to 150% of CL

Assume that amount is 75% of pay

OK, this means we are assuming that 404(a)(1)(D) applies to the Plan -- this becomes important in applying 404(a)(7)(A)(ii).

even Pre-PPA, 404(a)(7)(A)(ii) has language stating that if 404(a)(1)(D) applies, "the amount necessary to satisfy the minimum funding standard .... shall not be less than the unfunded current liability ....".

So, we can still deduct the amount that brings the plan up 100% of CL, even though we cannot go all the way up to 150%.

Assume that amount is 40% of pay

Assume the DB minimum 22% of pay

but now we can deduct up to 40% of pay in my example

If the DC contribution is 8% of pay, 404(a)(7) applies, 2% of the 8% applies in the 404(a)(7) calculation making the maximum DB deduction 23% of pay

If the DC contribution is 10% of pay, 404(a)(7) applies 4% of the 10% applies in the 404(a)(7) calculation, the maximum DB is 22% of pay (to meet min funding), the max DC deduction is 9% out of the 10% to satisfy 404(a)(7)

and in my examples you get to deduct the same 40% of pay you could deduct pre-PPA, plus the 6% DC that the PPA change gives us.

[ak2ary]

I agree that you get to fund to 100% of CL plus the 6% DC. I didn't hear Brian's talk, but that would be a change of the position he was taking 2 weeks ago. If thats the case, you probably want to wait on advising anyone to go over 6%

[Guest Jeff Hartmann]

I agree that you get to fund to 100% of CL plus the 6% DC. I didn't hear Brian's talk, but that would be a change of the position he was taking 2 weeks ago. If thats the case, you probably want to wait on advising anyone to go over 6%

It is interesting ..... everyone in my office heard Brian say we lose the free 6% DC if we go over 6%, yet when I challenged Brian on that (through email and phone calls) he claims he did not say that, so I am going with his latest statement to me that we never lose the free 6%. He claims he said only that we lose the 150% of current liability (minus assets) deduction for DB if we go over the 6% DC [agreed].

[Belgarath]

The JCT explanation doesn't provide a lot of insight. I'm wondering, however, if the whole thing is an attempt to coordinate the deduction limit with the excise tax provisions of IRC 4972©(6)(A). The 6% figure seems like too much of a coincidence.

I have always read this provision in 4972 to mean that if you had, say, a 10% nondeductible contribution to the DC plan due to the 404 combined plan deduction limitation, that you would pay excise tax ONLY on 4%.

I think that IF this coordination is deliberate, it would support the argument that your DC contribution would be deductible up to 6%, and nondeductible only to the extent it exceeds 6%. But whether deliberate or concidence, I still personally believe the correct reading of 404 is that the DC contribution up to 6% is deductible, and if you go over 6%, only that excess is not deductible - you don't lose the whole DC deduction.

[ak2ary]

I talked to Brian on this today and he confirmed that he never said you lose the 6%, the first 6% to the DC is always deductible. He doesn't know what he said that people have misinterpreted. But he was very clear if 404(a)(7) applies, only the amount in excess of 6% counts toward the limit.

[Guest Jeff Hartmann]

I talked to Brian on this today and he confirmed that he never said you lose the 6%, the first 6% to the DC is always deductible.

A lot of people, from different companies, believe they heard him say that in the 9/12 webcast, whether he meant to say that or something different ..... but it is reassuring to keep hearing him now say that we don't lose the first 6% deduction.

[SteveH]

The ASPPA webcast slide says that you lose the entire deduction if you go over 6%. It is hard to see, but I think it says slide 18. The slide reads:

"For 2006/2007 combined plan deduction limit 404(a)(7) does not apply if DC contributions do not exceed 6% of compensation. - 150% of CL deduction limit available."

"However, if contribution exceeds 6%, combined plan deduction limit does apply without regard to DC contributions. - Both plans then limited to DB minimum required contribution."

I don't see how that can be interpreted any other way. Now maybe the slide was wrong, but it sounds like someone is contradicting themselves.

[AndyH]

There was another ASPPA webcast today with Joan Gucciardi and Marty Pippins and if understood this correctly a couple of things jumped out at me for 2006 and 2007:

1. If the DC contribution exceeds 6% then the 150% unfunded CL deduction limit becomes 100%. But from the comments above the 100% is actually the geater of 25% of pay or 100%.

2. There remains uncertainty as to whether the first 6% is deductible if 404(a)(7) applies and the DC contribution exceeds 6% but apparently there is evidence that the intent was to penalize only amounts above 6% so this is the most likely end result. Guidance will be issued fairly soon.

Re: #1, if you are doing a beginning of year db val you have no way of knowing the deduction limit since the DC amount is typically determined much later.

Do I have this right?