The maximum amount of compensation taken into account for plan purposes

[scarabrad]

For 2014, the maximum amount of compensation taken into account for plan purposes will increase from $255,000 to $260,000.

If one has net schedule C income of $250k for 2012, $255k for 2013, $260k for 2014, does this allow annual adjustments to the maximum plan year annual benefit payable through a defined benefit plan at retirement (currently $210,000 for 2014). Anticipated retirement date is 2033 at age 62.

For example, if the maximum annual benefit adjusts upwards to $255k by 2025 (hypothetically speaking), will the fact that net schedule C income for 3 consecutive years (2012-2014) averaged $255k allow the annual benefit to adjust upward to the new max of $255k, even though the 3 highest year net Sch C income was accrued in 2012-2014?

Appreciate any input!

SR

[AndyH]

No, for an active, the benefit may not exceed the high 3, period.

[scarabrad]

But, hypothetically speaking, what if the benefit amount rises (adjusted for inflation) to, say, $255K in future years (ie, 2025, c/w $205K in 2013), when the plan participant is still earning income and the plan remains active? Would the fact that the 3 highest years averaged $255K were from 2012-2014 prevent one from capturing the higher benefit amount in the future?

In essence, if the 3 highest years (current, 2012-2014) of compensation reach the maximum annual compensation limit for 2012-2014, does that "protect" or allow for benefit increases in the future, as the maximum allowed benefit rises, adjusted for inflation?

Thanks in advance.

[Andy the Actuary]

(b) Limitation for defined benefit plans

(1) In general

Benefits with respect to a participant exceed the limitation of this subsection if, when expressed as an annual benefit (within the meaning of paragraph (2)), such annual benefit is greater than the lesser of—

(A) $160,000, or

(B) 100 percent of the participant’s average compensation for his high 3 years.

[AndyH]

The question seems to be (I think) can $300,000 earned in 2014 ever be worth more than $260,000 and the answer is NO, under current law.

[scarabrad]

I'm confused. I thought the maximum annual benefit payable by a defined benefit plan was $210,000 for 2014, $215,000 for 2013, $200,000 for 2012, etc? Where does the $160,000 limitation come into play?

[Andy the Actuary]

This question was posed like a problem from an actuarial exam. As I read it. Participant has average comp of $255,000 but say formula benefit is $180,000. However, participant (and this was not stated) has decline in compensation so that at the time of retirement, his recent high 3 is $200,000. His formula benefit is now $240,000 and the IRC (b)(1)(A) limit is $220,00. Is his benefit limited by $200,000 or by $220,000? I.e., is the restricted benefit $200,000 or $220,000. I.e., does High 3 apply forever so is High 3 limited by 415(b)(1)(A) limit in effect at time High 3 is determined?

If this is not the question, please restate because we're all answering different questions!

[Hojo]

scarabrad - Read up on 415 limits and how they work and how they have been indexed historically......then come back and ask your question (if you still have it because you probably won't).

Ninja'd by Andy!

[My 2 cents]

My understanding of the 415 regulations as they affect this discussion:

1. The earnings for all purposes of a plan for a given plan year are permanently limited by that year's 401(a)(17) limitation (based on limit for calendar year containing the first day of the plan year). Calculate the 415 high-3 average limitation with this in mind.
2. Except for governmental plans, the current IRS position (as it stands in the final regulations) is that no benefit ever accrues in excess of the current 415 limit (dollar or percentage of pay).
3. The 415 high-3 average is permanent. Earn $240,000 per year now for three years, then your 415 percentage of pay limit will never fall below $240,000.

Hope this helps.

[scarabrad]

My 2 cents,

Thanks for the response (worth at least 4 cents, IMHO!) So, if the section 415(b)(1)(A) limits increase in the future to $240,000 (from current $210k), does the benefit at age 62 adjust to meet that increased benefit under future 415(b)(1)(A) or is it limited to the 415(b)(1)(A) limits in place at the time the 415 high-3 average was earned (and thus would be limited to ~$210,000 currently in place.)

[My 2 cents]

It is my understanding that, in a situation where the 415 high-3 limit was reached in the past, there is no requirement whatsoever that one continue to use the 415 dollar limit in effect at the time that the high-3 earnings were received. So long as the person remains in covered employment, earns additional years of service and there were ongoing increases in the 415 dollar limit, then the higher current dollar limit, acting together with the de facto frozen 415 compensation limit, would apply. If, at the time the participant went to retire at age 62, the dollar limit had risen to $240,000 and the high-3 average (from younger days) was also $240,000, then the 415 limit to be applied to the accrued benefit would be $240,000. If the dollar limit had risen to $260,000 but the high-3 remained at the long-ago $240,000, then the 415 limit would be $240,000.

[scarabrad]

That was precisely the scenario about which my original post was trying to address, perhaps confusingly so. Thank you very much for your input!

[masteff]

A related question to be aware of is does the plan limit the window for when the high-3 must have occurred? E.g. high-3 out of the last 10 years of employment? This will vary plan by plan.

[scarabrad]

Solo DB plan (one participant). Assume plan docs do not limit the window.

Thank you all for useful and erudite input.

[My 2 cents]

A related question to be aware of is does the plan limit the window for when the high-3 must have occurred? E.g. high-3 out of the last 10 years of employment? This will vary plan by plan.

Short answer - no, this should not vary from plan to plan. Every plan should parrot the rules under 415 as is. The 415 compensation limit is measured during any three consecutive years during the entire period of service with the employer, including periods during which the employer maintains no retirement plans, periods during which the employee does not meet the plan's definition of eligible employee etc. If you want, you can impose more restrictive limits on benefits (such as 75% of the highest 5 consecutive out of the last 10), but those limits would not be 415 limits (and the plan should still explicitly parrot the high 3 consecutive ever 415 limit even if the other plan provisions render them moot).