Limiting Compensation in Year Prior to Effective Date

[emmetttrudy]

We took a one person plan over that was originally effective 1/1/2012. The average monthly compensation calculation is currently using the K-1 compensation (net income minus 1/2 se tax) for the years 2009, 2010 and 2011. Compensation has decreased since then so the benefit is likely to remain based on these three years. There was an amendment to the plan in 2012, prior to any valuations being done, and shortly after the plan document was executed, to change the average monthly compensation definition section of the plan document to say 2009 compensation in excess of $100,000 will not be taken into account for purposes of the average monthly compensation calculation.

Is this permissible? At first I thought no because it is essentially amending a compensation from three years prior. But the more I think about it the more I think it may be ok. It's essentially amending the benefit formula indirectly (not sure why they just didn't go that route). Thoughts?

[Effen]

As long as the accrued benefit prior to the change is protected, I don't see a problem. The change can only impact future benefits that have not yet been accrued.

It would be helpful to know what the benefit formula is and how the accruals work. If they are using past service for the accrual, he probably accrued a fairly large benefit the instant it was signed. Keep in mind that 415 will limit it to 10% of the $ max in year 1, so that might hold it down a little.

I wonder why they amended it shortly after adoption and didn't just "correct" it? This could be a problem, but more information would be helpful

[emmetttrudy]

Formula is 80% of AMC. Fractional accrual based on plan years of service. So his accrued benefit was $0 at 1/1/2009, the date of the first valuation. I noticed the amendment is actually signed on the same day the plan was adopted as well. Not sure why they didn't just fix the formula. Maybe they thought it was easier to just amend as opposed to redo the document, SPD, etc.?

[Effen]

I thought you said the plan was effective in 2012?

If it was adopted and amended on the same day, I might just treat it like it was always effective, unless it was intentional.

It is a 1 life plan...you have some flexibility. Did you ask your client what happened?

[emmetttrudy]

sorry yes, that was a typo. effective 1/1/2012, adopted sometime in late 2012. we did ask the client but he was unaware of what happeend, he didn't even remember it had been done.

[Effen]

ok, so back to my original question. How many years of service did he have when the plan was adopted and how many total years will he have a NRA?

Assuming he has past service, you could argue he accrued a benefit the instant the document was signed. Even if an amendment was signed a second later, it cant change what he already accrued.

[emmetttrudy]

the valuations aren't using prior service for accrual. the formula is 80% of average compensation, not based on credited service so his AB = $0 as of the effective date of the plan.

his entity had existed for 3 years prior to the effective date of the plan and he instituted the plan at age 60, with NRA=65, so future service = 5.

[Effen]

It doesn't matter what the valuation said - garbage in, garbage out.

I was asking what the plan document says. You said the formula is 80% of average comp, but how is it accrued. Is it 80% per year of service, or 80% times some fraction. If it is fractional, what are the years based on - they could be service or participation.

[emmetttrudy]

yes, i mentioned in one of my posts above that it is fractional based on plan years of service (i.e. participation), so the accrual isn't taking into account any years of service prior to the effective date of the plan. i may be misunderstanding your question, but i think that's the information you're asking for?

[Effen]

right, you said "years of service" for accrual, but that is inconsistent with your next statement that the accrual "isn't taking into account any years of service prior to the effective date of the plan", which would imply "participation", not service.

If it is service, you need to know his hire date. Say he started the company in at age 40 in 2007, then adopted the plan in 2012 and his retirement age is 65. Lets say his 3 year average comp from 2009-2011 was $150,000.

The instant he adopted the plan his AB is the lesser of (.8 * 5/25 * 150,000) or (.10*200,000) or 20,000. Now if they amended to plan to only include comp > 100K, his AB is still $20,000. It does not decrease as a result of the amendment.

It would remain $20,000 for another 8 years until his plan accrual exceeded $20,000. In 2025 his AB would be .8*13/25*50,000 or 20,800. This assumes no COLA on the 415 limit, which would actually result in small increases over the years.

If the accrual fraction is based on participation, you have an argument that the AB was $0 and therefore no cutback occurred. It all hinges on the accrual definition.