Tax Max Cushion Amount

[dan.jock]

Under 404(o), the cushion can include increases in FT due to expected increases in comp. If a first-year DB owner-only plan sponsor tells me that his 2016 compensation will be 100,000 but is certain that he/she will earn more in 2017 and later years, is it unreasonable to assume a higher comp limit and thus value a benefit greater than 10,000/yr comp limit for the tax max cushion? Say he's age 45 and NRA is 62. I'm thinking a reasonable approach is to assume 3% salary scale and use 100,000 * 1.03^17 / 10 / 12 =~ 1650 benefit adding 650 to the cushion benefit. Of course, warn the sponsor of the risk of overfunding. What if he's age 62 and starting a DB...how aggressive can we be with the sponsor's assurance of higher comp? Is there any other discussion or guidance I can lean on here?

[david rigby]

Has the plan actuary already contributed anything to your inquiry?

[dan.jock]

I'm an actuary who grew up in the large plan arena and still developing a worldview on these small plan issues. I'm working with a firm that is historically very aggressive on deductions. I'm seeking feedback on the reasonability of projecting salary increases based on my client's expectations of future experience. There is no experience study or valid industry research relating to an individual entrepreneur's profitability so I'm inclined to take his word for it with the warning of risking overfunding.

[david rigby]

The second part of the cushion in 404(o)(3)(A) is (in simple terms) the difference between the UC liability and the PUC liability. Of course, IRC 415 must not be ignored. Your salary scale must be reasonable, but those on this message board don't have any information to assess the reasonableness of 3% for this plan/employer.

Just my opinion.

[dan.jock]

Thx. I've done this calc in the large plan context before and for an owner-only plan, I think I'm OK projecting for younger participants. But I don't think I'm brave enough to project that an owner making 100k this year will make 200k next year because he is that optimistic.

[Effen]

Keep in mind that funding and accrual are much different. If you are new to the plan world you may not know that small plans sometimes terminate unexpectedly. If this is a new employer, with no past service or compensation history, his actual 415 limit will likely be much lower than the amount you are trying to fund. This can create a significant problem if the plan shuts down unexpectedly leaving significant assets that cannot be distributed.

Probably not a long term issue, but if the plan terminates in the first few years, it could be a problem. Just make sure everyone is aware of the issue.