Is the annual limit prorated in a money purchase pension plan for a sh

[Guest Tara Curran]

We have an employer who adopted a money purchase pension plan effective November 1, 2000 with a 5% contribution. When the Company computes its 2000 contribution does it take into account only salaries since November 1, 2000? the plan defines compensation from the first day of the plan year, not just when the employee became a participant. In addition, is the $30,000 limit prorated for 2 months of the year?

[Richard Anderson]

If the plan is effective 11/1 and plan year ends 12/31; and plan defines comp as plan year comp, then for the first short year the contribution will be calculated based on only Nov and Dec comp. Yes, the 30,000 415 limit will be pro-rated if the limitation year is also the plan year. But, 415 is not what is going to limit the contribution for the HCEs in this short plan year. The 401(a)(17) compensation limit of $170,000 must be pro-rated for two months; therefore, maximum comp for plan use will be $28,333.33. So, the contribution for someone with comp at or above the pro-rated 417(a)(17) limit will be $1,416.67 (28,333 x 5%). This is well below the pro-rated 415 limit of $5,000.

Why wasn't this plan set up with an effective date of 1/1?

[Earl]

Similar situation only on the other end...Plan Termination. If there is residual income to a closing biz and for calendar 2001, as of today, the biz can contribute $35,000 and payroll $140,000 to the sole participant, do they have to keep the plan open for the full year to get the full contribution? I am thinking termination creates a short year and pro-rated limits.

Anyway to avoid waiting till 2002 to terminate and distrbute assets?

[Richard Anderson]

Will defining comp as calendar year comp rather than plan year comp work? I'm not sure how that would work if the plan terminates prior to the end of the year.

[rcline46]

The crucial decision in a short year is based on what the document defines as a limitation year, and then the definition of compensation. All documents I have seen define the limitation period as 12 months for the first plan year. The only time it is less is if the plan year changes. Therefore there is no proration in the first year of the $170,000 or the 25%/$30,000 (now $35,000) limits.

If the document defines pay as while a participant, then the Nov - Dec pay is all that counts. You MUST read the document carefully. And you must read the regulations relating to limitation years.

[Guest xplan]

I disagree with rcline46. The plan was effective Nov 1st. Assuming the PYE is 12/31, the short plan year rules apply. Even if the document defines the limitation year as a 12 month period other than the calendar year, it does not discount the fact that the plan was a short plan year and as such must prorate all affected limits (IRC 415, 401(a)(17), 401(l)).

[Richard Anderson]

Most plans I have seen define the limitation year as the plan year. rcline46 is correct about the 415 limit NOT being pro rated if the limitation year is defined as a full 12 month period, such as the calendar year. But, if the limitation year is defined as the plan year, it has to be pro rated for a short plan year.

But I disagree about $170,000 not being pro rated. If the plan's definition of compensation that is used for allocation purposes is less than 12 months for a plan year, then the 417 must be pro rated (reg 1.401(a)(17)-1(B)(3)(iii). There is an exception to the proration rule if the plan limits compensation to the period of participation, but this exception is only valid if the normal compensation period for the plan year is 12 months. Therefore, if the normal compensation period for the plan is a 12 month period, no proration is necessary for an employee that participates for less than the full plan year.

[Guest]

for good reading see workshop #11 1998 APSA Conference by Kevin Donavan. Actually, he has given the talk a number of times. Amongst his notes a comment from the 1996 Conference Q & A #84 "If there is a short initial plan year, and the plan sponsor has been in existence for that same period of time, in that special situation is it possible to have a short initial limitation year?

Answer- Ther is no initial short limitation year. The limitation year is the full 12 month period working backward from the end of the year.

(This was in regards to the 415 limit)

now, in regards to comp limit, in his talk,

'when there is a short plan year, pro ration of the comp limit may or may not be required, depending on the period used for deterining allocations or benefit accruals. 1.401(a)(17)-1(B)(3)(i) annual comp limit is applied to the compensation for the plan year on which alloactions or benefit accruals are based.

Allocation of the comp limit is not required where a participant becomes a participant during the plan year or his comp is included only from date of participation, provided alloaction are otherwise deterined using a 12 month period 1.401(a)(17)-1(B)(3)(iii)(B)

This is the same as Richard Anderson has pointed out.

[rcline46]

Thank you Tom Poje. There is a tremendous amount of misinformation and misunderstanding on this topic. Until I read Kevin's stuff and reviewed the regs, I was under the same misimpression that a short initial year is a short plan year. That just ain't so!

[Guest]

you are not alone. It was one of the best talks I attended.

It is awful hard to unlearn stuff that you always thought was true isn't it? But then again, that is why I appreciate this Benefits Link, I can honestly say I pick up a lot from others questions and answers.

[Richard Anderson]

Tom

The 2000 edition of the ERISA Outline Book states that he 415 limit must be pro rated if the initial plan year is a short year and the plan defines the limitation year as the plan year. Are you saying this is incorrect? You would ignore the plan's definition of the limitation year and instead use 12 months for the first limitation year; and not pro rate?

[Guest]

can I cop out? I hate to go against any research done by Sal (ERISA Outline Book), because I thought he knew everything. (just kidding)

dang you, force me to look up things in the regs just to verify the stuff!

1.415-2(B)(5)Limitation year for years prior to the effective date.

(Cool, this is exactly what we are talking about!)

The limitation year for all years prior to the effective date of section 415 is the consecutive 12-month period which corresponds to the first limiation year of the plan after the effective date of section 415.

(see (B)(1) of this section for rules determination of plan's limitation year)

(B)(1) says limitation year is the calendar year unless you choose an option under (ii)

(ii) says instead of calendar year you use any other consecutive 12 month period.

then (4) gets into the effect of changing plan year and prorating the limit.

from this I conclude that I don't know what to think if the document defines limitation year to be plan year (The ERISA Outline book goes on to say to avoid doing this). As you point out, the book then goes on to say you pro rate. However, the regs still say in the initial year you still use the 12 month period which implies you shouldn't prorate. So, it sounds like the document is conflict with the regs??? do you follow the docuent or the regs. or are you stuck between a rock and a hard place in this case? or do the regs imply that despite the fact your document says limitation year = plan year (and plan year is only 6 months, you still use 12 months in that first year)

There, did I confuse myself enough?

[KJohnson]

Cheryl Morgan also has a good discussion of short year issues in the Summer 2000 issue of the Journal of Pension Benefits (p. 94). She also concludes that you prorate if you define the limitation year as the plan year but would not have to prorate if you define the limitation year as the caledar year ending on or within the plan year.

[Guest rhp]

Tom, doesn't the reference to "limitation years before the effective date of section 415" mean pre ERISA years?? I don't think that really applies to the question. I agree with the last comment that it depends on how the limitation year is defined.

[Guest]

you are correct, I was sort of using that as a refernce point for using 12 months, but didn't make that clear. even if you disregard that one, you are still left with (B)(i) or (ii) which says:

(i) a calendar year (which is 12 months)

or (ii) other 12 month period.

and the only time you prorate is if you Change plan year.

I realize document probably even has a determination letter, but its always possible to miss something. or it is entirely possible that when a document says limiation year = plan year it is in anticipation of the possibility the plan year may switch down the road, but that the first year it is implied in the regs that you use 12 months.

and the Q & A at ASPA conferences is still only a Q & A and might carry no weight anywhere else.

[rcline46]

Of course the document rules (providing there is a LOD or Notification letter.) However, in all of the documents I have read doing takeovers, not one used the option to do a short year for an initial year. Even when adoption agreements gave the option for a short year, the underlying document is very clear that the first year is NOT a short year.

[PMC]

For a new start-up plan - is the effective date of the plan basically irrelevant, for this discussion, if the plan defines the plan year as the calendar year and the limitation year as the calendar year/plan year? There would be no pro-rating for 415. And there would be no pro-rating of the 417 comp. limit since everyone obviously becomes a participant during the first year?

[rcline46]

Actually, why would the effective date for a plan be anything other than the first day of the plan year? As long as it is SIGNED before the year end, it is legal and avoids all of this discussion.

Even for 401(k)s, the effective date can be the first day, just that deferrals cannot begin before the plan is signed.

For you question, the answer is no proration. Just watch definition of compensation. If 'while a participant' and you make the effective date other than first of year, you could be forced to use less pay than desired.

[PMC]

Thanks. I guess the only reason I could think of for not making a 401(k)plan effective the first day of the plan year would be to avoid having to include employees who may have terminated before the "effective date" and have already met any requirements to share in any profit sharing allocation. But then again, if that's an issue for the employer can always draft the plan to avoid that.

[Guest lforesz]

Hi,

I agree with the 415 limit not needing to be prorated in the first plan year but I'm still unclear about he 401(a)(17) compensation proration. If the plan is a 401(k) plan only effective 10/1/01, then for ADP testing, do I have to limit compensation to $42,500 (.25 * $170,000)? HELP!

[Richard Anderson]

Yes, must be pro-rated.

1.401(a)(17)-1(B)(3)(iii)

[Guest D Ledden]

When the short plan year is the look back year for testing, is the HCE comp limit also prorated to $21,250? ($85,000 * 0.25)

[Tom Poje]

no.

lookback year is always 12 months