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Section 415 ACOPA Advanced Actuarial Conference June 2009. Tom Finnegan The Savitz Organization Philadelphia / Atlanta / Boston. Section 415. Application of 401(a)(17) limit 417(e) Benefits– PPA WRERA Multiple Annuity Starting Dates Basic Calculation Partial QJSA Distributions

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Section 415 ACOPA Advanced Actuarial ConferenceJune 2009

Tom Finnegan

The Savitz Organization

Philadelphia / Atlanta / Boston


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Section 415

  • Application of 401(a)(17) limit

  • 417(e) Benefits– PPA

    • WRERA

  • Multiple Annuity Starting Dates

  • Basic Calculation

  • Partial QJSA Distributions

  • $10,000 De minimis Benefit

  • Transfer/ Aggregation of benefits


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Section 415

  • Timing of COLA adjustments

  • Monthly vs Annual

  • Restorative Payments

  • Yrs of Participation

  • Post-Severance Compensation Issues

  • Average Compensation



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§ 401(a)(17) Application

  • Current Law

    • The compensation limit under Section 401(a)(17) of the Code applies for purposes of nondiscrimination and benefit determination

    • It does not apply for purposes of determining the 100% of pay 415 limit

    • The 100% of pay limit applies at any age to any form, it is NOT increased for delayed commencement


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§ 401(a)(17) Application

  • Final Regulation

    • The compensation limit under Section 401(a)(17) of the Code would apply for purposes of determining the 100% of pay 415 limit


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§ 401(a)(17) Application

  • Impact on small business

    • Income is generally more volatile in small businesses than in large

    • This especially true when you compare the income of the owner of a small business with the income of a corporate executive

    • The application of 401(a)(17) in benefit determination and testing is the cost of this volatility


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§ 401(a)(17) Application

  • Impact on small business

    • (Assume a $200,000 pay limit)

  • Consider a corporate executive earning $200,000 and a business owner whose high three year income is $100,000; $350,000 and $150,000

    • Under current law, for discrimination testing, the owner must use a compensation of $150,000; while the executive will be considered to have a $200,000 average pay

    • To provide the same benefit to the owner/exec, the small business must provide a greater benefit to staff


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    § 401(a)(17) Application

    • Impact on small business

      • Under the proposed regulation, the small business owner must pay twice for his/her income volatility

        • First the benefit must be on the lower average

        • Now the maximum benefit could not exceed the lower $150,000 average pay


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    § 401(a)(17) Application

    • Impact on older employees

      • The primary impact of the application of the 401(a)(17) limit for 415 purposes will be the elimination of most of the adjustment to 415 for deferral of benefit commencement past age 65

      • Under current law the 415(b) limitation is adjusted if benefit commencement is beyond age 65

        • The adjustment is made using the lesser of the plan’s interest rate or 5%

        • Because the 415 and 401(a)(17) limits are so close, the elimination of the deferred commencement adjustment occurs at age 68


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    § 401(a)(17) Application-2009(** 233,333 is the average of 225,000; 230,000 and 245,000)


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    § 401(a)(17) Application

    • Effective Date

      • Limitation years beginning on or after 7/01/07

      • Accrued benefits as of last day of limitation year prior to effective date, based on the plan as of 4/5/07, are grandfathered

      • Calendar year plan grandfathers 12/31/07 accrued benefit based on plan as of 4/5/07

        • Can continue to accrue til 12/31 under current law

      • What about actuarial increases to existing accrued benefits?

        • Are covered by grandfather


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    § 401(a)(17) Application

    • Effective Date – Example

      • Bob, 69, has AB of 244,013 as of 12/31/07

      • Bob’s average pay is 400,000

      • 401(a)(17) average pay is 218,333

      • 244,013 is grandfathered

      • At age 70, act. equiv. benefit is 264,109

      • Is the actuarial increase grandfathered?

        • 411 would say its part of the accrued benefit

        • Broad implications if answer is yes


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    § 401(a)(17) Application

    • Effective Date – Example 2

      • Bill, 69, has AB of 210,000 as of 12/31/07

      • 401(a)(17) average pay is 218,333

      • AB is less than both old and new 415

        • No grandfather?

      • At age 70, act. equiv. benefit is 254,029

      • Is the actuarial increase grandfathered?

        • If yes, anyone near the 415 limit may have a grandfathered benefit to track


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    401(a)(17)/ Suspension of Bfts

    • Beginning at age 68, participants at the 415 limit will have their benefits catch the 401(a)(17) limit

      • Cannot actuarially increase benefits

      • Must give Suspension of benefits notice or commence distributions

      • At age 70.5, can no longer suspend benefits

        • Must commence distributions

        • Even if participant is not a 5% owner



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    PPA Changes to 417(e) Max

    • Prior to PFEA (2004)

      • to calculate the max benefit payable in a form subject to Section 417(e) [ lump sums, installments etc]

        • Calculate the maximum single life annuity payable at the ASD

        • Convert maximum SLA to the 417(e) form using the lesser result of

          • Plan interest and mortality and

          • Applicable (GATT) interest and mortality


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    PPA Changes to 417(e) Max

    • PFEA Changes 2004,2005 (Temporary)

      • Calculate the maximum single life annuity payable at the ASD in exactly the same manner as before

      • Convert maximum SLA to the 417(e) form using the lesser result of

        • Plan interest and mortality and

        • 5.5% interest and applicable mortality


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    PPA Changes to 417(e) Max

    • PFEA Expiration 1/1/2006

      • Reverts back to pre PFEA rules

        • Determine max SLA payable at ASD

        • Convert max to 417(e) form using lesser result

          • Plan interest and mortality

          • Applicable (GATT) interest and mortality


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    PPA Changes to 417(e) Max

    • PPA Changes

      • Retroactively effective to 1/1/2006

        • Determine max SLA payable at ASD

          • Same as always (well... post SBJPA)

        • 417(e) maximum is the least of

          • 417e benefit with Plan interest and mortality

          • 417e benefit with 5.5% interest and applicable mortality

          • 105% of the 417e benefit with applicable (GATT) interest and mortality


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    PPA Changes to 417(e) Max

    • PPA Changes

      • SO WHAT’S THE PROBLEM?

        • The problem is that GATT interest rates early in 2006 were below 5.5%

        • At the lapse of PFEA it became the law that the maximum benefit was calculated on the lesser result of plan or GATT rates

        • Thus, perfectly legal lump sums were paid early in 2006 that, apparently, are retroactively illegal



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    Basic Calculation – Pre 62

    • Calculation is essentially unchanged

      • Simplified method is provided for “plan rates” for non 417(e) benefits by taking the ratio of the benefit payable at 62 to the benefit payable at determination date

      • Examples raised a few eyebrows, but appear to generate the same (perhaps unexpected) results as current law


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    Basic Calculation – Pre 62

    • Calculation is essentially unchanged

      • The limit at any age prior to 62 is the lesser of the age 62 limit reduced with the applicable mortality table and 5% interest or the age 62 limit reduced with plan rates

        • No mortality adjustment necessary if QPSA or greater death benefit


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    Basic Calculation – Pre 62

    • Example

      • 415(b) limit = 185,000

      • NRA = 65

      • Normal Form = Single life annuity

      • ERA = 60

      • Early retirement reduction = 4% per year

      • Death benefit = QPSA

      • Participant M (age 60 with 30 years service) has an accrued benefit of $100,000

    • WHAT IS M’s 415 LIMIT AT AGE 60?


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    Basic Calculation – Pre 62

    • Example

      • M’s Benefit at 62 = $88,000

        • 100,000 x (1-(3 x 4%))

      • M’s Benefit at 60 = $80,000

        • 100,000 x (1-(5 x 4%))

    • Plan rate reduced 415 limit = 168,182

      • 185,000 x (80,000 / 88,000)


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    Basic Calculation – Pre 62

    • Example

      • Single Life Annuity Rates (5% Applic. Mortality)

        • Age 60 = 13.2508

        • Age 62 = 12.6798

      • Statutory rate reduced 415 limit = $160,569

        • (185,000 / (1.05^2)) x (12.6798 / 13.2508)


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    Basic Calculation – Pre 62

    • Example

      • Age 60 415 limit is the lesser of

        • Plan rate reduced 415 limit = 168,182

        • Statutory rate reduced 415 limit = 160,569

        • $160,569


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    415 Lump Sum

    • The maximum lump sum payable is the least of

      • Maximum life annuity valued using plan rates

      • Maximum life annuity valued using applicable mortality table and 5.5% interest

      • 105% of the value of the maximum life annuity valued with 417(e) rates


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    415 Lump Sum

    • Example

      • Plan Act Equiv 83 IAM(f) 5.75%

      • Segment rates

        • First Segment 5.25%

        • Second Segment 5.75%

        • Third Segment 6.50%

        • Assume GATT mortality


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    415 Lump Sum

    • Example

    • Plan Act Equiv

      • 83 IAM(f) 5.75% APR = 13.1323

  • Applicable Mortality 5.5% APR = 12.6409

  • 1st Segment (5.25%)

    • N60=566762; N65=376279; D60=43800

  • 2nd Segment (5.75%)

    • N65=265413; N80=47521; D60=32960

  • Third Segment (6.50%)

    • N80=26052; D60=21569


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    415 Lump Sum

    • Example

    • Value of maximum benefit

      • Plan rates

        • 160569 x 13.1323= 2,108,640

      • GATT mort and 5.5%

        • 160569 x 12.6409= 2,029,737


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    415 Lump Sum

    • Example

    • Value of maximum benefit

      • First segment piece

        • 160569 x (N60-N65) / D60 =

        • 160569 x (566762 – 376279) / 43800 =

        • 698307

      • Second segment piece

        • 160569 x (N65-N80) / D60 =

        • 160569 x (265413-47521) / 32960 =

        • 1,061,490


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    415 Lump Sum

    • Example

    • Value of maximum benefit

      • Third segment piece

        • 160569 x N80 / D60 =

        • 160569 x 26052 / 21569 =

        • 193942


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    415 Lump Sum

    • Example

    • Value of maximum benefit

      • 417(e) max benefit value

        • 698,307 + 1,061,490 + 193942 = 1,953,739

      • 105% of 417(e) value

        • 1,953,739 x 1.05 = 2,051,426


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    415 Lump Sum

    • Example

    • Max lump sum

      • Least of

        • Plan rates 2,108,640

        • Applic Mortality 5.5% 2,029,737

        • 105% of 417(e) result 2,051,426


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    WRERA Changes

    • Confirms use of 417(e) mortality table effective 2009, optional 2006-2008

    • Provides that plans with under 100 lives need not use the 105% of 417(e) rates calculation to determine maximum lump sum (eff. 2009)

    • Meant to allow a small employer to set actuarial equivalence at 5.5% or higher and not worry about fluctuations in 417(e) rates changing the max lump sum

      • It may have worked


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    Plan Rates

    • What the heck are plan rates?

    • WE thought we knew

    • Plan provides a lump sum equal to the greater of the result using 5% or the result using PBGC/GATT/PPA rates has a 5% plan rate, correct?

    • Recently the IRS has been saying it depends

      • If PPA rates would yield the greater result for THIS distribution, PPA rates are the plan rate for this distribution


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    Plan Rates

    • Interesting…no reg change to account for this

    • Apparently PBGC rates were plan rates for all those years…we just didn’t know it…EPCRS here we come


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    Plan Rates-

    • Assuming new interpretation

    • If plan uses 5.5% as actuarial equiv, max lump sum is stable

      • When PPA rates yield greater lump sum than 5.5%; statutory 5.5% controls the max lump sum

      • When plan rate controls the LS, the plan rate and statutory 5.5% yield the same LS

    • If plan uses 6% as act equiv max LS will fluctuate based on PPA rates



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    Multiple Annuity Starting Dates

    • Applies when there are two separate distributions which count against the 415 limit

      • Prior plans

      • Change in distribution pattern for 401(a)(9)

      • 415 COLA adjustments to benefits in pay status

      • Rehires

      • Lump sums to retirees at plan termination

      • Many others


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    Multiple Annuity Starting Dates

    • PROPOSED REGULATION

      • The remaining 415 limit is equal to the total 415 limit at the second (or later) Annuity Starting Date

        • reduced by

      • the actuarial equivalent of the prior payments and the remains of the existing stream of payments

      • Most controversial item in the proposed regulation

        • Did not work where the 415 limit plateaus

          • Dollar limit from 62 to 65

          • 100% of pay limit

            • Especially now with 401(a)(17) application


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    Multiple Annuity Starting Dates

    • 100% of pay limit

      • 5% owner has 415 pay of 50,000

      • Takes MRD at age 71 of 50,000

      • Takes second MRD of 50,000 at 72

      • Wants lump sum at age 73

      • Can he take a lump sum equal to the actuarial equivalent of 50,000 per year ???


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    Multiple Annuity Starting Dates

    • 100% of pay limit

      • NOT UNDER PROPOSED REGS

      • Because he has separate elections at 71,72 and 73, the limit at 73 must be reduced by the actuarial equivalent of the prior distributions

        • The lump sum at 73 equals the lump sum value of a life annuity of 50,000 per year minus the life annuity that could have been provided by the two prior distributions


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    Multiple Annuity Starting Dates

    • Age 62 to 65 dollar limit

      • Assume $180,000 limit

      • Assume no dollar limit COLAs

        • Participant age 62 commences 180,000 life annuity

        • Plan terminates at age 65 and offers lump sum

        • CAN HE HAVE IT ???


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    Multiple Annuity Starting Dates

    • Age 62 to 65 dollar limit

      • NOT UNDER PROPOSED REGS

        • By same reasoning the 180,000 limit must be reduced by the actuarial equivalent of the three distributions he already received

        • The maximum lump sum will be less than the actuarial equivalent of a life annuity at 65 of 180,000

        • This is less than his accrued benefit and would violate 411(a) to have an optional form of less than the accrued


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    Multiple Annuity Starting Dates

    • Final Regulations reserve guidance on MASDs

    • Preamble and regs say…

      • The limitations of 415 must be satisfied as of each of the ASDs,

        • taking into account benefits that have been or will be provided at all of the ASDs…

        • The plan is required to actuarially adjust past and future distributions with respect to the benefit that commenced at the other annuity starting dates


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    Multiple Annuity Starting Dates

    • Is this a new standard or rule for handling MASDs???

      • Apparently not, IRS has made statements that a reasonable interpretation must be made and that you cannot ignore payments as of other annuity starting dates.


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    Multiple Annuity Starting Dates

    • Example:

      • 415 limit is 180,000

      • Bob commences a life annuity of 50,000 at 62

      • At age 65, after an amendment and additional accruals, Bob attempts to commence a benefit of 180,000, plus the 390,000 he didn’t get at 62, 63 and 64 spread over his remaining life expectancy

      • UNREASONABLE AND FAILS 415 AT 2nd ASD



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    Basic Calculation – Pre 62

    • Example 2

      • Same as Example 1 except plan provides unreduced benefit if

        • 30 years service and

        • Defer commencement to age 62

      • If commence prior to age 62, ERFs apply all the way from age 65 (4% per year)

      • What is M’s 415 limit at age 60?


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    Basic Calculation – Pre 62

    • Example 2

      • M’s Benefit at 62 = $100,000

      • M’s Benefit at 60 = $80,000

        • 100,000 x (1-(5 x 4%))

          • Note 5 year reduction, because plan reduction factors apply to the age 65 benefit not the subsidized age 62 benefit

    • Plan rate reduced 415 limit = 148,000

      • 185,000 x (80,000 / 100,000)


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    Basic Calculation – Pre 62

    • Example 2

      • Age 60 415 limit is the lesser of

        • Plan rate reduced 415 limit = 148,000

        • Statutory rate reduced 415 limit = 160,569

        • $148,000


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    Basic Calculation – Pre 62

    • Odd Result

      • It seems that the addition of an unreduced age 62 benefit decreases M’s 415 limit at age 60

        • Under the change described between Examples 1 and 2, the benefit increases at age 62 but not at age 60, thus the plan’s reduction from age 62 to age 60 becomes much steeper

        • It is as if the plan added a second set of ERFs for those with 30 years service as follows

          • 62-65 No reduction

          • 61 16% reduction

          • Thereafter 4% per year


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    Basic Calculation – Pre 62

    • Odd Result

      • Thus, the plan’s tabular factor for 30 year employees for reductions for age 62 to age 60 is 20%, which corresponds to a 20% 415 reduction from $185,000 to $148,000

      • Same result as under current law

      • Interestingly, for a participant with 29 years service, completion of another year would result in a reduced 415 limit

      • ASPPA, ABC and ERIC had all commented to the IRS on the unfair result and asked for a rule that would prevent the reduction in 415 as a result of completion of additional service or aging


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    Basic Calculation – Pre 62

    • Odd Result

      • Final regs provide that the 415 limit cannot be reduced because of the attainment of an additional year of age or the completion of additional year of service



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    Partial QJSAs

    • Benefits payable in a form other than a straight life annuity are subject to a reduction in the §415 limit to the actuarial equivalent of a life annuity

      • Exception provided for benefits payable in the form of a Qualified Joint and Survivor Annuity (QJSA)

      • Under current rules, in order to qualify for this exception, the entire benefit had to be provided as a QJSA


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    Partial QJSAs

    • Proposed regulations relax the rules for benefits payable partially as a QJSA and partially in another form

      • The portion of the benefit payable as a QJSA will be treated being paid as a single life annuity for 415 purposes

      • The spousal death benefit will not be counted against the limit


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    Partial QJSAs

    • Example

      • Assume $180,000 §415(b) limit

      • Assume conversion to QJSA from life annuity is 90%

      • Participant, age 62, has an accrued benefit of $175,000

      • Wishes to take a $75,000 J&S benefit and remainder as a lump sum


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    Partial QJSAs

    • Example

      • Under prior guidance $75,000 J&S is equivalent to a $83,333 life annuity

        • $75,000 / .9

        • Max lump sum is actuarial equivalent of a $96,666 life annuity

      • Under Prop. Reg., $75,000 J&S is equivalent to a $75,000 life benefit

        • Lump sum is the equivalent of a $100,000 life benefit



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    $10,000 De Minimis Benefit

    • $10,000 may be paid in any form

      • Phase in for 10 years service

      • Never participated in any DC plan maintained by employer

    • Normal form must be least valuable form under the plan

      • Or plan must limit the normal form such that the least valuable form does not violate the $10,000 limit


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    $10,000 De Minimis Benefit

    • Assume a $10,000 10 C&L benefit and an $11,000 life only benefit are actuarially equivalent

      • Plan can provide a $10,000 benefit with 10C&L as the normal form

        • Plan cannot permit an optional form of life only

          • Paying $11,000 would violate 415

          • Paying $10,000 as a life annuity would be an impermissible forfeiture under Section 411


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    $10,000 De Minimis Benefit

    • Plan could limit normal form benefit

      • If max 10 C&L under the plan was $9090.90, the equivalent life only benefit would be $10,000 satisfying Section 415

  • Clarifies long held IRS position that the $10,000 deminimis benefit cannot be paid as a lump sum

    • Lump sum would be limited to the greater of $10,000 or the lump sum value of the 100% of pay limit

    • If that result is less than the PVAB of the deminimis annuity, it is an impermissible forfeiture



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    Transfer of Benefits

    • Different methodologies for rollovers and transfers

    • Rollovers

      • Rollover amount disregarded in determining annual benefit payable from recipient plan

      • If rollover converted to annual benefit, only portion that is actuarial equivalent is disregarded

      • Actuarial equivalence determined using 411(c) factors


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    Transfer of Benefits

    • Rollovers

      • Excess annual benefit included in recipient plan’s annual benefit for §415(b)

        • Treated as employee contribution

      • Application of 411(c) factors

        • Employee contributions accumulated to determination date using 120% of mid-term AFR

        • Projected to NRA using §417(e) assumptions


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    Transfer of Benefits

    • Benefits Transferred Among Plans

      • Between plans sponsored by same employer, only transferee plan includes benefit in §415 annual benefit

        • Avoids double counting of benefits

        • Apparent change from current regulations, which exclude benefit from transferee plan

        • Still include benefit in only one plan


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    Transfer of Benefits

    • Benefits Transferred Among Plans

      • Plans not aggregated for §415 purposes

        • Transfer treated as single sum distribution from transferor plan

        • Transfer included in annual benefit tested from transferee plan

      • Transferred benefit included in annual benefit under both plans


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    Transfer of Benefits

    • Benefits Transferred Among Plans

      • Treating benefit transferred as single sum distribution

        • Applies employer sponsoring transferor plan is predecessor employer

        • Broad definition of predecessor employer


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    Aggregation of Benefits

    • All DBs ever maintained by members of the controlled group, ASG, or other related employer are treated as one plan

    • Same with DCs

    • Parent/sub controlled group rules replace “at least 80%” with “more than 50%”

    • Predecessor employer, using a broad facts and circumstances definition, is aggregated

      • If new employer maintains plan see earlier slide

      • If not maintained, see “former Affiliate” below

    • Former affiliated employer is aggregated, but the plan is deemed for 415 to have terminated on the day the affiliation ceased



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    Timing of COLAs

    • Surprising change of interpretation

      • 415 COLAs are announced for limitation years ending within calendar years

        • Example A plan with a limitation year of May 1, 2007 to April 30, 2008 is subject to the 2008 415 limit

      • Proposed reg provides that the COLA increase cannot be applied until January 1


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    Timing of COLAs

    • Surprising change of interpretation

      • Assume the 2008 415( b) limit rises from 180,000 to 190,000

        • Participant takes a lump sum benefit on Dec 15 2007

        • Even though distribution is in the 2008 LY, it is not allowed to take into account the 2008 COLA

        • Plan must specifically allow 415 COLAs to retirees to permit addl distrib after 1/2008

        • Cannot give COLA to someone completely paid out who could not accrue more without the COLA



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    Monthly vs Annual

    • Final regs treat the 415(b) limit as an annual benefit payable monthly, in essence

    • Thus, you cannot take advantage of the fact that the present value of an annual benefit payable as of the first day of the year is greater than the present value of a monthly benefit commencing on the same date


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    Social Security Supplements

    • Social Security supplements are treated as retirement benefits rather than ancillary benefits for purposes of 415.

    • This treatment extends to QSUPPs

    • Thus a form adjustment is required for this type of benefit


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    Restorative Payments

    • In general, restorative payments are not treated as annual additions under DC plans if they correct a fiduciary violation

    • Final regs extend this treatment to situations where there is a reasonable risk of liability for a fiduciary violation

      • Allows for quicker restoration of benefits


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    Years of Participation

    • Credited with the number of hours required to accrue a benefit

    • Eligible for at least 1 day during the year

    • If hours provide pro-rata accrual, YOP is prorated

    • What about frozen plan?

      • Is YOP based on hours requirement before freeze?

      • Is YOP not granted?

      • What if plan is subsequently unfrozen with retro credit?



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    Compensation Issues

    • Severance and other post-employment pay

      • Four types to consider

        • Regular pay- final paycheck, bonuses etc

          • Must be included in 415 pay (if paid timely) although can often be excluded under a 414(s)/401(a)(4) sage harbor

        • Leave pay- sick, vacation etc..

          • includible only if the amounts would have been paid had employment continued

          • Plan must specify if pay is to be included


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    Compensation Issues

    • Severance and other post-employment pay

      • Four types to consider

        • NQ Plan Pay- Deferred comp payments

          • Includible only if benefit would have been paid absent termination of employment

          • Plan must specify if it is includible

        • Severance Pay- and other pay as a result of termination

          • Not includible regardless of timing of payments


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    Compensation Issues

    • Severance and other post-employment pay

      • Generally only amounts paid within 2.5 months of termination or, if later, the last day of the limitation year including the severance date, are includible and only if the amounts would have been paid had employment continued


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    Compensation Issues

    • Timing of Amendments and 411(d)(6)

      • ABC Company 401k plan allows for deferrals from all W-2

      • Calendar year plan, 2008 PY & LY

      • Plan wants to stop deferrals for all post employment pay

        • Can do so and still have a 414s definition

        • Bob terminates 1/18/08

        • On 1/31, Bob’s paycheck includes

          • Regular pay for 1/16-1/18

          • Accrued vacation time

          • Severance pay


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    Compensation Issues

    • Timing of Amendments and 411(d)(6)

      • When must ABC amend plan to stop Bob’s deferral?

        • General amendment deadline?

        • 12/31/08?

        • Before Bob terminates employment

      • What if ABC only wanted to stop the deferral from severance pay?

        • Does this affect the amendment deadline?


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    Average Compensation

    • Allows bridging of service for high 3 consecutive determination

    • If a participant leaves and is later rehired, the year of termination and rehire are deemed consecutive


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