Pension Trends   Volume I, No. 2, May 2000

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Section 415(e) Repeal Effective

Recent law changes have created new opportunities for small business owners.  Effective for plan years beginning in 2000, the limits that apply to benefits in a defined benefit plan and contributions in a defined contribution plan no longer affect one another.  This allows the older small business owner who has had a SEP, 401(k) plan or other defined contribution plan to enjoy the best of both worlds:  the defined contribution plan that suited the young owner and the defined benefit plan that is more fitting for that same owner as he or she gets closer to retirement age.

Contributions to a defined benefit plan are not subject to a percentage of current pay restriction.  A defined contribution plan may still be maintained at the same time, as long as the total contribution to all plans does not exceed 25% of pay.  The defined benefit plan contribution by itself may exceed 25% of pay, but then nothing may be contributed to a defined contribution plan.

The Internal Revenue Code imposes a limit on contributions to a defined contribution plan and a limit on benefits payable from a defined benefit plan.  Section 415(c) limits the annual additions to all defined contribution plans of a plan sponsor to the lesser of $30,000 or 25% of compensation.

Section 415(b) limits the benefit that a defined benefit plan can provide to a life annuity equivalent to the lesser of $135,000 per year, payable at the age at which full social security benefits are payable, or the average of compensation over the high three consecutive years.  These limits are also subject to plan participation and service phase-ins over 10 years.  Benefits can be converted to equivalent lump sums.

Deductible contributions to a defined benefit plan can be significantly greater than the lesser of $30,000 or 25% of compensation, many times greater than $100,000.  Section 415(e) of the code required that contribution limits applied to defined contribution plans and benefit limits applied to defined benefit plans be coordinated.  In other words, you could not participate fully in plans of the same employer that approached both limits.  The Small Business Job Protection Act repealed this section in 1996.  However, the repeal did not go into effect until 2000.  Now, after a 4 year wait, the time has come!

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New Comparability Plans Challenged

In Notice 2000-14, the IRS announced it is re-examining its regulations on "new comparability" plans (also called "cross tested" plans) with an eye toward placing additional restrictions on these plans.  This move is being strenuously resisted by several industry organizations, such as the American Society of Pension Actuaries.  As a result of these efforts, the IRS has informally agreed not to apply any changes in regulations to plan years beginning before 2002 for certain plans.  Those plans eligible for delayed compliance with the new rules are those plans that already contain "new comparability" features on February 24, 2000.  In addition, those plans that are adopted or amended to include these features after February 24, 2000 without having had any other previous plan other than a 401(k) plan, with or without a match, are also eligible for delayed compliance.

IRS regulations effective in 1994 laid out complex rules to be used to make a mathematical determination as to whether a plan satisfied the requirements of Section 401(a)(4) of the Code.  That section says simply that a qualified retirement plan cannot discriminate in favor of Highly Compensated Employees.

Since 1994, pension practitioners have created plan designs that used these regulations to meet certain objectives.  One popular design was the "new comparability" plan.  A "new comparability" plan is a defined contribution plan that divides the eligible employees into groups.  The contribution constitutes a much higher percentage of pay for the "favored" group(s) than the other group(s).  The plan is shown to be "non-discriminatory" by converting the contributions to equivalent retirement benefits that do not discriminate in favor of the Highly Compensated Employees.  This works when most of the Highly Compensated Employees are older than most of the other employees.

We do not believe that this type of plan will be eliminated.  However, it is likely that the rules will change after much discussion and debate.  We think it will be some time before the final result is known.

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