On April 5, 2007, the IRS proposed new regulations under section 415 of the Internal Revenue Code (IRC), as amended. Section 415 limits the benefits that may be paid by defined benefit plans and contributions that may be made to defined contribution plans. While some of the provisions may be a restatement of the current rules or a codification of guidance issued over the years since the current regulations were adopted, other provisions may represent new interpretations that need to be studied carefully.
It is essential for each governmental plan to have the regulations reviewed by those who are responsible for the plan’s compliance with section 415 to determine whether the regulations pose issues for the plan and what action should be taken to deal with any such issues.
The regulations apply, subject to certain transition rules, to limitation years beginning on or after July 1, 2007.
Among the possible areas that governmental plans might consider are the following:
- Cost of Living Adjustments
Many public sector defined benefit plans provide one or another type of mechanism for protecting retirees from the effects of inflation. The IRS raised concern within the public pension community when it issued Private Letter Ruling 200452039 (September 30, 2004) that stated that the plan involved had to convert a retiring participant’s future COLA entitlements into a single life straight line annuity when testing a retiring participant’s benefits under the section 415(b) defined benefit limitation. The regulations make no express mention of this position so it is unclear whether that position has been adopted in the proposals. If it has not been adopted, it may mean the IRS intends that COLA increases under the plan rules in effect at the time of retirement are to be tested under the new complicated multiple annuity starting date rules for defined benefit plans included in the proposals, when the COLA increases are received. The new multiple annuity starting date rules are discussed immediately below.
- Multiple Annuity Starting Date Rules
These rules require the benefit of a retired participant in a defined benefit plan to be retested under the complex new multiple annuity starting dates rules when the retiree’s benefit is increased, for example, because of an additional accrual obtained as a result of a return to service, a post-retirement change in the retiree’s option selection, the commencement of benefits from a second defined benefit plan required to be aggregated with the plan for section 415(b) purposes, and possibly COLA increases. The complex rules, among other things, require the plan to include in the benefit to be tested, a straight line annuity representing the actuarial value of benefits previously received by the retiree. The regulations do provide a safe harbor for cost of living increases provided solely to retirees whose benefits had previously been limited by the application of the defined benefit limit where such increases occur when the section 415(b) limits are increased, but that safe harbor does not appear to apply to other kinds of COLA increases.
- Converting Benefits to Single Life Straight Line Annuities for Section 415(b) Testing Purposes
The regulations provide in the case of public sector plans (which are not subject to IRC section 417(e)(3)) that, when a retirees benefit is paid in a form other than a single life straight line annuity, the annuity benefit to be tested is the lesser of the straight line annuity, if any, that is payable at the same age under the plan (not the single life equivalent using the plan’s actuarial assumptions) or the straight line actuarial equivalent determined using a 5% interest rate and the IRS mortality assumptions.
- Treatment of Transferred Benefits
The regulations distinguish between situations in which benefits are transferred among defined benefit plans that are required to be treated as one plan for section 415(b) testing purposes (e.g., in the case of transfers among defined benefit plans considered to be maintained by the “same employer”) and those in which benefits are transferred among defined benefit plans that are not required to be “aggregated,” that is, treated as one plan. Where benefits are transferred between plans that are not required to be aggregated, the transfers are treated like rollover contributions discussed immediately below. Because such rollovers would be considered distributions by the transferor plan, presumably they would have to be tested by the transferor plan under the section 415(b) limits at the time of distribution.
- Rollover Contributions
The regulations provide that benefits attributable to rollover contributions to a defined benefit plan, e.g., from an IRA to a defined benefit plan, are to be disregarded when testing the benefits provided by the recipient defined benefit plan under section 415(b).
However, the exact amount of benefits to be disregarded is to be determined under some complicated rules. The interest and mortality assumptions of IRC section 411 are to be used in calculating the benefits attributable to the rollover contributions (even though governmental plans are not otherwise subject to section 411). If the rollover contributions generate a benefit under the plan that is greater than the benefits determined attributable to the rollovers under the regulations, the excess is still to be included in the benefit to be tested under section 415(b).
Presumably this interpretation is subject to section 415(n)(1)(A) that allows governmental plans to test an entire benefit under the defined benefit limits even where a portion of the benefit is derived from employee contributions used to purchase permissive service credit.
- Inclusion of Social Security Supplements in Annual Benefit
All Social Security supplements are to be included when determining the retiree’s annual benefit to be tested under the section 415 defined benefit limitations.
- Dollar Limitations for Early Benefits to Employees of Police and Fire Departments
Under the regulations, no downward adjustment to the section 415(b) defined benefit dollar limit would be required for early commencement of benefits to employees of police and fire departments, even if they are not considered police or firefighters by the employer. Only the classification of the employer, not the job classification of the employees, would be relevant.
- Accrual of Benefits in Excess of the Section 415(b) Limits
The regulations prohibit not only the payment of a benefit in excess of the section 415(b) limits but also the accrual of any benefit in excess of those limits.
- Inclusion of Compensation Following Severance of Employment in Calculating IRC Section 415(c) Compensation Limits and Compensation Eligible for Deferral Under IRC Sections 401(k), 403(b), and 457(b)
Amounts received following severance from employment are not to be considered compensation for the purposes of the section 415(c) defined contribution plan compensation limitation and are not permitted to be deferred pursuant to sections 410(k), 403(b), or 457(b), except certain payments made within 2Ã‚Â½ months following severance. The excepted payments are payments that would have been payable if employment had not been terminated (such as regular compensation and overtime, commission, and bonus payments) and payments in respect of leave that would have been available for use if employment had not been terminated.