Future Cost-of-Living Increases Included in 415(b) Calculation (Posted on January 4, 2005 by )

Private Letter Ruling 200452039 discussed the situation of a plan that provided a 3% cost-of-living adjustment to the benefits of each retired participant each year, beginning on the January 1 following the third anniversary of the participant’s retirement date. The private letter ruling held, in effect, that a participant whose annual benefit beginning in 2005 was equal to the dollar limit for 2005 ($170,000 per year), but whose benefit was subject to a cost of living increase starting in January 2009, would be in violation of the limit.

Section 415(b) of the Internal Revenue Code of 1986, as amended (“Code”) provides that a participant’s benefit in the form of a straight life annuity must not exceed a dollar limit ($170,000 for 2005). If the benefit is in any form other than a straight life annuity or qualified joint and survivor annuity, the benefit must be adjusted to the actuarially equivalent straight life annuity in order to determine whether it is in excess of the dollar limit.

The dollar limit is subject to annual cost-of-living adjustments. Treas. Reg. § 1.415-5(c)(1) allows for benefits which have been reduced as a result of the application of section 415(b) to be later increased as the 415(b) limit increases.

In the letter ruling, the plan had requested a ruling that the first year’s benefit could be measured against the dollar limit applicable to that year, and that the benefit for each subsequent year could be measured against the dollar limit (as adjusted) for each subsequent year. Instead, the IRS required that the benefit (including the present value of the future cost-of-living adjustments) be converted to an equivalent single life annuity. Thus, an annual benefit of $170,000 beginning in 2005 would have to be reduced below $170,000 for 2005 in order to meet the 415(b) limit to take account of the present value of the future cost-of-living increases. This is true even though by 2009, when those increases would take effect, the $170,000 limit might well have been increased to the point that the benefit payable in 2009 would be below the dollar limit for 2009.

You can click here to see the ruling.