Dealing with Pension Contribution Limitations[1]
Outline of Contribution Limitations
by
Paul A. Green
Mooney, Green, Baker & Saindon, P.C.
1. Types of Limitations
a. Defined Contribution Plans[2]
i. Employer Contributions
(1) Maximum Benefit Limitations – Section 415
(a) Effect of maximum benefit limitations
(i) Deductibility of employer contributions is directly limited by the maximum benefit limitations. I.R.C. § 404(j)(1)(B).[3] Because the benefit limitations applicable to defined contribution plans are expressed in terms of “annual additions” to an employee’s individual account, they are effectively the same as limitations upon deductibility.
(ii) Exceeding maximum benefit limitations may result in plan disqualification
(b) Maximum “annual additions” are limited to the lesser of:
(i) $40,000 (adjusted periodically for inflation beginning in 2003), and
(c) Benefit limitations are determined individually for each participant.
(d) If employer maintains multiple defined contribution plans:
(i) Limitations for contributions to single employer plans are aggregated, so that all contributions are treated as if they are to a single plan.
(ii) Limitations for contributions to multiemployer plans are not aggregated, but are determined solely on a plan-by-plan basis.
(e) “Annual additions” (the amount counted towards the maximum annual benefit limitation) include:
(i) employer contributions;
(ii) employee contributions; and
(iii) forfeitures allocated to employee accounts.
(2) Maximum Deductibility Limitations – I.R.C. § 404(a)(7)(A)
(a) Deductible contribution is limited to 25% of total compensation.
(b) Determined on an aggregate basis among all employees participating in the plan.
(c) Voluntary wage deferrals (employee contributions) are not counted toward limit.
ii. Employee Contributions
(1) Maximum pretax employee contribution is limited as follows:
|
Year |
Annual Limit |
|
2002 |
$11,000 |
|
2003 |
$12,000 |
|
2004 |
$13,000 |
|
2005 |
$14,000 |
|
2006 |
$15,000 |
|
2007 and thereafter |
$15,000 adjusted periodically for inflation |
I.R.C. § 402(g).
(2) Catch-up contributions. I.R.C. § 414(v).
(a) Applicable to employees who turn 50 within the year.
(b) Permit employee contributions above and beyond any other limitation on employee contributions.
(c) Maximum amount:
|
Year |
Annual Limit |
|
2002 |
$1,000 |
|
2003 |
$2,000 |
|
2004 |
$3,000 |
|
2005 |
$4,000 |
|
2006 |
$5,000 |
|
2007 and thereafter |
$5,000 adjusted periodically for inflation |
b. Defined Benefit Plans[5]
i. Maximum Benefit Limitations
(1) Unlike defined contribution plans, maximum benefit limitations do not directly limit the deductible employer contribution. However, plans are prohibited from taking benefits in excess of the maximum benefit limitations into account. I.R.C. § 404(j)(1)(B). Consequently, maximum benefit limitations may indirectly limit the amount of permitted employer contributions.
(2) Annual benefits for each participant are limited to the greater of:
(a) $10,000,[6] or
(b) the lesser of:
(i) 100% of compensation[7] (for plans other than multiemployer plans) or
(ii) $160,000, adjusted periodically for inflation beginning in 2003.
(3) The $160,000 limitation is:
(a) actuarially reduced for:
(i) pensions payable in a form other than either a straight-life or qualified joint and survivor annuity; and
(ii) pensions payable before age 62 (other than disability pensions).
(b) actuarially increased for pensions payable after age 65.
(4) The limitations in paragraph (2)(b) are actuarially increased to carve out those portions of the benefit attributable to rollovers and employee contributions.
(5) The 100% of compensation limitation does not apply to multiemployer plans.
ii. Maximum Deductibility Limitations
(1) In general, contributions may not exceed the greatest of:
(a) The minimum funding contribution;[8]
(b) The amount necessary to fully fund the plan’s current liability;[9] or
(c) The “normal cost,” plus the plan’s past service cost with the amortization periods reduced to 10 years (or in some cases, the amount necessary to amortize the plan’s unfunded accrued liability[10] over the remaining working lives of the covered employees). This amount is reduced to the extent necessary to prevent contributions in excess of the full funding limitation.[11]
(a) The “full funding limitation” is the amount of money that, if contributed to the plan, would cause the plan to reach “full funding.” Full funding occurs when the assets of the plan equal or exceed the value of plan benefits determined in one of two different ways.
(b) For purposes of determining the full funding limitation, the value of plan benefits is the lesser of:
(i) 100% of the plan’s “accrued liability”[12].
(ii) For years prior to 2004, a fixed percentage of the plan’s “current liability”[13].
1) That fixed percentage is as follows:
|
Year |
Percentage |
|
2002 |
165% |
|
2003 |
170% |
|
2004 and thereafter |
Repealed |
2) Beginning in 2004, the fixed percentage of current liability limitation will no longer apply.
(c) In any case, the amount of the full funding limitation will not be less than the amount necessary to bring the value of the plan’s assets up to 90% of the plan’s current liability.
c. Limitations Requiring Coordination Between Defined Benefit and Defined Contribution Plans
i. Benefits – Effective 2000, individual benefit limitations between defined benefit and defined contribution plans no longer need to be coordinated.
ii. Deductibility
(1) The 25% of aggregate compensation limitation on contributions to an employer’s defined contribution plans (see paragraph a.i(2) on page 2) is reduced by the amount of the employer’s contributions to its defined benefit plans for the same employees. I.R.C. § 404(a)(7)(A)(I).
(2) The aggregate 25% limit may be exceeded if required by minimum funding standards.
(3) The aggregate limit does not apply:
(a) if the multiple plans do not cover the same employees, or
(b) to voluntary wage deferrals (employee contributions).
2. Effect of Exceeding Maximum Contribution Limitations
a. Contributions are not deductible by the employers.
b. Excise Taxes
i. A 10% excise tax is imposed on employers who make non-deductible contributions
ii. Exceptions—the excise tax is generally not chargeable:
(1) Except to the extent that contributions exceed the “accrued liability” full funding limitation (see paragraph 1.b.ii(2)(b)(i) on p. 6).
(2) For contributions to terminating underfunded defined benefit plans.
(3) For certain contributions (up to 6% of compensation) to defined contribution plans to the extent that they are nondeductible solely because they exceed the 25% of aggregate compensation deductibility limitation described in paragraph 1.c.ii on p. 2.
[1]The
limitations described herein are applicable to non-governmental plans. Additionally, they include the amendments to
the law made under the Economic Growth and Tax Relief Reconciliation Act of
2001 (“EGTRRA”), even though those provisions expire in 2011. For funding purposes, the IRS has stated that
plans are permitted to assume that the EGTRRA changes will become
permanent. Revenue Ruling 2001-51,
I.R.B. 2001-45, (
[2] A “defined contribution” plan (also called an “individual account” plan) is a pension plan where each participant has a separate account that includes all contributions made on his or her behalf, plus earnings, and less administrative expenses. A participant’s accrued benefit is the balance in his or her account.
[3] All references to the
“I.R.C.” are to the Internal Revenue Code of 1986, as amended, I.R.C.
§§ 1 et seq.
[4]In all cases, the maximum amount of annual compensation that may be taken into account for purposes of Section 415 is $200,000, adjusted periodically for inflation beginning in 2003.
[5]Technically, a “defined benefit” plan is any plan that is not a defined contribution plan (see fn. 2.) Practically speaking, a defined benefit plan is a plan in which the pension is determined according to a formula that may take into account such factors as length of service, the employer’s contribution rate and an employee’s annual compensation.
[6]The $10,000 “small benefit” carve-out is reduced if the employee has fewer than 10 years of participation in the plan, and does not apply at all if the employee is also covered under a defined contribution plan maintained by the employer.
[8] The amount of the required
minimum funding contribution takes into account a plan’s full funding limitation,
so that it is generally reduced to the extent that the contribution would cause
a plan to exceed full funding. See
paragraph 1.b.ii(2) on p. 5.
[12]The plan’s “accrued liability” takes into account the value of benefits projected to be earned in the future. By contrast, a plan’s “current liability” only takes into account the value of currently accrued benefits. In addition, different interest rates and mortality assumptions may be used in calculating these two liability values.