Qualified Retirement Plan Rules - Examples Flashcards
Integrated Defined Benefit Plans -
Under the excess method of integration with Social Security, the plan defines a level of compensation called the integration level. The plan then provides a higher rate of benefits for compensation above the integration level. A plan’s integration level is an amount of compensation specified under the plan by a dollar amount or formula. Benefits under the plan expressed as a percentage of compensation are lower for compensation below the integration level than they are for compensation above the integration level.
For example, suppose Plan A’s integrated formula provides an annual benefit of 30% of final average annual compensation plus 25% of compensation above the plan’s integration level. Labelle, born in 1950, is a participant in plan A. He retires this year. Labelle’s final average compensation is $80,000. The integration level is $75,000. Labelle’s annual retirement benefit is determined as follows:
30% of final average compensation of $80,000 $24,000
Plus: 25% of $5,000 ($80,000 - $75,000) $1,250
Equals: Total Benefit $25,250
Integrated Defined Benefit Plans -
Under the offset method of integration, the plan formula is reduced by a fixed amount or a formula amount that is designed to represent the existence of Social Security benefits. When speaking of an offset plan the integration level is replaced by the offset level. In contrast to an excess plan where benefits are added to compensation above the integration level, in an offset plan benefits are deducted for compensation below the offset level.
For example, suppose Plan A’s integrated formula provides an annual benefit of 30% of final average annual compensation plus 25% of compensation above the plan’s integration level. Labelle, born in 1950, is a participant in plan A. He retires this year. Labelle’s final average compensation is $80,000. The integration level is $75,000. Labelle’s annual retirement benefit is determined as follows:
If the same example above were designed as an offset plan, it would provide 55% of compensation less 25% of compensation below the offset level:
55% of final average compensation of $80,000 $44,000
Minus: 25% of $75,000 (offset level) $18,750
Equals: Total Benefit $25,250
Maximum Spreads in Defined Benefit Plans -
Under an excess benefit plan the spread between benefits below and above the integration level cannot exceed the lesser of:
0.75% of compensation per year of service, up to a maximum of 35 years
The benefit percentage applied to compensation below the integration level
Put another way, the benefit over the integration level cannot be more than twice that below the integration level.
As an example, if a plan provided a benefit of 0.5% of compensation up to the integration level, and 1.25% of compensation above the integration level, it would exceed the maximum allowed disparity. Although the benefit over the integration level is 0.75% higher than that below, it is also more than twice that of the benefit below the integration level. If the benefit amount below the integration level were higher, say 1%, with a benefit above the integration level of 1.75%, the arrangement would be permitted.
Maximum Spreads in Defined Benefit Plans -
Under an offset plan, the offset allowance is limited in a similar fashion to 0.75% of compensation per year of service, with a maximum offset of 50% of the benefit that would accrue without the offset.
For example, if a plan formula provides 50% of final average compensation with an offset, even the lowest paid employee must receive at least 25% of final average compensation from the plan.
Deduction Limits -
The maximum amount an employer can contribute and deduct to a defined contribution plan cannot be more than 25% of covered compensation. This includes compensation paid or accrued during the year to eligible employees participating in the plan.
The definition of covered compensation includes employee elective deferrals to a qualified plan, 403(b) plan, 457 plan, SEP, or SIMPLE. This has the effect of creating a higher total payroll amount which allows for greater employer contribution levels. This means that the payroll upon which the 25 percent is based can become higher than it was previously, resulting in a higher deduction limit for employer contributions to the plan. Employee elective deferrals do not have to be counted as part of the 25% contribution limit placed on employers. This allows a still higher contribution amount by the employer as employee elective contributions are not part of the 25% number—they are in addition to this 25% contribution limit.
For example, Lauren owns a small security firm, Eyeballs, Inc. Payroll is $100,000 and employees have made total elective contributions to the 401(k) plan of $10,000. Because elective deferrals of $10,000 do not count toward the $25,000 limit ($100,000 × 25%), the largest contribution that Eyeballs Inc. can make to the company’s profit-sharing plan will be $25,000. However, the total that Eyeballs, Inc. and Lauren can take as a deduction on her tax return is $35,000.
Loans Requirements -
The Tax Cuts and Jobs Act extended the rollover deadline for “qualified plan loan offsets” in 2018. A “qualified” offset is one that occurs within 12 months of severance from employment or on account of termination of the plan. The new deadline is the borrower’s tax return due date, including extensions, for the year of the offset—normally October 15 of the following year.
For example, Mia, age 50, left her job on May 15, 2024 with $75,000 in her 401(k), including a $30,000 loan balance. Mia could not repay the loan. She elected a direct rollover of her 401(k) funds to an IRA. On June 30, 2022, the plan did a loan offset of $30,000 and transferred $45,000 to her IRA. Mia included $30,000 taxable income and a $3,000 early distribution penalty on her 2024 federal tax return. She has until October 15, 2025 to come up with the $30,000 and do a rollover. If she does, she can file an amended 2024 return to recoup the taxes and penalty paid on the loan offset.
