Employee Benefits After Tefra
| Publication year | 1983 |
| Pages | 423 |
| Citation | Vol. 12 No. 3 Pg. 423 |
1983, March, Pg. 423. Employee Benefits After TEFRA
David H. Jaffer is an associate and R. Michael Sanchez and Cynthia C. Benson are partners in the firm of Sherman & Howard, Denver.
President Reagan signed the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA") on September 3, 1982. TEFRA enacts the first major changes of the employee benefit provisions of the Internal Revenue Code since the Employee Retirement Income Security Act of 1974 ("ERISA").
TEFRA's most important changes include reduced benefit and contribution limits, and special qualification requirements for plans that primarily benefit key employees ("top-heavy" plans). Most of the distinctions between corporate plans and Keogh plans have been repealed, with a few Keogh rules extended to all plans. Participant loans from qualified plans are restricted. Distributions from qualified plans are subject to withholding of federal income tax. Use of personal service corporations as vehicles for maximizing retirement benefits have been severely curtailed.
These new provisions require review of all qualified plans. Many plans will need to be restructured to comply with TEFRA. This article outlines the changes that TEFRA makes in the area of employee benefits and alerts practitioners to the implications of the changes.
TEFRA reduces the maximum benefits from and contributions to qualified plans. ERISA permitted an annual single life annuity, or joint and survivor annuity, from a defined benefit plan of the lesser of $75,000 or 100 percent of a participant's average compensation for his three highest consecutive years. The defined contribution plan maximum contribution was the lesser of $25,000 or 25 percent of the participant's compensation in the year of the contribution. By 1982, the maximum dollar benefit and contribution limits had been increased by cost-of-living adjustments to $136,425 and $45,475, respectively.(fn1)
TEFRA does not alter the limits on percentage of compensation, but the dollar maximums are sharply reduced.(fn2) The new annual limit for a single life annuity or joint and survivor annuity from a defined benefit plan is $90,000. Annual contributions to defined contribution plans may not exceed $30,000. These new dollar limits are effective for years beginning after 1982 (and for years ending after July 1, 1982, for plans not existing on July 1, 1982).(fn3)
TEFRA provides a transition rule for the new defined benefit limits. For plans in existence on July 1, 1982, the current accrued benefit of a participant, as of the close of the 1982 limitation year, may continue to be provided even if it would otherwise exceed the new lower benefit limits.(fn4)
TEFRA also provides that a defined benefit plan will not fail to satisfy the benefit limitation requirements for any limitation year beginning before 1984 merely because the plan provides for benefits in excess of the new lower limits. Generally, plans funding such benefits need not be amended until the 1984 limitation year.(fn5) However, the Internal Revenue Service ("IRS") has issued a notice that if the failure to amend such a plan before the beginning of the 1983 limitation year causes a participant to accrue a benefit in excess of the new lower limitations during the 1983 limitation year, then as of the beginning of the 1984 limitation year, the plan will provide for a benefit that violates the new limits. This failure can result in a disqualification of the plan. Any amount contributed for such excess benefits will not be currently deductible by the employer.
To avoid both the plan qualification and employer deduction problems, a defined benefit plan must be amended by the last day of the 1982 limitation year to preclude the excess accruals. The IRS has drafted a standard plan amendment that it will accept for these purposes without a determination letter.(fn6)
The maximum annual benefit that may accrue under certain collectively bargained plans has also been changed. If such benefits exceed 100 percent of a participant's average compensation for his high three years, and the participant's compensation did not exceed the average compensation of all participants in the plan in any three years
of the ten years preceding his separation from service, the benefits now may not exceed the greater of $68,212 or 50 percent of the otherwise applicable defined benefit dollar limit (currently 50 percent of the $90,000 limit).(fn7)
For example, if a collectively bargained plan would result in a participant accruing a benefit of $50,000 when his three-year average compensation was only $45,000, TEFRA would permit this result up to $68,212. When the cost-of-living adjustments increase the $90,000 limit above $136,424, the 50 percent rule will be the limiting factor for benefits above 100 percent of three-year average pay. These limits apply to years beginning on the earlier of the termination of the collective bargaining agreement or January 1, 1986.(fn8)
TEFRA temporarily freezes the new dollar limits.(fn9) No cost-of-living adjustments may be made for years beginning after December 31, 1982, and before January 1, 1986. After January 1, 1986, the limits may be adjusted, but only for cost-of-living increases beginning with the quarter starting October 1, 1984. Such adjustments will be indexed to increases in Social Security benefit payments rather than the cost of living. Therefore, any adjustments in Social Security increases will directly affect private plans as well.
TEFRA specifies that no deduction is available for contributions in excess of the new limitations. In addition, TEFRA codified the pre-TEFRA IRS position that defined benefit plans cannot anticipate cost-of-living adjustments by advance funding of them.(fn10) This change ends the dispute between the IRS and the actuarial profession regarding the reasonableness of predicting cost-of-living increases. These rules are effective for plan years beginning after 1982 (immediately for new plans).(fn11)
Under prior law, an individual who participated in both a defined benefit and a defined contribution plan could receive benefits and contributions up to a sum of the defined benefit plan fraction and the defined contribution plan fraction of 1.4. The plan fractions were calculated by using the actual benefit or contribution as the numerator, with the maximum allowable benefit or contribution as the denominator. For example, if under the 1982 limits the participant was entitled to a defined benefit of $136,425, he would be limited to a maximum defined contribution of the lesser of $18,190 ($45,475 times 0.4) or 10 percent of compensation (25 percent of compensation times 0.4). Conversely, if the participant received a defined contribution of $45,475, he would be limited to a maximum defined benefit of $54,570 ($136,425 times 0.4).(fn12)
TEFRA reduces the aggregate limit for the sum of the fractions to 1.0, but redefines the fractions.(fn13) In effect, the new plan fractions provide a limit of the lesser of 1.25 times the dollar limits or 1.4 times the percentage limits.
The new defined benefit plan fraction is:
As under prior law, the new defined contribution plan fraction involves a running average over the employee's total years of service:
TEFRA adds a transition rule for computing the defined contribution plan fraction.(fn14) A plan administrator may elect to calculate the denominator of the defined contribution plan fraction as the pre-TEFRA denominator times a transition fraction. The pre-TEFRA denominator is the sum of the maximum allowed annual additions to the participant's account for each year of service with the employer. The transition fraction is defined as:
These changes in permissible ratios will directly affect employees whose benefits and contributions approach the maximum dollar limits. However, other employees will be affected to the extent companies amend plans so that the benefits and contributions for the highest paid employees do not exceed the new limits.
Under prior law, downward actuarial adjustment of the maximum benefit payable from a defined benefit plan was only required for payments beginning before age 55. TEFRA raises the...
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