Closer scrutiny of state and local plans by Sec. 415.

• Author: Lantry, Terry L.

The effects of Sec. 415 on potential state retirees requires prompt attention.

Tax-exempt pension funds

A state retirement system that satisfies aH of the requirements of Sec. 401(a) will be exempt from Federal taxation. Additionally, a qualified retirement fund has the following advantages.

* Participants are not taxed on the earnings generated by fund assets while they remain in the fund.

* Participants are not taxed on contributions made by the employer on behalf of the participants.

* In accordance with Sec. 414(h), employee contributions may be "picked up" by the employer and will not be taxed before being contributed to the fund.

Ignoring Sec. 415

A nonqualified fund loses all of these advantages. Under Sec. 401(a), a fund will be nonqualified if the Sec. 415 limitations are exceeded. One limit is on the amount of the retirement benefit to be paid to retirement plan participants.

Sec. 415 benefit limits

Under Sec. 415(b)(2)(F), special rules apply to exempt state and local government defined benefit retirement plans. The actuarial reduction of the limit on annual benefits for early retirement may not be reduced below (1) $90,000 (indexed amount for 1992 is $112,221) for benefits beginning on or after the date the participant reaches age 69., (2) $75,000 for benefits beginning on or after age 55, or (3) the actuarial equivalent of $75,000 at age 55 for benefits beginning before age 55.

Likewise, if benefits begin after age 65, the limit will be increased by actuarial adjustment. Between the ages of 62 through 65, the benefit limit remains constant except for cost-of-living adjustments.

The limit on annual benefits will also be exceeded if the annual benefit is greater than 100% of the participant's average taxable compensation for three consecutive years.

It is not easy to comply with this limit, as the example at right illustrates.

The point made by these scenarios is that a violation of a Sec. 415 limitation can occur at a relatively modest level of salary, and not (as one might assume) only at high levels.

The penalty is extreme. It takes only one participant violating the "limitation" to disqualify the entire fund.

Solutions

Regs. Sec. 1.415-1(d)requires that a plan's provisions must preclude the possibility that the limitation imposed by Sec. 415 will be exceeded or the fund will lose its qualification for tax exemption.

The easiest and most practical way to accomplish this is to inelude a provision in the plan providing for an...