Impact of $150,000 compensation limit for benefit plans.

• Author: Davis, Jeff

The Revenue Reconciliation Act of 1993 reduced the limit on the amount of compensation that may be taken into account under qualified pension and profit-sharing plans to $150,000. This limit also applies for deduction limit purposes and for testing plan benefits for nondiscrimination. Indexed for inflation, the 1993 limit was $235,840.

The reduction is effective for 1994 plan years. Existing accrued benefits at the end of 1993 based on compensation of more than $150,000 are protected. After 1994, the $150,000 limit will be indexed for inflation in $10,000 increments.

Plan amendments incorporating the $150,000 limit are not required to be in place before the end of the 1994 plan year. As long as it is adopted in a timely manner, the amendment may apply retroactively even though it results in a reduction of some accrued benefits. The IRS has provided model plan amendment language that satisfies the new requirements.

Because the reduced compensation limit has to be taken into account in calculating maximum deduction limits, it will result in delayed funding for some defined benefit pension plans. Moreover, because it must be reflected in applying the plan's benefit formula, future benefit accruals for employees earning more than $150,000 will be reduced. In recently proposed rules the Service has clarified how future defined benefit accruals will be affected by the "grandfathered" accrued benefit at the end of 1993 that may be based on compensation of more than $150,000. The IRS has provided three alternative methods for coordinating the 1993 grandfathered accrued benefit with future benefit accruals subject to the $150,000 limit. These are the same transition alternatives provided when the $200,000 limit took effect in 1989. In selecting the appropriate alternative, plan sponsors must...