Mercer Says Plan Limits Could Drop

Plan sponsors might want to prepare for the possibility of retirement plan limits dropping for 2010, Mercer said.

In a new report, Mercer pointed out that depending on inflation levels for August and September 2009, the statutory formula used for calculating limits could produce lower figures in 2010 relative to 2009. The limits affect elective deferrals, catch-up contributions, plan compensation, Code Section 415 annual additions and maximum defined benefit (DB) annuities, and compensation amounts for identifying highly compensated and key employees.

Employers might want to prepare now by assessing the implications for participant communications (including whether a 204(h) notice might be required for pension plans), financial planning tools, benefit calculation systems, and discrimination testing (including ADP/ACP testing for 401(k) plans), Mercer suggested.

The code is unclear what happens when the rounded value under the statutory formula goes down. Mercer said one interpretation is that the prior year’s limit remains in effect, and another possibility is that the limit goes down, but not below the base amount ($15,000 for the elective deferral limit and $200,000 for the compensation limit).

The second interpretation, if adopted, also could adversely affect ADP/ACP nondiscrimination testing for 401(k) plans, as some limits could go down while others remain unchanged under the statutory formula, Mercer warned.

For example, if the third-quarter CPI-U, which is used in the formula for calculating limits, requires only a modest uptick in inflation,  the elective deferral limit would remain unchanged at $16,500, but the compensation limit would drop to $240,000. For highly compensated participants, this would result in a higher actual deferral percentage (ADP) although they really are not contributing more to their retirement plans.

Mercer said the effects of declining 2010 limits could even carry over to 2011 ADP/ACP testing for 401(k) plans and general nondiscrimination testing for other retirement plans. A drop in the Section 414(q)(1)(B) compensation threshold from $110,000 in 2009 to $105,000 in 2010 would affect the determination of highly compensated employees for 2011 nondiscrimination tests.

Mercer noted that the issue only affects qualified retirement plans, because other benefit plan limits are tied to the CPI-U (or its medical care component) for different periods.

Benefit Limit Drop for DB Plans

For defined benefit pension plans, the Mercer report said a drop next year in the Section 415 maximum annual benefit should not affect participants who accrued the maximum amount in 2009 because Section 411(d)(6) prohibits plan amendments that reduce accrued benefits, and the IRS treats the annual adjustment in the 415 limit as a plan amendment.

However, benefit calculation systems would have to be modified if the current $195,000 maximum annuity is reduced to $190,000 next year and applied to future benefit accruals (the 415 limit is adjusted if benefits start before age 62 or after age 65, or if benefits are paid in a form other than straight life annuity or qualified joint and survivor annuity).

Mercer explained that should the limit drop to $190,000 in 2010, DB plans would have to calculate 411(d)(6)-protected benefits at the end of the 2009 limitation year for participants starting benefits in 2010. Though few participants would likely be affected, the calculations could be quite burdensome, Mercer said.

If IRS allows plan compensation limits and 415 limits on DC annual additions and DB maximum annuities to go down in 2010, some participants' 2010 benefits will be reduced. Because IRS views these annual limit adjustments as plan amendments, sponsors of DB and money-purchase pension plans must consider whether the reductions are significant enough to trigger a 204(h) notice.

ERISA Section 204(h) requires pension plans to provide 45 days' advance notice of a plan amendment to any participant whose future accruals are reasonably expected to be significantly reduced. For calendar-year plans, the notice deadline would be November 17, 2009.

Mercer said DB and money-purchase pension plan sponsors should identify participants who could be affected by declining 415 and 401(a)(17) compensation limits and discuss with counsel whether a 204(h) notice should be provided if IRS allows the limits to go down.