Chapter 4: defined benefit integration provisions

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Chapter 4 defined benefit integration provisions

• Last updated 9/17/00

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How xyzs Retirement Benefit Is Combined With
Social Security

• Example
• Age 65 - 30 years of service - FAE 3,000 -
  Social Security Benefit 1,313.10
• 60 of 3000 1,800.00
• 50 of 1313 - 656.55
• xyz Retirement Benefit 1,143.45
• Social Security Benefit 1,313.10
• Total Monthly Retirement Benefit 2,456.55 (81.9
  of FAE)
• In this example, the final average earnings is
  3,000. The total retirement benefit is
  2,456.55.
• FAE - Final Average Earnings, including Profit
  Sharing

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A quick review of PIA offset plans

• pre-TRA86 Revenue Ruling 71-446 imposed a
  maximum limit on the permitted offset
• up to 83 1/3 percent but most employers did not
  want to explain a reduction higher than 50
  percent to employees
• N.B. linked to primary PIA
• did not change as Social Security benefits
  increased through colas

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TRA 86

• Add Section 401(l) defining statutory permitted
  disparity and killing pure excess
• offset Abbot provides 1.1 highest average pay
  (max 35) with offset of .5 highest 3 year
  average pay up to Social Security covered comp
  (yob table) participation (max 35 years)
• excess Acco provides (0.75 HAP to CC 1.25
  HAP over CC) service (max 30)

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Impact of TRA 86 on employers

• According to CRS, it appears to have influenced
  plan sponsors to change their integration methods
  from offset to excess
• Although more than 1/2 of all pension
  participants were still covered by integrated
  plans

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Employer breakdown by size
KPMG Retirement Benefits in the 1990s 1998
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What happened to PIA offset?

• Conventional PIA-offset plan violates the
  integration disparity condition under 401(l)
• Does not mean that this violates the
  nondiscrimination requirement
• However, must satisfy the general
  nondiscrimination test (Section 401(a)(4))

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What does this mean?

• Quick definition of rate groups and minimum
  coverage principles
• IF the plan covers no HCEs, then satisfaction
  should be automatic
• Otherwise, depends on demographics of the group
  (see Benefits Quarterly article)

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What is the difference between a PIA-offset and a
statutory offset?

• Mathematically they may be essentially the same
• See Record of the Society of Actuaries, Volume
  16, Number 4B, page 3071 for a discussion
• BUT from the employees standpoint it MAY be true
  that the impact of the latter is harder to discern

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Interested in more detail on permitted disparity?
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Permitted disparity

• The benefits from the employer's plan must be
  dovetailed with Social Security benefits
• in such a manner that employees earning over the
  taxable base will not receive combined benefits
  under the two programs that are proportionately
  greater than the combined benefits for employees
  earning under this amount.
• The integration level
• the dollar amount specified in an excess plan at
  or below which the rate of employer-provided
  contributions or the plan is less than the rate
  of employer provided contributions or benefits
  under the plan above such dollar amount.
• The offset level
• the dollar limit specified in the plan for the
  amount of each employee's final average
  compensation taken into account in determining
  the offset under an offset plan
• The covered compensation
• the average (without indexing) of the taxable
  wage bases in effect for an employee for each
  year during the 35-year period ending with the
  year in which Social Security retirement age is
  attained

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Alternative methods of meeting the Section 401(l)
requirements for a defined benefit plan

• excess plan
• the rate at which employer-provided benefits are
  determined with respect to average annual
  compensation above the integration level is
  greater than the rate at which employer-provided
  benefits are determined with respect to average
  annual compensation at or below the integration
  level
• expressed as a percentage of such average annual
  compensation
• offset plan
• each employee's employer-provided benefit is
  reduced or offset by a specified percentage of
  the employee's final average compensation up to
  the offset level under the plan.

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Average annual compensation and final average
compensation.

• Average annual compensation is calculated as an
  average over a period of at least three
  consecutive years, and can exclude years before
  the final ten years of service.
• Final average compensation is the average of the
  employee's annual compensation from the employer
  for the three consecutive year period ending with
  or within the plan year.
• Compensation for any year in excess of the
  taxable wage base in effect at the beginning of
  that year must not be taken into account in
  determining final average compensation.

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Maximum excess allowance

• The disparity between the excess benefit
  percentage and the base benefit percentage may
  not exceed the maximum excess allowance defined
  as the lesser of
• the base benefit percentage or
• 0.75 percent (reduced for any integration level
  or retirement age modifications)

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Gross benefit percentage

• The rate at which employer-provided benefit are
  determined under an offset plan (before
  application of the offset) with respect to an
  employee's average annual compensation (expressed
  as a percentage of average annual compensation)
• The disparity (as determined by the offset
  percentage) may not exceed the maximum offset
  allowance defined as the lesser of
• 0.75 percent (reduced for any integration level
  or retirement age modifications as explained
  below) or
• one-half of the gross benefit percentage,
  multiplied by a fraction (not to exceed one)
  equal to the employee's average annual
  compensation divided by the employee's final
  average compensation up to the offset level

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Annual/Cumulative disparity fractions

• Disparity provided under the plan divided by
  either the maximum excess allowance (for excess
  plans) or the maximum offset allowance (for
  offset plans)
• ? disparity fractions ? 1
• The cumulative permitted disparity limit is
  satisfied if the sum of the employee's total
  annual disparity fractions does not exceed 35

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The future of PIA offsets?

• If the government were to improve Social
  Security benefits and the gross pension benefit
  did not change, the larger offset would result in
  a smaller net benefit
• Section 411 of the IRC (vesting) generally
  prohibits a reduction in benefits already accrued
• Will this be modified????

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The other side of Social Security reform
KPMG Retirement Benefits in the 1990s 1998
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Questions

• The following facts apply to the next three
  questions unless otherwise provided plan is
  noncontributory and is the only plan ever
  maintained by the employer the plan uses a
  normal retirement age of 65 and contains no
  provision that would require a reduction on the
  0.75 percent factor. Defined benefit excess
  plans used each employee's covered compensation
  as the integration level offset plans used each
  employee's covered compensation is the offset
  level and provides that an employee's final
  average compensation is limited to the employee's
  average annual compensation each employee has a
  Social Security retirement age of 65.

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Db integration - 1

• An excess plan provides a normal retirement
  benefit of 0.5 percent of average annual
  compensation in excess of the integration level,
  for each year of service. The plan provides not
  benefits with respect to average annual
  compensation up to the integration level. Result?

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Db integration - 2

• An offset plan that provides a normal retirement
  benefit of 2 percent of average annual
  compensation, minus 0.75 percent of final average
  compensation up to the offset level, for each
  year of service up to 35. result?

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Db integration 3

• skip

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Db integration - 4

• An employee benefits under C, a dc excess plans
  and B, a Defined benefit excess plan of the
  employer. Plan C provides a base contribution
  percentage of 5 percent and an excess
  contribution percentage of 7 percent. Plan B
  provides a base benefit percentage of 1 percent
  and an excess benefit percentage of 1.35 percent.
  Do the plans satisfy the annual overall pd limit
  with respect to the employee?

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Db integration - 5

• A Defined benefit excess plan that provides a
  normal retirement benefit of 0.75 percent of
  average annual compensation up to cc, plus 1.25
  percent of average annual compensation above cc,
  for each year of service up to 45. result?