IRS ANSWERS QUESTIONS ON PLAN BENEFITS AND CONTRIBUTIONS LIMITS.

Rev. Rul. 95-29

This revenue ruling provides questions and answers on the limitations on benefits and contributions under section 415 of the Internal Revenue Code (Code), as amended by the Uruguay Round Agreements Act, Pub. L. 103-465 (GATT), which includes the Retirement Protection Act of 1994 (RPA '94).

Until further guidance is issued, the guidance provided by these questions and answers may be relied on to administer plans. If, and to the extent, future guidance is more restrictive than the guidance in this revenue ruling, the future guidance will be applied without retroactive effect. No inference should be drawn regarding issues not raised that may be suggested by a particular question and answer or as to why certain questions, and not others, are included. Background

Section 415 provides that benefits accrued or payable under a qualified defined benefit plan may not exceed certain specified limitations. In general, annual benefits are limited to the lesser of a specified dollar amount, i.e., $90,000, as adjusted for cost-of- living increases (the section 415(b)(1)(A) dollar limitation), or 100 percent of the participant's average compensation for the participant's high three years (the section 415(b)(1)(B) compensation limitation).

Section 415(b)(2)(B) provides, with certain exceptions, that, if a benefit is payable other than as an annual straight life annuity, the benefit must be actuarially adjusted to an equivalent annual straight life annuity.

Sections 415(b)(2)(C) and (D) require that, if a benefit is payable beginning at an age other than the participant's social security retirement age (SSRA), the section 415(b)(1)(A) dollar limitation is actuarially adjusted so that the limitation equals an annual benefit that is equivalent to the dollar limitation at the participant's SSRA.

Section 415(b)(2)(E) of the Code, which provides rules for actuarial assumptions for purposes of these adjustments, was amended by section 767(b) of RPA '94. Section 415(b)(2)(E)(i) generally requires that, for purposes of adjusting any benefit or limitation under section 415(b)(2)(B) or (C), the interest rate assumption shall not be less than the greater of 5 percent or the rate specified in the plan. Section 415(b)(2)(E)(ii) provides that, for purposes of adjusting the benefit or limitation of any form of benefit subject to section 417(e)(3), the applicable interest rate (as defined in section 417(e)(3)) shall be substituted for 5 percent. Section 415(b)(2)(E)(v) requires that, for purposes of adjusting any benefit or limitation under section 415(b)(2), the mortality table prescribed by the Secretary must be used.

Section 415(d)(1)(B) provides that the section 415(b)(1)(B) compensation limitation is adjusted annually for cost-of-living increases in the case of participants who have separated from service. Section 732 of GATT changed the periods used to compute increases in the cost of living for purposes of these adjustments.

Questions and Answers

Q-1. When are the changes to section 415(b)(2)(E) made by section 767(b) of RPA '94 (section 415(b)(2)(E) changes) effective?

A-1. The section 415(b)(2)(E) changes are effective as of the first day of the first limitation year beginning in 1995. This effective date applies regardless of when the plan is amended to reflect changes made to section 417(e)(3) by section 767(a) of RPA '94 (section 417(e)(3) changes). However, an employer may elect to treat the section 415(b)(2)(E) changes as being effective on or after December 8, 1994.

Q-2. When must qualified plans be amended to comply with the section 415(b)(2)(E) changes?

A-2. Under section 767(d)(3)(B) of RPA '94, until such date as the Secretary provides, a plan that operates in accordance with the section 415(b)(2)(E) changes shall not be treated as failing to satisfy section 401(a) merely because it has not been amended to reflect the section 415(b)(2)(E) changes.

The Service will specify a date by which ongoing plans must be amended to comply with these rules. Before that date, the Service intends to issue model plan amendments to implement the new rules under section 415.

Plans generally must be amended to conform to the changes to section 415 upon plan termination if termination occurs prior to the date by which amendments must otherwise be adopted.

Q-3. What plan benefits are subject to the new interest rate provided in section 415(b)(2)(E)(ii)?

A-3. The new interest rate under section 415(b)(2)(E)(ii) applies to a benefit payable in the form of a benefit subject to section 417(e)(3). Under section 417(e)(3) and the Income Tax Regulations thereunder, benefits subject to section 417(e)(3) include all forms of benefit except non-decreasing annuity benefits payable for a period not less than the life of the participant or, in the case of a QPSA, the life of the surviving spouse. For this purpose, a non-decreasing annuity includes a QJSA, a QPSA, and an annuity that decreases merely because of the cessation or reduction of Social Security supplements or qualified disability payments (as defined in section 411(a)(9)).

Q-4. Are plans that are not subject to section 417(e)(3) subject to the new restrictions on assumptions under section 415(b)(2)(E)?

A-4. Plans that are not subject to section 417(e)(3), such as government plans and certain church plans, are not subject to the new interest rate under section 415(b)(2)(E)(ii), but are subject to the new mortality table under section 415(b)(2)(E)(v).

Q-5. What is the applicable interest rate, as defined in section 417(e)(3), as referenced by section 415(b)(2)(E)(ii)?

A-5. The applicable interest rate under section 417(e)(3), as referenced by section 415(b)(2)(E)(ii), is the annual interest rate on 30-year Treasury securities as specified by the Commissioner.

Q-6. What is the time for determining the applicable interest rate?

A-6. A plan that has been amended to reflect the section 417(e)(3) changes must use the same date for determining the applicable interest rate for purposes of section 415 as it uses for purposes of section 417(e)(3). A plan that has not yet been amended to reflect the section 417(e)(3) changes may use any date for determining the applicable interest rate for purposes of section 415 that is permitted under section 417(e)(3) and the regulations thereunder for use in determining the applicable interest rate for purposes of section 417(e)(3).

Q-7. What mortality table must be used to make adjustments to benefits and limitations under section 415(b)(2)(E)?

A-7. Section 415(b)(2)(E)(v), added by RPA '94, provides that, for purposes of adjusting any benefit or limitation under sections 415(b)(2)(B), (C), or (D), the mortality table used shall be the table prescribed by the Secretary. Rev. Rul. 95-6, 1995-4 I.R.B. 22, provides the mortality table to be used for purposes of section 415(b)(2)(E)(v) (applicable mortality table). Generally, the applicable mortality table must be used to determine actuarial equivalence for purposes of section 415(b). As under the law prior to RPA '94, the mortality decrement is taken into account to the extent provided in Notice 83-10, 1983-1 C.B. 536.

Q-8. How is section 415(b) applied to a benefit under a defined benefit plan that is not payable in the form of an annual straight life annuity within the meaning of section 415(b)(2)(A), and that is not subject to section 417(e)(3)?

A-8. The determination as to whether such a benefit satisfies the requirements of section 415 is made in three steps:

Step 1: Determine the annual benefit in the form of a straight life annuity commencing at the same age that is actuarially equivalent to the plan benefit. In general, sections 415(b)(2)(E)(i) and (v) require that the equivalent annual benefit be the greater of the equivalent annual benefit computed using the interest rate and mortality table specified in the plan for actuarial equivalence for the particular form of benefit payable and the equivalent annual benefit computed using a 5 percent interest rate assumption and the applicable mortality table.

Step 2: Determine the section 415(b)(1)(A) dollar limitation that applies at the age the benefit is payable. To determine this limitation, the dollar limitation that applies at the participant's SSRA is adjusted so that the adjusted dollar limitation equals an annual benefit that is equivalent to the dollar limitation at the participant's SSRA.

If the benefit is payable at or after age 62 and before the participant's SSRA, the dollar limitation at the participant's SSRA is reduced to the age at which the benefit is payable using adjustment factors that are consistent with the factors used to reduce old-age insurance benefits under the Social Security Act. Pursuant to Notice 87-21, 1987-1 C.B. 458, the dollar limitation at the participant's SSRA is reduced by 5/9 of 1% for each of the first 36 months by which benefits commence before the month in which the participant's SSRA is attained, and by 5/12 of 1% for each additional month.

If the age at which the benefit is payable is less than age 62, the dollar limitation is further reduced so that the limitation is actuarially equivalent to the limitation at age 62. In general, sections 415(b)(2)(E)(i) and (v) require that the reduced dollar limitation is the lesser of the equivalent amount computed using the interest rate and mortality table (or other tabular factor) used for actuarial equivalence for early retirement benefits under the plan and the amount computed using 5 percent interest and the applicable mortality table.

If the age at which the benefit is payable is greater than the participant's SSRA, the dollar limitation is increased so that the limitation is actuarially equivalent to the limitation at the participant's SSRA. In general, sections 415(b)(2)(E)(i) and (v) require that the increased dollar limitation is the lesser of the equivalent amount computed using the interest rate and mortality table (or other tabular factor) used for actuarial equivalence for late retirement benefits under the plan and the amount computed using 5 percent interest and the applicable mortality table.

Step 3: Determine the participant's section 415(b)(1)(B) compensation limitation. This limitation is equal to the participant's compensation averaged over the consecutive three year period producing the highest average as provided in section 415(b)(3).

The plan does not satisfy the requirements of section 415(b) unless the amount determined in Step 1 is no greater than the lesser of the amount determined in Step 2 and the amount determined in Step 3.

Q-9. How is section 415(b)(2)(B) applied to a benefit under a defined benefit plan that is payable in a form subject to section 417(e)(3)?

A-9. If a defined benefit plan provides a benefit in a form that is subject to section 417(e)(3), the determination of the equivalent annual benefit is the same as in Q&A-8, Step 1, except that, under section 415(b)(2)(E)(ii), the applicable interest rate is substituted for the 5 percent interest rate under section 415(b)(2)(E)(i). The equivalent annual benefit must be the greater of the equivalent annual benefit computed using the interest rate and mortality table specified in the plan for actuarial equivalence for the particular form of benefit payable and the equivalent annual benefit computed using the applicable interest rate and the applicable mortality table.

EXAMPLE: Plan A provides that single-sum distributions are determined as the actuarial present value of the annual single life annuity payable at the actual retirement date. The single sum is the greater of the present value using 6 percent interest and the UP-1984 mortality table and the present value using the applicable interest rate and applicable mortality table. In accordance with section 417(e) and the regulations thereunder, the single sum is not less than the actuarial present value of the normal retirement benefit using the applicable interest rate and the applicable mortality table.

In 1995, Participant M, whose SSRA is age 65, retires at age 60 from Plan A and elects to receive his distribution in the form of a single sum. Under the plan formula, and before the application of section 415, the amount of the single sum is $950,000, which is the present value of the early retirement benefit. This benefit must be adjusted to an actuarially equivalent single life annuity commencing at age 60 in order to apply the annual section 415 limitation under the plan at that age. Assuming that the plan's applicable interest rate under section 417(e)(3) is 8 percent, the adjustment is made as follows:

First, divide $950,000 by an immediate single life annuity purchase rate at age 60 using the plan's interest rate and mortality table. Based on 6 percent interest and the UP-1984 mortality table, the equivalent annual benefit is $950,000/10.596, or $89,656. Second, divide the $950,000 by an immediate single life annuity purchase rate using the applicable interest rate and the applicable mortality table. Based on 8 percent interest and the applicable mortality table, the equivalent annual benefit is $950,000/10.098, or $94,078. The equivalent annual benefit for purposes of section 415(b)(2)(B) is the greater of the two resulting amounts, or $94,078.

Q-10. How is section 415(b)(2)(C) applied to adjust the section 415(b)(1)(A) dollar limitation if a benefit is payable in a form subject to section 417(e)?

A-10. If a defined benefit plan provides a benefit payable in a form that is subject to section 417(e)(3), and the benefit is payable before a participant's SSRA, the section 415(b)(1)(A) dollar limitation is determined in the same manner as in Q&A-8, Step 2, except that, under section 415(b)(2)(E)(ii), the applicable interest rate is substituted for the 5 percent interest rate under section 415(b)(2)(E)(i). Thus, if the benefit is payable at or after age 62, the dollar limitation at the participant's SSRA is reduced by 5/9 of 1% for each of the first 36 months by which benefits commence before the month in which the participant's SSRA is attained, and by 5/12 of 1% for each additional month. If the benefit is payable at an age earlier than age 62, the dollar limitation is further reduced using the interest rate under section 415(b)(2)(E)(ii).

EXAMPLE: Plan A described in Q&A-9 also provides that early retirement annuity benefits are equal to the normal form of annuity benefit payable at age 65, reduced by 4 percent for each year by which the early retirement age is less than 65. Participant M's retirement age is age 60, and Participant M has more than 10 years of plan participation at age 60. The dollar limitation at age 60 is computed as follows:

First, the dollar limitation at age 62 is determined by reducing the 1995 dollar limitation of $120,000 at SSRA (age 65) by a factor of of 1 percent for 36 months. This results in a limitation of $96,000 at age 62.

The resulting $96,000 limitation is further reduced as follows: Using the tabular plan reduction factor of 4 percent per year, the benefit adjustment factor at age 62 would be 88 percent (100%-(4% x 3)). At age 60, the factor would be 80 percent (100%-(4% x 5)). Accordingly, the dollar limitation at age 60 reduced in accordance with plan factors is equal to $96,000 x 80%/88%, or $87,273. Because Participant M's distribution is in the form of a single sum which is subject to section 417(e)(3), the limitation at age 62 is now reduced using the applicable interest rate of 8 percent and the applicable mortality table. Assuming the mortality decrement is applied only on a post-retirement basis (since plan benefits are not subject to forfeiture upon death prior to the annuity starting date), this reduced limitation is $79,541. The limitation that would apply at age 60 is the lesser of $87,273 and $79,541, or $79,541. Thus, the equivalent annual benefit of $94,078 determined in Q&A-9 does not satisfy the requirements of section 415(b)(2)(A).

Q-11. Does a plan that applies the section 415(b)(2)(E) changes violate section 411(d)(6)?

A-11. In general, a plan amendment that changes the interest rate or mortality table taken into account in determining a participant's accrued benefit is subject to the anti-cutback rules under section 411(d)(6) of the Code. However, under section 767(d)(2) of RPA '94, a participant's accrued benefit is not considered to be reduced in violation of section 411(d)(6) merely because the plan applies the section 415(b)(2)(E) changes. Accordingly, a participant's accrued benefit may be reduced below the accrued benefit as of the last day of the last limitation year beginning before January 1, 1995 if the reduction results solely from the application of the section 415(b)(2)(E) changes.

Q-12. Must a plan reduce a participant's accrued benefit as of the last day of the last plan year beginning before January 1, 1995 (freeze date) in order to apply the section 415(b)(2)(E) changes?

A-12. Although a participant's accrued benefit is permitted to be reduced in accordance with Q&A-11, under section 767(d)(3) of RPA '94, an accrued benefit is not required to be reduced below the accrued benefit as of the freeze date merely because of the application of the section 415(b)(2)(E) changes. Thus, after the effective date of the section 415(b)(2)(E) changes, a plan will not violate section 415 merely because it provides a benefit equal to the greater of (1) the participant's benefit under the terms of the plan, for the annuity starting date and optional form and taking into account the limitations of section 415 as amended, and (2) the participant's protected accrued benefit as of the freeze date. The freeze date must be determined without taking into account any change in the plan or limitation year that would delay the effective date for the section 415(b)(2)(E) changes or postpone the otherwise determined freeze date for the plan.

Q-13. How is the participant's protected accrued benefit as of the freeze date determined?

A-13. The participant's protected accrued benefit as of the freeze date is determined as the participant's benefit under the terms of the plan as of the freeze date, for the annuity starting date and optional form and taking into account the limitations of section 415 prior to the section 415(b)(2)(E) changes, including the participation requirements under section 415(b)(5). For this purpose, plan amendments increasing benefits that are adopted after the freeze date are not taken into account and the accrued benefit is determined without regard to cost-of-living adjustments that become effective under section 415(d) after the freeze date.

EXAMPLE: Plan B has a plan and limitation year that is the calendar year. Thus, the freeze date for Plan B is December 31, 1994. As of that date, the plan provides the normal retirement benefit in the form of a single life annuity beginning at age 65. Early retirement benefits are available at any age on or after age 60 with actuarial equivalence for early retirement computed using 5 percent interest and the UP-1984 mortality table. In addition to the QJSA under the plan, single-sum distributions are available at any permitted retirement age. Single sums are calculated as the actuarial present value of the early retirement benefit payable at the actual retirement age computed using the PBGC immediate interest rate and the UP-1984 mortality table. In accordance with section 1.417(e)-1(d), the plan further provides that any single-sum distribution must be at least as great as the actuarial present value of the participant's accrued normal retirement benefit computed using the PBGC interest rates for deferred annuities and the UP-1984 mortality table. There is no forfeiture of accrued benefits under the plan on account of death prior to the annuity starting date. Under the plan, the section 415 limitations are applied after the otherwise determined benefit has been adjusted for early retirement and for any optional form of benefit.

Participant N's SSRA is 65. As of the freeze date, Participant N has 10 years of participation in the plan. Under the plan formula as of the freeze date, Participant N's accrued normal retirement benefit is $110,000. This is Participant N's protected accrued benefit payable at normal retirement age. Any other optional form of benefit provided under the plan as of the freeze date (taking into account the limits of section 415 prior to amendment by RPA '94) is also protected.

Participant N retires in 1997 at age 60, and elects, with spousal consent, to receive a distribution in the form of a single sum. Participant N's protected single-sum distribution at retirement equals the single-sum equivalent of the protected accrued benefit under the terms of the plan. Participant N's protected early retirement benefit at age 60, determined using the plan factors based on a 5 percent interest rate and the UP-1984 mortality table, is $75,242. Under the plan, the single-sum distribution at age 60 (before the application of the limitations of section 415) is equal to the greater of the present value of $75,242 payable as a single life annuity commencing at age 60 determined using the PBGC immediate interest rate for 1997 and the UP-1984 mortality table, and the present value as of age 60 of a deferred annuity of $110,000 payable as a single life annuity commencing at age 65 determined using the PBGC interest rates for deferred annuities and the UP-1984 mortality table. Assuming that the PBGC immediate interest rate for 1997 is equal to 7 percent, and that the PBGC interest rate used for the deferred period is 6.025 percent, the resulting single sum is the greater of $738,500 (the present value of the immediate annuity) and $709,677 (the present value of the deferred annuity), or $738,500.

The plan limits under section 415(b) effective prior to amendment by RPA '94 must now be applied. First, $738,500 is adjusted so that it is equivalent to a straight life annuity commencing at age 60. For purposes of this adjustment, the interest rate used must be 7 percent, which is the greater of the rate used under the plan to compute the single sum (in this case the PBGC immediate rate of 7 percent) or 5 percent. The mortality table is the UP-1984 Table. The equivalent annual amount is equal to $75,242.

Next, the dollar limitation at age 60 must be determined. In this case, the dollar limit at age 65 taking into account Participant N's years of participation as of the freeze date and without taking into account cost-of-living increases under section 415(d) after the freeze date is $118,800. This amount is reduced to an equivalent amount payable at age 62 in accordance with section 415(b)(2)(C) by applying an adjustment factor equal to (1-(5/9 x 1%) x 36), or 80 percent. The resulting amount ($95,040) is further reduced to age 60 using an interest rate that is the greater of the rate used under the plan to determine actuarial equivalence for early retirement benefits and 5 percent along with the UP-1984 mortality table. In this case, the resulting limit is $81,870.

Because $75,242 does not exceed $81,870, the protected single sum distribution is not limited. Accordingly, Participant N's protected single sum distribution is equal to $738,500.

Q-14. Can the protected accrued benefit change after the freeze date?

A-14. The protected accrued benefit can change after the freeze date if the limitations of section 415 that apply to a participant prior to amendment by RPA '94 are changed. For example, if subsequent annual additions are credited to a participant's account in an existing defined contribution plan of the same employer, increases in that participant's defined contribution fraction could result in decreases to the protected accrued benefit (depending on the terms of the plans). The protected accrued benefit could also be reduced if the interest rate generally used under the plan to comply with section 417(e)(3) is changed as shown in the following examples.

EXAMPLE 1: Prior to amendment for RPA '94, Plan C provided that single-sum distributions were determined using the interest rates provided in sections 417(e)(3)(A)(i) and (ii), as in effect prior to RPA '94, and the UP-1984 mortality table. Plan C also provided that for purposes of computing the section 415 limitations, an interest rate equal to the greater of 5 percent or the plan interest rate would be used with the UP-1984 mortality table.

In order to reflect the section 417(e)(3) changes, Plan C is amended to substitute the applicable interest rate and the applicable mortality table for the original plan interest rate and the UP-1984 mortality table, respectively, to compute single-sum distributions under the plan. These new provisions are applied to benefits accrued both before and after the amendment date.

Prior to the section 415(b)(2)(E) changes, the interest rate required to be used to convert a single-sum distribution to an actuarially equivalent single life annuity was the greater of 5 percent and the interest rate specified in the plan. In this case the plan has been amended to use the applicable interest rate in determining benefits accrued as of the freeze date. Therefore, in order to determine the protected accrued benefit, the accrued benefit as of the freeze date taking into account the limitations of section 415 prior to amendment by RPA '94 must be redetermined. If, after the amendment, the applicable interest rate that applies to the participant's distribution is more than the greater of 5 percent and the original plan interest rate, the protected accrued benefit must be reduced accordingly. Although section 767(d)(3) of RPA '94 protects a participant's accrued benefit from being reduced merely because of the application of the section 415(b)(2)(E) changes under section 767(b) of RPA '94, use of the applicable interest rate in place of the original plan interest rate results from the application of the section 417(e)(3) changes under section 767(a) of RPA '94 to benefits accrued as of the freeze date.

EXAMPLE 2: Prior to amendment for RPA '94, Plan D provided that single-sum distributions were determined using the lesser of 6 percent and the PBGC interest rate, and the UP-1984 mortality table. Plan D also provided that for purposes of computing benefit adjustments under section 415, an interest rate equal to the greater of 5 percent and the lesser of 6 percent or the PBGC interest rate would be used with the UP-1984 mortality table.

In order to reflect the section 417(e)(3) changes, Plan D is amended after the freeze date to substitute the applicable interest rate and the applicable mortality table for the PBGC interest rate and the UP-1984 mortality table, respectively, but only with respect to benefits accruing after the amendment date. Because the amendment has no effect on the benefits accrued under Plan D as of the freeze date, the protected accrued benefit (determined as of the freeze date for the annuity starting date and optional form and taking into account the limitations of section 415 prior to amendment by RPA '94) will not be affected by the amendment.

Q-15. Are fully insured plans that meet the accrued benefit requirements of section 411(b) by satisfying the requirements of section 411(b)(1)(F) subject to the new requirements under section 415(b)(2)(E) as amended by RPA '94?

A-15. Yes, these plans are subject to all of the requirements of section 415.

Q-16. May the section 415(b)(2)(E) changes be taken into account for purposes of the minimum funding requirements under section 412 before the plan is amended to reflect these changes?

A-16. Except as provided under section 412(c)(12) or by the Commissioner, changes in plan benefits that become effective after the first day of the current plan year may not be anticipated for purposes of section 412. See section 1.412(c)(3)-1(d)(1). Because section 404(j) provides that benefits in excess of the limitations of section 415 may not be taken into account in determining a deduction under section 404, an employer that has not yet amended its plan to reflect the section 415(b)(2)(E) changes, but that is operating its plan in accordance with these changes, could be required to make nondeductible contributions to the plan. However, an employer that operates its plan in accordance with the section 415(b)(2)(E) changes is hereby permitted to anticipate the benefit change for purposes of section 412 until the earlier of the date that section 415 amendments are made or the date that section 415 amendments are required to be made to the plan.

Q-17. How is the section 415(b)(1)(B) compensation limitation adjusted for years beginning after December 31, 1994?

A-17. Section 415(d)(1)(B) provides that the section 415(b)(1)(B) compensation limitation is adjusted annually for cost- of-living increases in the case of participants who have separated from service. Section 732(b) of GATT changed the base period for computing the annual adjustments.

For a participant separating from service on or before December 31, 1994, the section 415(b)(1)(B) compensation limitation for the 1995 calendar year is computed by multiplying the participant's compensation limitation, as adjusted under prior law through the 1994 calendar year, by 1.0217. Future annual adjustment factors, that will apply to participants separating from service either before or after December 31, 1994, will be provided by the Service.

DRAFTING INFORMATION

The principal author of this revenue ruling is John Heil of the Employee Plans Division. For further information regarding this revenue ruling, contact the Employee Plans Division's taxpayer assistance number at (202) 622-6076 (not a toll-free number) between the hours of 2:30 p.m. and 4:00 p.m., Eastern Time, Monday through Thursday. Mr. Heil's telephone number is (202) 622-7383 (also not a toll-free number).