For the Summer 2013 IRS CPE training (which we’ll refer to below as the “IRS CPE chapter”), one of the topics was floor-offset arrangements. For the training, a floor-offset arrangement was characterized as two separate, related plans. The “floor plan” is a defined benefit plan, and the “base plan” is a defined contribution plan. The DB plan uses a standard formula to define a minimum benefit level or floor. As described, if the DC plan account balance provides an annuity benefit which equals or exceeds the floor benefit in the DB plan, the participant receives only the DC plan benefit. If the floor benefit exceeds the DC plan annuity benefit, the DB plan pays the difference. Thus, the annuity benefit payable from the DC plan offsets the DB plan benefit.
One issue that is addressed in the IRS CPE chapter is compliance with the limitations of IRC Section 415
. The material on page 42 of the IRS CPE chapter pertains to the basic limitations of Section 415. The material on page 43 of the IRS CPE chapter states that the IRC Section 415(b) dollar limit applies to the benefit payable from the DB plan. The material then states that the “current approach is that the limit applies to the gross benefit (i.e. prior to offset).”
The material on page 43 provides an example where the gross benefit before offset is $220,000 a year, but the net benefit (after an offset of $18,000 for the DC plan benefit) is $202,000. The example states that the gross benefit would be limited to the dollar limit (then $205,000 for 2013), with a net benefit of $187,000 ($205,000 less the $18,000 offset due to the DC plan). No further legal rationale is provided for the statement or the example.
Below the authors address the question of whether the IRS CPE chapter is a correct interpretation of how Section 415 pertains to floor-offset plans. Jim Holland takes the position that the IRS CPE chapter is correct, and thus the gross benefit must be limited. Jeff Wadle takes the position the IRS CPE chapter is not correct, and only applying the Section 415 limits to the net benefit is acceptable. (Readers should note that the authors have agreed to argue a particular view and that the views expressed may or may not represent their actual views on the subject.)
Both will accept that the current Section 415 regulations (right or wrong) require that the accrued benefit be limited for a plan subject to IRC Section 411
. Also, both will accept that Revenue Ruling 76-259
(right or wrong) may generally be relied upon for compliance with the law and is the relevant authority with respect to floor offset plans. Furthermore, it is assumed for this argument that the floor offset plan is as described in the IRS CPE chapter (right or wrong) and provides that the offset is applied to the accrued benefit payable at NRD in normal form prior to conversion to any other form or payment date.
Jim: Limiting the gross benefit clearly satisfies the Section 415 requirements. Surely you agree with that. The only question is whether it is permissible to limit the net accrued benefit instead. I say it is not acceptable.
Jeff: While I agree that limiting the gross benefit will obviously comply with Section 415, that does not necessarily mean that the resulting net benefit is the Section 415 limit for a DB plan, which has other implications. For example, that resulting net benefit (Section 415 limit minus offset) should still be subject to Section 417(e) if paid in an applicable form meaning the Section 415 limits may need to be applied twice — and the final amount of that form might end up still being 100% of the Section 415 limit with no offset. But I do agree that providing the gross benefit is limited by Section 415 first — in annuity form or all forms, it is acceptable and violates no rule. To start, how about offering some reasons as to why using the net benefit is not acceptable? What requirement in the official guidance the IRS has issued says to limit the gross benefit to the Section 415 limit? (Bear in mind that a CPE chapter is not official guidance.)
Jim: Look at Rev. Rul. 76-259, which is official guidance. It provides a safe harbor for the accrual rules provided two conditions are met. The second condition is that the offset to the “benefit otherwise payable” is equal to the amount deemed provided by the vested portion of the account balance in the DC plan. The use of the words “benefit otherwise payable” would indicate that the gross benefit needs to be a benefit that could be paid in the absence of the floor offset. Therefore, the gross benefit would need to be limited to the Section 415 limit.
Now it’s my turn: Can you provide reasons as to why limiting the net benefit is acceptable?
Jeff: First, if the IRS wanted to specifically limit the gross benefit, Rev. Rul. 76-259 could have required that the gross benefit be limited. But Rev. Rul. 76-259 did not require that the gross benefit be limited; and in the absence of a specific rule, a plan can limit the net benefit. The absence of a rule means that there is no rule. Or at least that there is enough ambiguity to allow an alternative reasonable interpretation in the absence of some other legal condition which would require Section 415 to be applied on the gross benefit. The IRS has full authority to revise the Revenue Ruling to explicitly require this if they want to do so but they have not done so.
Second, even if the phrase “benefit otherwise payable” would mean after Section 415 limits are applied (which I concede is a fair position), the following paragraph of Rev. Rul. 76-259 states that the condition “will not fail to be satisfied merely because the defined benefit plan states that only a specified portion of the account balance will be the offset.” If the plan only provides that Section 415 applies to the net benefit, this is effectively equivalent to limiting the gross benefit to the Section 415 limit, and then only using a portion of the account balance for the offset.
Jim: I do not agree with that notion. The absence of a specific rule does not mean that there is no rule. It merely means that there is a lack of clarity as to what the rule actually is. Also, while I can see where you are coming from with your statement about effectively using a portion of the account balance, I think that view is problematic. The mathematical result is that the portion would not be uniform for all participants. I think that under Rev. Rul. 76-259, if only a portion of the account balance was going to be used, the portion would need to be the same for all participants. Can you point to any specific official guidance to support the view that the net benefit can be offset?
First, there is nothing I can see in Rev. Rul. 76-259 that requires any sort of uniformity on the account balances used for an offset for different participants. The rule is part of the Section 411 safe harbor for floor offsets and a plan can specify different formulas for different participants as long as each participant’s formula satisfies Section 411. There is a uniformity requirement, but that is part of the Section 401(a)(26)
rules for floor offsets, not Rev Rul. 76-259. And the regulations under Section 401(a)(26) would be one place I would look for some implicit guidance that you can apply Section 415 on the net benefit.
generally provides that an employee is treated as accruing a benefit under a plan that includes an offset if either the employee accrues a benefit under the plan for the year, or the employee would have accrued a benefit if the offset were disregarded. Pursuant to Section 1.401(a)(26)-5(a)(1)
, accruing a benefit means under the rules of Section 1.410(b)-3(a)
. Under Section 1.410(b)-3(a)(2)(ii), plan provisions that limit the benefits to the Section 415 limits can be disregarded. The impact on the Section 401(a)(26) regulations is that the gross benefit without a limit for Section 415 purposes is used for accruing a benefit. The regulations would be somewhat inconsistent in providing you ignore an offset applied after Section 415 to a benefitting concept determined before Section 415.
Jim: Hmm. Well, those regulations are only concerned with coverage (minimum coverage in the case of 401(a)(26) regulations), not how Section 415 applies. Even if the gross benefit was limited by Section 415, the cited regulations would still apply.
But speaking of regulations, let’s look at the safe harbor for floor offset arrangements found in Section 1.401(a)(4)-8(d)
. Section 1.401(a)(4)-8(d)(1)(i) generally provides that the accrued benefit (as defined in Section 411(a)(7)(A)(i))
that would otherwise be provided under the DB plan must be reduced. The accrued benefit that would otherwise be provided would have to be limited to the Section 415 limit.
Jeff: That is only a safe harbor floor offset arrangement and cannot be extrapolated to a general way that Section 415 applies to a floor offset arrangement. I do agree that the reference to the 411(a)(7)(a)(i) accrued benefit as the gross benefit would mean that the gross benefit must be limited by Section 415. But that could only be a rule with respect for the safe harbor and not a general rule for floor offsets. In addition, that meaning is only valid because of the current position that 415 is applied to accruals. While I accept that as the current position, it is not clear that this was the position at the time the 401(a)(4) regulations were adopted — and therefore it is not clear that this is the meaning that should be given to that phrase in context.
Furthermore, the inconsistency with this would be even worse than with Section 401(a)(26). Consider that the safe harbor requires that the DB formula and DC formula used for offset must both pass a form of discrimination testing. But the DB formula can pass prior to Section 415 being applied. It would be absurd to have the DB formula only be non-discriminatory prior to applying Section 415 and then apply the offset to the benefit only after Section 415 is applied.
Jim: I want to raise one final point. If one believes that Rev. Rul. 76-259 is ambiguous, the IRS could revise Rev. Rul. 76-259 (perhaps by issuing a clarifying revenue ruling) to require that the Section 415 limit be applied to the gross benefit. If that step were taken, I think you would have to agree that then there would be no argument.
Jeff: I agree that the IRS could issue formal guidance revising the Revenue Ruling and stating that the gross benefit must be limited by Section 415. If they really want to take that view, that is what they should do. However, I do not think the IRS can change the meaning on the words of an existing Revenue Ruling without formally revising the Revenue Ruling. The interpretation of the words of Rev. Rul. 76-259, to the extent there is any ambiguity, were established in 1976 and subsequent years as the IRS accepted applying Section 415 on net benefits. And taxpayers should be able to rely on that original interpretation until the IRS formally revises the Revenue Ruling.
I would note that the IRS CPE does state that applying Section 415 to gross benefits is the “current position,” which implies that this was not the prior position. I object to the concept that the IRS can change their position on the correct interpretation of ambiguous language from their own Revenue Ruling without revising the Ruling. The words continue to mean what they originally meant.
Jim: I think that we can agree that practitioners should not be shocked if IRS reviewers request that the gross benefit be limited. Whether the arguments that ensue will convince the reviewers to change their mind is another matter.
Jeff: I agree that IRS reviewers might try to take this position but, if a pre-approved plan has clear language providing that Section 415 is applied to net benefits, taxpayers should have reliance in any case on that pre-approved plan. But it would not be shocking if the IRS insists on requiring their new position for any PPA pre-approved plans. As things develop, we may have to do another article.
James E. Holland, ASA, FCA, MAAA, EA, is the Chief Research Actuary at Cheiron, Inc. in McLean, Va.
Jeffrey D. Wadle is an actuary at Greenspan & Associates in Encino, Calif.