If you are an administrator for a defined benefit (DB) pension plan you are likely aware that benefits payable from qualified DB pension plans must be limited by section 415 of the Internal Revenue Code (IRC). If your plan allows for in-service distributions or for rehired participants to accrue a benefit after receiving a distribution, then you may have participants who receive two distributions at separate dates. This article addresses how to make sure your plan complies with 415 limits in the case of multiple distribution dates.

Section 1.415(b)-1(b)(1)(iii)(A) states as follows:

If a participant has or will have distributions commencing at more than one annuity starting date, then the limitations of section 415 must be satisfied as of each of the annuity starting dates, taking into account the benefits that have been or will be provided at all of the annuity starting dates.

This means that if a participant receives a distribution of plan benefits and then subsequently receives another distribution, it is not enough to make sure that the subsequent benefit payment alone satisfies section 415; the original payment must be taken into account as well.

In their session “Advanced 415 Limits” at the 2013 enrolled actuaries meeting, James E. Holland, Jr., Thomas J. Finnegan, and Michael W. Spaid presented a couple of methods for considering 415 limits when confronted with multiple distributions. One of them was based on a February 2006 letter from the American Society of Pension Professionals and Actuaries (ASPPA) to the IRS, “Comments on Multiple Annuity Starting Dates.” The remainder of this article will consider this “ASPPA approach.”

Consider a DB plan with the following features:

• In-service distribution allowed at age 62
• Normal retirement age is 65
• Plan year is the calendar year
• Participants may elect to receive their benefit as a lump sum equal to their cash balance account
• Actuarial equivalence (AE) for forms of payment not subject to 417e:
• Mortality – 417e
• Interest – lesser of 3% and 30-year Treasury rate (November look-back)
• AE for forms of payment subject to 417e:
• Mortality – 417e
• Interest – 417e (November look-back)

Now consider the following:

• Participant with 20 years of service and compensation in excess of 401(a)(17) limits elects to take an in-service distribution at age 62 and receives a lump sum payment of $2 million in 2020.
• Participant retires at age 65 and receives a lump sum of $250,000 in 2023.

First, consider the in-service distribution made in 2020. Under the plan, the cash balance amount is converted to a single life annuity (SLA):

Because the participant’s compensation was in excess of the 410(a)(17) limits, the 415 compensation limit is based on the 401(a)(17) limit for the 2017-2019 period:

The overall 415 limit is the lesser of the dollar limit for 2020 ($230,000) and the high three-year average compensation ($275,000): $230,000. The participant’s benefit expressed as an annual SLA ($111,462) is well below this.

Under the plan, the lump sum benefit is equal to the cash balance amount ($2 million). To see whether this amount is within 415 limits, we must convert the annual SLA limit ($230,000) to a lump sum in three ways:

1. Using the plan actuarial equivalence (AE)
2. Taking 105% of the result obtained by using 417e mortality and interest
3. Using 417e mortality and 5.5% interest

If the lump sum benefit of $2 million is not greater than the least of these three calculations, then the benefit satisfies 415.

Because the plan AE for 417e forms of payment (such as a lump sum) is 417e mortality and interest, we can ignore calculation #2 (it will be 105% of the result from calculation #1):

Because the lump sum benefit of $2 million does not exceed $2,948,462, the benefit satisfies 415.

Turning now to the distribution made at retirement, we follow the same procedure to see whether it satisfies 415. First, the cash balance amount is converted to a SLA:

Again, the participant’s compensation is determined by the 401(a)(17) limits:

And, again, the overall 415 limit is the lesser of the dollar limit for 2023 ($265,000) and the compensation limit ($293,333): $265,000. The annual SLA payable from the plan is far less than this.

For the lump sum, the process is as before:

As with the annual SLA, the lump sum benefit ($250,000) is far less than the 415 limit ($3,211,164).

It is not surprising that the benefit at retirement so easily satisfies 415, given that the benefit at retirement is based on only three years of benefit accrual while the in-service distribution was based on 20 years. The remaining question we must answer, however, is whether both payments (the in-service distribution and the retirement benefit) satisfy 415 as of the in-service distribution date.

To do this, we first convert the lump sums paid to annuities, as follows:

1. The conversion is done using the plan AE and the 415 AE. Whichever results in the greater amount is used.
2. The AE assumptions are those in effect as of the first annuity start date, i.e., as of the in-service distribution date. This is so that benefit amounts are definitely determinable as of the first annuity start date.

Remember, we are trying to determine whether an immediate payment of a lump sum of $2 million at age 62 and a deferred payment of a lump sum of $250,000 three years later at age 65 satisfy 415 as of the original date of distribution, i.e., age 62. In the table above we determined the annuity equivalent of the lump sum paid at age 62 ($156,014) and age 65 ($20,754). Next, we must adjust actuarially the annuity at age 65 for payment at age 62. Because the plan provides a preretirement death benefit, the adjustment is done by discounting with interest only to ASD1.

Again we compare the results of using the plan AE and the 415 AE, only this time we take the lesser value:

The combined annuity as of the original payment date is $172,622 ($156,014 + $16,608). Comparing this amount with the 415 limit as of the original payment date ($230,000), we see that the benefit does not exceed the limit, and therefore the two distributions satisfy 415 as of the original payment date.

In this example, we did not consider either early retirement or late retirement factors. The presence of either can complicate the calculation. Plan administrators should be sure to have their actuary review any calculations involving multiple annuity start dates for compliance with 415.

Our example centered on a highly paid participant who received an in-service distribution, followed by a subsequent distribution at retirement. Note that neither highly paid participants nor provisions for in-service distributions are required for there to be potential issues with section 415 and multiple payment dates.

Consider the previous example with the following changes:

• Instead of taking an in-service distribution at age 62, the participant retires at age 62 and receives a lump sum payment of $500,000 in 2020.
• The participant is rehired at age 63 and accrues a benefit until retiring again at age 65, receiving a lump sum of $25,000 in 2023.
• High three-year average compensation is $45,000.

For the distribution made in 2020, the cash balance amount, as before, is converted to a SLA: $500,000 / 17.9434 = $27,865. This is less than the 415 limit of $45,000.

To see whether the lump sum distribution is within 415 limits, we must convert the annual SLA limit ($45,000) to a lump sum in three ways:

1. Using the plan AE
2. Taking 105% of the result obtained by using 417e mortality and interest
3. Using 417e mortality and 5.5% interest

If the lump sum benefit of $500,000 is not greater than the least of these three calculations, then the benefit satisfies 415.

Because the plan AE for 417e forms of payment (such as a lump sum) is 417e mortality and interest, we can ignore calculation #2 (it will be 105% of the result from calculation #1):

Because the lump sum benefit of $500,000 does not exceed $576,873, the benefit satisfies 415.

At subsequent retirement, we follow the same procedure to see whether the distribution satisfies 415. First, the cash balance amount is converted to a SLA: $25,000 / 15.3455 = $1,629. This is less than the 415 limit of $45,000.

For the lump sum, the process is as before:

As with the annual SLA, the lump sum benefit ($25,000) is far less than the 415 limit ($545,292).

Now we look to whether both payments satisfy 415 as of the initial distribution date. We start by converting the lump sums paid to annuities, using AE assumptions as of the initial distribution date:

Next, we must adjust actuarially the annuity at age 65 for payment at age 62. Because the plan provides a preretirement death benefit, the adjustment is done by discounting with interest only to ASD1.

Again we compare the results of using the plan AE and the 415 AE, only this time we take the lesser value:

The combined annuity as of the original payment date is $40,663 ($39,003 + $1,660). Comparing this amount with the 415 limit as of the original payment date ($45,000), we see that the benefit does not exceed the limit, and therefore the two distributions satisfy 415 as of the original payment date.