SERVICE ISSUES ADVANCE NOTICE PROVIDING TEMPORARY GUIDANCE FOR ADMINISTRATION OF QUALIFIED RETIREMENT PLANS.

Notice 87-21

This notice provides guidance, in the form of questions and answers, with respect to the effect of certain provisions of the Tax Reform Act of 1986 (TRA'86) dealing principally with the new limitations on contributions and benefits under section 415 of the Internal Revenue Code. Until further guidance is published, the guidance provided by these questions and answers may be relied on to design and administer plans. The Service will apply the questions and answers in issuing determination letters, opinion letters, and other rulings with respect to qualified retirement plans. If future guidance is more restrictive than the guidance in this Notice, it will be applied without retroactive effect. However, no inference should be drawn regarding issues not raised which may be suggested by a particular question and answer or as to why certain questions, and not others, are included. Many areas of the changes in the limitations on benefits and contributions under section 415 are not addressed in this Notice. Further guidance will be provided at a later date.

Q-1 What changes were made in section 415 of the Code by TRA'86?

A-1 TRA'86 revised the manner of computing the section 415 limitations for both defined contribution and defined benefit plans. For defined contributions plans, TRA'86 changed the manner in which the dollar limitation is adjusted for cost-of- living increases, the treatment of employee contributions in determining annual additions, and the compensation limitation applicable to contributions for post-retirement medical benefits.

For defined benefit plans, TRA'86 increased the age at which the unreduced dollar limit applies. The dollar limit applicable to early commencement of payments was generally reduced. However, such changes do not apply to certain exempted plans and participants, such as governmental plans, plans for employees of tax-exempt organizations, police and firefighters, and commercial airline pilots. The Act also reduced the dollar limit for participants with less than 10 years of plan participation. Finally, section 415(k)(2) was added to the Code to provide for qualified cost-of-living arrangements.

Benefits accrued prior to the effective date of the changes in law are protected. A transitional rule is provided in cases where the changes to section 415 cause the sum of the defined contribution fraction and the defined benefit fraction to exceed 1.0 as of the effective date of the changes. A plan is now permitted to incorporate the requirements of section 415 by reference, with certain exceptions.

Q-2 How did TRA'86 change the limits applicable to annual additions under a defined contribution plan?

A-2 Under prior law, annual additions for a limitation year to a participant's account in a defined contribution plan were limited to the lesser of $30,000 or 25% of the participant's compensation for such year. The $30,000 limitation was subject to cost-of-living increase beginning in 1988.

Under TRA'86, the dollar limitation in section 415(c)(1)(A) of the Code for defined contribution plans shall be the greater of $30,000 or 1/4 of the dollar limitation in section 415(b)(1)(A) of the Code for defined benefit plans (currently $90,000). Consequently, the dollar limitation for defined contribution plans will not increase above $30,000 until the dollar limitation for defined benefit plans exceeds $120,000.

Q-3 How did TRA'86 change the treatment of employee contributions in determining annual additions?

A-3 Under prior law, the lesser of (i) employee contributions in excess of 6% of compensation, or (ii) one-half of employee contributions constituted an annual addition to a participant's account regardless of whether the employee contributions were made under a defined contribution plan or a defined benefit plan or whether the employee contributions were voluntary or mandatory.

Under TRA'86, all employee contributions constitute an annual addition to a participant's account. However, for purposes of computing the defined contribution fraction of section 415(e) of the Code for any year, it is not necessary to recompute annual additions (using the new rule) for limitation years beginning before 1987.

Q-4 How did TRA'86 change the limits applicable to benefits payable from a defined benefit plan?

A-4 Under prior law, the maximum annual benefit payable under a defined benefit plan was limited to the lesser of $90,000 or 100% of the participant's high three-year average compensation. The $90,000 limitation was to be increased beginning in 1988 for cost-of-living changes. The dollar limitation of $90,000 was reduced if benefit payments commenced before age 62 and increased if benefit payments commenced after age 65. However, the dollar limitation was not reduced below $75,000 for a benefit payment commencing at, or after, age 55. The 100% of high three-year average compensation limitation applied regardless of the age at which benefit payments commenced. TRA'86 changes the $90,000 limitation by providing that it applies to benefit payments commencing at the participant's "social security retirement age" In the event that a participant's benefit payments commence before the social security retirement age, the $90,000 limit must be actuarially reduced to the participant's age at commencement; the $75,000 floor applicable to benefit payments commencing on or after age 55 is eliminated. The $90,000 limit may be increased for benefit payments commencing after the participant's social security retirement age.

The "social security retirement age" is defined as the retirement age under section 216(l) of the Social Security Act, applied as if the early retirement age under section 216(1)(2) of such Act were age 62. Accordingly, the social security retirement age is 65 for a participant attaining age 62 before January 1, 2000 (i.e., born before January 1, 1938), 66 for a participant attaining age 62 after December 31, 1999, and before January 1, 2017 (i.e., born after December 31, 1937, but before January 1, 1955), and 67 for a participant attaining age 62 after December 31, 2016 (i.e., born after December 31, 1954).

TRA'86 does not alter the 100% of compensation limitation of prior law. Also, the $90,000 limit is scheduled to increase beginning in 1988 for cost-of-living changes, as under prior law.

Q-5 How did TRA'86 change the manner in which the maximum dollar benefit is reduced for the early commencement of benefit payments under a defined benefit plan?

A-5 Under prior law, if a participant's benefit payments commenced on or after age 62 and before age 65, the $90,000 limit applied. If the payments commenced prior to age 62, the $90,000 limit was actuarially adjusted to be equivalent to an annual benefit of $90,000 commencing at age 62. However, the $90,000 limitation was not reduced below $75,000 for benefit payments commencing on, or after, the attainment of age 55. (Question and Answer G-3 of , 1983-1 C.B. 536, discusses the manner in which the $90,000 limitation is actuarially reduced.)

TRA'86 modifies the actuarial equivalence factors used in reducing the $90,000 limit for benefits commencing prior to the social security retirement age. In addition, the $75,000 floor for benefit payments commencing on, or after, the attainment of age 55 is eliminated.

The dollar limitation applicable to benefit payments commencing on or after age 62 is computed using a reduction factor determined in a manner that is consistent with the reduction for old-age social security benefits commencing before the social security retirement age. Thus, if a participant's social security retirement age is 65, the applicable dollar limitation for benefits commencing on or after age 62 is reduced by 5/9 of 1% for each month by which benefits commence before the month in which the participant attains age 65. If a participant's social security retirement age is greater than 65, the dollar limitation for benefits commencing at or after age 62 is determined by reducing the $90,000 limitation by 5/9 of 1% for each of the first 36 months and 5/12 of 1% for each of the additional months (up to 24 months) by which benefits commence before the month of the participant's social security retirement age.

The dollar limitation for benefits commencing prior to age 62 is the actuarial equivalent of the limitation for benefits commencing at age 62, with the dollar limitation for benefits commencing at age 62 reduced for each month by which benefits commence before the month in which a participant attains age 62. As under prior law, in determining actuarial equivalence for this purpose, it is generally necessary to use a reasonable mortality table. However, the mortality decrement may be ignore to the extent that a forfeiture does not occur at death. The interest rate used must be the greater of 5% or the rate specified in the plan for determining actuarial equivalence for early retirement. Thus, a separate interest rate may not be specified solely for the purpose of adjusting the dollar limitation for commencement of benefits prior to age 62. (See G- 3 of , 1983-1 C.8. 536).

For example, if a participant's social security retirement age is age 66 and the age at which benefit payments commence is age 64 and 6 months, the dollar limitation is reduced by 10% (5/9 of 1% per month times 18 months). If the age at which benefit payments commence is age 62, the dollar limitation is reduced by 25% which is equal to the sum of (i) the product of 5/9 of 1% per month times 36 months (20%), and (ii) 5/12 of 1% per month times 12 months (5%). Thus, the dollar limitation for benefits commencing at age 64 and 6 months is $81,000 (90% of $90,000) and the dollar limitation for benefit payments commencing at age 62 is $67,500 (75% of 90,000). If benefit payments commence prior to age 62, the applicable dollar limitation is $67,500 actuarially reduced from age 62 to the age benefit payments commence, with the $67,500 limitation for benefits commencing at age 62 reduced for each month by which benefit payments commence before the month in which the participant attains age 62.

Q-6 Are all defined benefit plans and participants subject to the revised dollar limits applicable to benefit payments commencing prior to the social security retirement age?

A-6 No. Certain plans and participants are subject to the following special rules:

(1) For governmental plans (within the meaning of section 414(d)), plans maintained by tax-exempt organizations (other than governmental units), and qualified merchant marine plans, the adjustments to the $90,000 limitation for early or deferred commencement of payments shall be determined as under prior law. (For this purpose, the term "qualified merchant marine plan" means a plan in existence on January 1, 1986, the participants in which are qualified merchant marine officers holding licenses issued by the Secretary of Transportation under Title 46, United States Code.)

(2) For participants in a plan maintained by a State or political subdivision thereof, who are credited with at least 20 years of service for benefit accrual purposes in such plan as either (i) a full-time employee of any police department or fire department, of such State or political subdivision, providing police protection, firefighting services, or emergency medical services, or (ii) a member of the Armed Forces of the United States, the adjustment to the $90,000 limitation for early or deferred benefit commencement shall be determined as under prior law, with the exception that the maximum dollar limitation at any age for such participants shall not be less than $50,000.

(3) For commercial airline pilots who are required to separate from service as a commercial airline pilot, pursuant to Federal Aviation Administration regulations, after attaining a certain age which is on or after age 60 but before the social security retirement age, the dollar limitation under section 415(b)(1)(A) shall be $90,000 at the age separation from service is required. The dollar limitation at any earlier age is the actuarial equivalent of the $90,000 limitation at such age. However, the dollar limitation applicable to benefit payments commencing on or after age 55 shall not be reduced below $75,000, and the dollar limitation applicable to benefit payments commencing prior to age 55 shall not be less than the actuarial equivalent of the $75,000 limitation at age 55. However, if a participant described above separates from service prior to age 60, the adjustments to the $90,000 limitation for early or deferred commencement of payments shall be determined as under prior law (that is, reduced for commencement before age 62).

(4) As under prior law, for individuals who were participants of defined benefit plans at any time before October 3, 1973, the transitional rule of section 1.415-4(a) of the regulations will continue to apply, provided the conditions and special rules of section 1.415-4(b) and (c) of the regulations are met. For such a participant, the denominator of the defined benefit fraction under section 415(e)(2) is deemed to equal the numerator of such fraction multiplied by 1.25, or 1.0 if section 416(h)(1) of the Code applies to the plan.

Q-7 How did TRA'86 change the limitation of section 415(b)(5)?

A-7 Under prior law, the limitations on annual benefits found in section 415(b)(1) (i.e., currently the lesser of $90,000 or 100% of the high three-year average compensation) and section 415(b)(4) (i.e., $10,000 available to certain participants) were proportionately reduced for participants having less than 10 years of service with the employer.

Under TRA'86, the dollar limitation of section 415(b)(1)(A) is reduced for participants with less than 10 years of participation in the plan. Specifically, the dollar limitation of section 415(b)(1)(A) is multiplied by a fraction, the numerator of which is the number of years (computed to fractional parts of a year) of participation in the defined benefit plan of the employer, and the denominator of which is 10. The compensation limitation of section 415(b)(1)(B) and the special $10,000 benefit limitation of section 415(b)(4) are reduced for participants with less then 10 years of service with the employer as under prior law. However, in no event will such adjustments for years of participation or service, as applicable, reduce the limitations of section 415(b)(1)(A), (1)(B) and (4) to amounts less than 1/10 of such limitations determined without such adjustments.

For purposes of determining a participant's years of participation for the adjustment required by section 415(b)(5)(A) to the dollar limitation of section 415(b)(1)(A), the participant shall be credited with a year of participation (computed to fractional parts of a year) for each accrual computation period for which the following conditions are met: (1) the participant is credited with at least the number of hours of service, or period of service if the elapsed time method is used for benefit accrual purposes, required under the terms of the plan in order to accrue a benefit for the accrual computation period, and (2) the participant is included as a plan participant under the eligibility provisions of the plan for at least one day of the accrual computation period. If these two conditions are met, the portion of a year of participation credited to the participant shall equal the amount of benefit accrual service credited to the participant for such accrual computation period. For example, if under the terms of a plan, a participant receives 1/10 of a year of benefit accrual service for an accrual computation period for each 200 hours of service, and the participant is credited with 1,000 hours of service for the period, the participant is credited with 1/2 a year of participation for purposes of section 415(b)(5)(A). A participant who is permanently and totally disabled within the meaning of section 415(c)(3)(C)(i) for an accrual computation period shall receive a year of participation with respect to that period. In addition, for a participant to receive a year of participation (or part thereof) for an accrual computation period, the plan must be established no later than the last day of such accrual computation period. In no event will more than one year of participation be credited for any 12-month period.

In addition, under section 415(b)(5)(D) the reductions specified in section 415(b)(5) as amended by TRA'86 shall apply separately to each change in benefit structure of a plan, to the extent provided in regulations. Any amendment changing the benefit structure of a plan that is adopted and made effective prior to the issuance of regulations under section 415(b)(5)(D) shall not be subject to section 415(b)(5)(D). However, changes in benefit structure effective after regulations are issued for such purpose will be subject to section 415(b)(5)(D) even if the amendment is adopted prior to the issuance of regulations.

In calculating the adjustments to the limitations of section 415 required by section 415(b)(5) for purposes of determining the denominator of the defined benefit fraction under section 415(e)(2) for any limitation year, the years of participation or service, as applicable, that are used shall include future years occurring before the participant's normal retirement age. For purposes of the preceding sentence, years of participation or service, as applicable, may include the future year including the date the participant reaches normal retirement age provided that it can be reasonably anticipated that the participant will receive a year of participation or service, as applicable, for such year. In projecting years of participation or service for future years, it may be assumed that a participant is a full- time employee if the participant is currently a full-time employee.

Q-8 When are the TRA'86 changes to section 415 of the Code effective?

A-8 The amendments to section 415 of the Code made by TRA'86 are generally effective for limitation years beginning after December 31, 1986. (See section 1106(i)(1) of TRA'86.) A special rule is provided in section 1106(i)(2) of TRA'86 for participants in plans maintained pursuant to collective bargaining agreements ratified before March 1, 1986; however, such delayed effective date is applicable only to plan participants covered by such agreements. For such participants, the amendments to section 415 shall not be effective for limitation years beginning before the earlier of (1) the date on which the last of such collective bargaining agreements terminates (determined without regard to any extension agreed to after February 28, 1986), or (2) January 1, 1989.

Q-9 When must plans be amended for qualification purposes to comply with the changes made to section 415 of the Code by TRA'86?

A-9 Section 1140 of TRA'86 generally provides that any amendment to a qualified retirement plan that is required for qualification purposes as a result of changes made by TRA'86 (including amendments required as a result of the changes to section 415 of the Code) is not required before the first plan year beginning on or after January 1, 1989, provided the following conditions are met:

(1) During the period between the effective date of the changes (discussed in Q&A-8) and the date the plan is amended for such changes, the plan must be operated in accordance with the requirements of the changes in law or in accordance with an amendment prescribed by the Secretary of the Treasury and adopted by the plan.

(2) Any amendment incorporating the section 415 changes made by TRA'86 that is adopted after the effective date of such changes must apply retroactively to the effective date.

(3) The plan is amended to comply with the required changes no later than the last day of the first plan year beginning on or after January 1, 1989, or upon plan termination, if earlier.

During the period a plan is operated in accordance with the above conditions, the plan will not be disqualified solely because compliance with the above conditions causes the plan to (1) provide benefits that are not definitely determinable or (2) fails to be operated in accordance with its terms. A plan will not be treated as being operated in accordance with the changes in law during the period described in (1) and will cease to be qualified if, during this period, an annual addition is made or a benefit is accrued or paid in excess of the applicable TRA'86 section 415 limits. An exception is permitted for a lump sum distribution meeting the conditions of section 1124 of TRA'86. (See Q&A-13 concerning the elimination of excess accruals where distributions of such amounts have not yet been made.)

A special rule is provided for a plan maintained pursuant to one or more collective bargaining agreements ratified before March 1, 1986. In such a case, the above rules are applied by replacing "the first plan year beginning on or after January 1, 1989" with "the first plan year beginning after the earlier of -

(1) the later of January 1, 1989, or the date on which the last of such collective bargaining agreements terminates (determined without regard to any extension of such agreement after February 28, 1986), or

(2) January 1, 1991."

Q-10 Is a plan amendment reflecting the changes in section 415 of the Code required to be made before the date required under section 1140 of TRA'86 in order to satisfy Code section 411(d)(6) and Code section 412?

A-10 No. In order for a plan to satisfy section 1140 of TRA'86, the plan must be operated in accordance with the new section 415 limits notwithstanding any conflicting plan provision. Because adherence to plan provisions that permit accruals in excess of the section 415 limits may preclude a plan from satisfying the operational rule of section 1140 of TRA'86, such plan provisions are deemed to be ineffective to the extent the plan satisfies the operational rule. Plans that operationally satisfy the section 415 limits as amended by TRA'86 will be treated as though they were amended to the extent necessary to satisfy the new section 415 limits. Thus, a plan that satisfies section 1140 of TRA'86 is deemed not to provide benefits in excess of the TRA'86 section 415 limits. When the plan is retroactively amended by the date specified in section 1140 of TRA'86 to comply with the required section 415 changes, there is no section 411(d)(6) reduction of an accrued benefit because no benefits will be treated as having accrued in excess of the TRA'86 section 415 limits.

For plans subject to the minimum funding requirements of section 412 of the Code, the written terms of the plan must be used to determine the minimum required contribution. (See section 1.412(c)(3)-1(d)(1) of the Income Tax Regulations.) Section 1140 of TRA'86 provides an exception to this rule. Since plans that are operated in accordance with the TRA'86 section 415 limits pursuant to section 1140 of such Act are treated as not permitting benefit accruals in excess of such limits, any such excess benefits under the written terms of the plan are to be disregarded in determining the minimum required contribution.

In accordance with section 404(j) of the Code, benefits in excess of the section 415 limits may not be taken into account in determining the deductible limits under section 404 for that year. In applying section 404(j), the changes in the section 415 limitations made by TRA'86 are treated as changes in the benefit structure of the plan effective as of the first day of the first limitation year beginning after 1986. The deductible limit calculated for the first plan year for which the new limits apply is linked to the appropriate taxable year of the employer using one of the rules described in section 1.404(a)- 14(c) of the regulations. In determining the deductible limit with respect to such plan year, Rev. Rul. 77-2, 1977-1 C.B, 120, applies. However, the exception in section 3 of that ruling does not apply to changes covered by section 404(j).

In certain situations, TRA'86 increased the section 415 limitations for defined benefit plans (e.g., the limits applicable to commercial airline pilots). Plans must be amended to take advantage of such increases. They may not use the increased limitations in operation without having been amended.

Plans that are operated in accordance with the new section 415 limitations pursuant to section 1140 of TRA'86 must be amended retroactively to comply with the required changes no later than the last day of the first plan year beginning on or after January 1, 1989, or such later or earlier date as specified in Q&A-9. Prior to such amendment, the plan will not be considered to comply operationally with section 415 if the plan pays out benefits in excess of the new limitations. (See Q&A-9.)

If plans are not amended by the date required in Q&A-9, such plans will retroactively cease to be qualified as of the effective date of the changes made to section 415 by TRA'86. In addition, such plans must retroactively restore any accruals in excess of the TRA'86 section 415 limits that were operationally treated as having not accrued. Also, the minimum funding requirements must be retroactively redetermined for all plan years for which the TRA'86 section 415 limits were reflected in accordance with the operational rule of Q&A-9.

In order to assure that plans are amended for the new section 415 requirements for plan years beginning before the plan year for which the plan is required to be amended pursuant to Q&A-9, the Service has developed a simplified plan amendment that implements the new limits. Adoption of the amendment by plan sponsors, including sponsors of master and prototype plans, will not adversely affect the qualified status of the plan or the right to rely on a prior letter issued with respect to the qualification of the plan. Therefore, the Internal Revenue Service shall not issue a determination or opinion letter with respect to this amendment. The simplified amendment may be used only until a plan is amended by an individually designed amendment or the model amendment contained in Notice 87-2, 1987- 2 I.R.B. 17. Such second amendment must be made no later than the date specified in Q&A-9. Thus, the simplified model amendment will not apply to the first plan year beginning on or after January 1, 1989, or the plan year of termination, if earlier. (A delayed date is applicable to participants covered under certain collective bargaining agreements).

PLAN AMENDMENT

"In addition to other limitations set forth in the Plan and notwithstanding any other provisions of the Plan, the accrued benefit, including the right to any optional benefits provided in the Plan (and all other defined benefit plans required to be aggregated with this Plan under the provisions of section 415 of the Internal Revenue Code of 1986), shall not increase to an amount in excess of the amount permitted under section 415 of such Code at any time. Notwithstanding any provision of this Plan to the contrary, for purposes of the preceding sentence and for purposes of determining whether the benefits of this Plan exceed the limitations of section 415 of such Code, with respect to limitations years beginning after December 31, 1986, the term "annual addition" shall include all employee contributions to the Plan. This shall not require the recomputation of annual additions for limitation years beginning before January 1, 1987. For purposes of this paragraph and determining compliance with section 415 of the Code, compensation shall mean compensation as defined in section 415(b)(3) and the regulations thereunder."

Q-11 May a plan incorporate by reference the limitations under section 415 of the Internal Revenue Code of 1986?

A-11 Yes. Effective for limitation years beginning after December 31, 1986, TRA'86 permits a plan to incorporate by reference the limitations of section 415 of the Code. A plan will not fail to meet the definitely determinable benefits requirements merely because it incorporates the limits by reference, However, if a limitation of section 415 may be applied in more than one manner, the plan must specify the manner in which the limitation is to be applied instead of incorporating the limitation by reference. For example, if an employee participates in both a defined contribution plan and a defined benefit plan maintained by the same employer, the manner in which adjustments must be made to comply with the combined plan limitation of section 415(e) must be specified. If an employee participates in two or more defined contribution plans (or two or more defined benefit plans) maintained by the same employer, the manner in which annual additions are restricted (or annual benefits are restricted for defined benefit plans) to comply with the aggregate 415(c) limitations (or 415(b) limitations for defined benefit plans) must be specified. Also, in certain limited circumstances, section 1.415-6(b)(6) of the Income Tax Regulations permits a suspense account for excess annual additions. The regulations provide several alternative methods for establishing a suspense account and allocating amounts held in the suspense account. The plan must specify which method is to be used. Future regulations will provide additional guidance on which limitations of section 415 may be applied in more than one manner.

Q-12 Are benefits accrued as of the TRA'86 effective date for section 415 protected?

A-12 Yes. Section 1106(i)(3) of TRA'86 protects the "current accrued benefit" for any individual who is a participant in a defined benefit plan as of the first day of the first limitation year to which the changes made by TRA'86 apply provided the plan was in existence on May 6, 1986, and satisfied the applicable section 415 limits for all limitation years before the changes in section 415 made by TRA'86 become effective. For purposes of determining if a plan was in existence on May 6, 1986, the rules expressed in T-1 of apply,

The "current accrued benefit" is the participant's accrued benefit as of the close of the last pre-TRA'86 limitation year (determined as if the individual separated from service as of the end of that year) but determined without regard to changes in the terms and conditions of the plan or cost-of-living increases occurring after May 5, 1986. A change in the limitation year is considered a change in the terms and conditions of the plan for this purpose. A change in the terms and conditions of the plan made pursuant to a collective bargaining agreement that was ratified before May 6, 1986, is considered a change in the plan made before May 6, 1986, even if the plan amendment making such change is adopted after May 5, 1986. The current accrued benefit includes optional benefit forms and early retirement benefits or retirement-type subsidies that are protected under section 411(d)(6) of the Code.

If the protected current accrued benefit for a participant is larger than the applicable limitation of section 415(b)(1)(A) as amended by TRA'86, such limitation shall equal the protected current accrued benefit in applying the limitations of section 415(b) and (e). Thus, the protected current accrued benefit is reflected in the denominator of the defined benefit fraction and in making the numerator adjustment to the defined contribution fraction described in Q&A-14, (However, the current accrued benefit is not subject to cost-of-living adjustments pursuant to section 415(d).)

Thus, for a plan that is not top-heavy, if a participant has a current accrued benefit of $88,000, and if the dollar limit under section 415 as amended by TRA'86 (prior to recognizing the current accrued benefit but after the adjustment required by section 415(b)(5)) is $84,000, the defined benefit fraction for the participant would be .8, computed as $88,000 divided by the product of 1.25 and $88,000.

For an insured plan that meets the accrued benefit requirements of section 411(b) of the Code by satisfying the requirements of section 411(b)(1)(F) of the Code and section 1.411(b)-1(d)(2) of the regulations, the current accrued benefit for a participant that is protected by section 1106(i)(3) of TRA'86 is the cash surrender value of the insurance contracts as of the close of the last pre-TRA'86 limitation year, with such cash surrender value determined in the manner specified in section 1.411(b)- 1(d)(2) of the regulations.

Q-13 What will happen if, as of the beginning of the first limitation year beginning after 1986, the TRA'86 section 415 defined benefit limits are not satisfied?

A-13 As of the first day of the first limitation year beginning after December 31, 1986, accrued benefits for participants of some plans may exceed the TRA'86 benefit limitations (including the protected current accrued benefit). For example, accruals due to either changes in the terms and conditions of the plan made after May 5, 1986, or the establishment of a plan after that date may result in accruals in excess of the TRA'86 section 415(b) limits as of the first day of the first limitation year beginning after 1986. Future regulations will provide that such plans will be allowed to reduce such excess accrued benefits to the level permitted under TRA'86 without violating section 411(d)(6) of the Code. As stated in Q&A-9, if such excess accruals are not eliminated (i.e., reduced), the plan will cease to be qualified. To avoid this result, such excess accruals must be eliminated as of the first day of the first limitation year to which the changes to section 415 made by TRA'86 apply. The excess accruals may be eliminated operationally until a plan is amended for the changes in section 415 made by TRA'86 for a plan using the operational rule of Q&A-9.

Q-14 How is the defined contribution fraction adjustment described in section 1106(i)(4) of TRA'86 computed?

A-14 Section 1106(i)(4) of TRA'86 provides for an adjustment to the defined contribution fraction as soon as TRA'86 becomes effective to assure that the sum of the defined contribution fraction plus the defined benefit fraction (both computed under the TRA'86 rules) does not exceed 1.0 as of that date. This adjustment applies only if both the defined contribution plan and the defined benefit plan were in existence on May 6, 1986, and if both plans satisfied the requirements of section 415 for the last limitation year beginning before January 1, 1987. In addition, the adjustment will be made only after any accruals in excess of the TRA'86 section 415 limits are reduced as described in Q&A-13. The adjustment to the defined contribution fraction will be made after the elimination of any such excess accruals, or ignoring any excess accruals if the excess accruals are not eliminated. In addition, changes in the terms and conditions of the plan made after May 5, 1986, may not be recognized in making the defined contribution fraction adjustment.

The adjustment is to permanently subtract from the defined contribution fraction numerator an amount equal to the product of:

(a) the sum of the defined contribution fraction plus the defined benefit fraction as of the determination date minus one, times

(b) the denominator of the defined contribution fraction as of the determination date.

For purposes of (a) and (b), above, the determination date is the day immediately preceding the first limitation year beginning after 1986. Also, in (a) and (b) both fractions are computed in accordance with section 415 as amended by TRA'86 and section 1106(i)(3) of TRA'86. (Therefore, the protected current accrued benefit is used in the numerator and denominator of the defined benefit fraction in making this adjustment to the extent it is greater than the otherwise applicable limitation. See Q&A- 12.)

The following example illustrates the reduction. An individual is a participant in both a defined contribution plan and a defined benefit plan of an employer. The limitation year for each plan is the calendar year. The plans are not top-heavy within the meaning of section 416(g) of the Code. As of December 31, 1986, the defined contribution numerator is $150,000 and the defined contribution denominator is $500,000. The social security retirement age of the participant is 66 and the normal retirement age under the terms of the defined benefit plan is 65. The participant will have 10 years of participation, within the meaning of Q&A-7, at normal retirement age. The participant's projected annual benefit within the meaning of section 1.415-7(b)(3) of the regulations, after the application of section 415(e) under prior law but before the application of section 415(e) under TRA'86, is $78,750. The participant's high three-year average compensation for purposes of section 415(b) is $100,000. Therefore, under prior law the participant's defined contribution fraction is .3 ($150,000 divided by $500,000), and the participant's defined benefit fraction is .7 ($78,750 divided by the product of 1.25 times $90,000).

Under TRA'86, the maximum dollar limitation applicable to the participant at age 65 is $84,000 ($90,000 reduced by 5/9 of 1% per month for 12 months). Therefore, under TRA'86, the defined benefit fraction is .75 ($78,750 divided by the product of 1.25 times $84,000), and the defined contribution fraction is .3. The sum of the two fractions is 1.05. The amount subtracted from the defined contribution fraction numerator would be $25,000 (.05 times $500,000). A denominator of $105,000 (1.25 times $84,000) is used in the defined benefit fraction even if the defined benefit plan had terminated prior to the first limitation year beginning after December 31, 1986.

Q-15. Will a defined benefit or defined contribution plan providing a pre-retirement death benefit be required to reduce the amount of the death benefit in order to satisfy the incidental death benefit rules of section 1.401-1(b)(1) of the Income Tax Regulations because the anticipated normal retirement benefits or employer contributions are reduced to the extent necessary to satisfy the changes to section 415 of the Code made by TRA'86?

A-15 The incidental death benefit rules under section 1.401-1(b)(1) of the Income Tax Regulations limit the death benefits that may be provided by a qualified plan. Such limits relate either the death benefits to the anticipated normal retirement benefits or the costs of the death benefits to employer contributions (including forfeitures). The death benefits provided under a qualified plan must reflect any limitation on the normal retirement benefits or employer contributions imposed by section 415 of the Code. Pursuant to T-8 of , in certain cases, death benefits in excess of incidental death benefits were permitted provided such excess death benefits resulted from the reduction in the section 415 limitations by the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA).

Due to the changes to the section 415 limits made by TRA'86, death benefits from qualified plans may need to be reduced to avoid violating the incidental death benefit requirements. Death benefits that become in excess of the incidental death benefit limits because of the changes to section 415 made by TRA'86 may no longer be provided. However, death benefits (expressed as a dollar amount) that were protected pursuant to T-8 of will continue to be protected provided the conditions stated in T-8 for such protection are met.

In order to allow plans the time needed to comply with the reduced limits for incidental death benefits, plans are not required to reduce death benefits that had been provided prior to the effective date for the plan of the changes to section 415 made by TRA'86 to the level necessitated by such changes for the period beginning on such effective date and ending on the day before the first day of the first plan year beginning after December 31, 1987. This relief is provided pursuant to section 7805(b) of the Code. The Service solicits comments to determine if the required reductions in the incidental death benefit limits due to the amendments to section 415 made by TRA'86 are unduly burdensome for plans and plan participants. Comments should be addressed to: Internal Revenue Service OP:E:EP:PA, Attention: John F. Wade, 1111 Constitution Avenue, N.W., Washington, D.C. 20224.

During the period the relief described above is provided, the death benefits provided by a plan will be deemed to satisfy the incidental death benefit rules if the death benefits (1) satisfied the incidental death benefit rules (including the provisions of T-8 of Notice 83-10) prior to the effective date of the changes in section 415 made by TRA'86, (2) the death benefit expressed as a dollar amount provided by the plan is not increased for any participant unless the total death benefit as increased would satisfy the incidental death benefit rules without this relief (or without the relief granted under T-8 of ), and (3) the anticipated normal retirement benefits or employer contributions are decreased only to the extent required by section 415. The preceding sentence applies only to changes mandated by TRA'86 under section 415. The mere use of dividends on participating individual insurance contracts under a defined contribution plan to purchase additional insurance of the same type will not violate (2) above. Furthermore, this section 7805(b) relief is solely with respect to the incidental death benefit rules and does not permit any violations of section 415 that could result if the maintenance of the death benefits under retirement income or annuity contracts also results in the maintenance of pension benefits that violate section 415. This relief is not available to the extent that decreases in retirement benefits or employer contributions are generated operationally because of either decreased compensation of participants or changes because of operational coordination under section 415(e).

Even though certain unreduced death benefits are considered incidental for the period described above, benefits may be retained only if the results are not discriminatory. See T-8 of for a more detailed explanation.

A plan is not required to be amended to comply with the reduced incidental death benefit limits until the date the plan is required to be amended to comply with the changes to section 415 of the Code made by TRA'86, provided the conditions stated in Q&A-9 are met. Therefore, in operation the plan must comply with the reduced incidental death benefit limits as of the first day after the end of the above described relief period. As stated in Q&A-9, during the period the plan is applying the reduced incidental death benefit limits in operation, the plan will not be disqualified solely because such operational compliance causes the plan to (1) provide benefits that are not definitely determinable or (2) fail to be operated in accordance with its terms.

Q-16 Is there any change in the application of Rev. Rul. 85-131 because of the change to section 415(b)(5) requiring 10 years of participation for the dollar limitation?

A-16 Yes. Although the basic principles of Rev. Rul. 85-131 have not changed, the effect of these principles on a particular situation may be modified because of the change to section 415(b)(5) to reduce the dollar limit of section 415(b)(1)(A) for participants with less than 10 years of participation. The provision of section 415(b)(5)(C) which stipulates that section 415(b)(5) does not reduce the limitations of sections 415(b)(1)(A), (1)(B), and (4) below 1/10 of such limitations without adjustment must also be taken into account. Thus, because of the 10 years of participation requirement, a participant may accrue benefits at a rate nor greater than 10 percent of the dollar limitation per year of participation. (The percentage limitation of section 415(b)(1)(B) may result in a lower rate of accrual.) Currently, therefore, with the exceptions for a current accrued benefit and the provisions of sections 415(b)(5)(C) and (b)(4), a participant's accrued benefit may not exceed 1/10 of the applicable dollar limitation ($9,000 if the applicable dollar limitation is $90,000) multiplied by the number of years of participation. Rev. Rul. 85-131, however, provided for a past service benefit where a participant had the requisite years of service. Because the phase-in of the dollar limitation is now based on years of participation, the past service benefit and resulting amortization base of Rev. Rul. 85-131 are no longer allowed, except to the extent permitted due to the exceptions of the current accrued benefit and the provisions of sections 415(b)(5)(C) and (b)(4). The benefits that had been attributed to past service under the revenue ruling and now are no longer so attributed will now be attributable to future years of participation and will be deductible as part of the normal cost of future years. This is true for both career average and final average pay plans.

Q-17 How is the defined benefit fraction affected if a defined benefit plan is amended after May 5, 1986, but before the effective date of the changes made to section 415 by TRA'86, to increase either projected or accrued benefits?

A-17 If a defined benefit plan is amended after May 5, 1986, but before the first limitation year beginning on or after January 1, 1987 (the 1987 limitation year) to increase accrued benefits to a level below the section 415 limits for the pre-TRA'86 limitation years but above the section 415 limits for the 1987 and subsequent limitations years, such excess accruals are not reflected in the denominator of the defined benefit fraction for the 1987 and subsequent limitation years or in making the numerator adjustment to the defined contribution fraction described in Q&A-14. This is the case even if the plan is terminated prior to the 1987 limitation year. The excess accruals are reflected in the numerator of the defined benefit fraction for 1987 and subsequent limitation years, however, to the extent they are not eliminated as provided in Q&A-13. (Such excess accruals are not included in the current accrued benefit, either. See Q&A-12.) In addition, any increase in the projected annual benefit, within the meaning of section 1.415-7(b)(3) of the regulations, due to a plan amendment made after May 5, 1986, is ignored in computing the numerator adjustment to the defined contribution fraction described in Q&A-14.

This may be illustrated by the following example. A defined benefit plan with calendar year limitation and plan years is amended after May 5, 1986 to increase benefits. The plan is terminated after the plan is amended and prior to January 1, 1987. The accrued benefit of one of the plan participants upon termination of the plan is $80,000. The participant receives a lump sum distribution before January 1, 1987, equal to the present value of the accrued benefit of $80,000. If the plan had not been amended, the participant's accrued benefit would have been $70,000, and the participant's projected annual benefit within the meaning of section 1.415-7(b)(3) of the regulations would have been $71,000. The participant has a high three-year average compensation of $90,000.

The participant's social security retirement age is age 65. Normal retirement age under the terms of the plan is age 62. The participant has not attained age 62 at the time the lump sum distribution is made. The actuarial equivalence factors used in computing the amount of the lump sum distribution are the same as the factors applicable to adjusting the dollar limitation for early commencement of payment. The participant is also a participant in a defined contribution plan sponsored by the same employer. The plans at all times were in compliance with section 415 of the Code prior to the effective date of the section 415 changes made by TRA'86. The plans are not top-heavy. The participant has more than 10 years of participation in the defined benefit plan.

The maximum annual benefit commencing at age 62 for the participant from a defined benefit plan under section 415(b) as amended by TRA'86 is $72,000 ($90,000 reduced by 5/9 of 1% for 36 months). In determining the adjustment to the numerator of the defined contribution fraction as described in Q&A-14, accruals in excess of the section 415 limits as amended by TRA'86 and increases in projected benefits due to amendments after May 5, 1986 are ignored. Thus, a defined benefit fraction of .7889 ($71,000 divided by the product of 1.25 and $72,000) is used in making the numerator adjustment of section 1106(i)(4) of TRA'86. Therefore, the participant's defined contribution fraction after adjustment must be no more than .2111. However, the participant's actual defined benefit fraction for 1987 is .8889, computed by using the actual accrued benefit of $80,000 distributed from the defined benefit plan divided by the product of 1.25 and $72,000. Therefore, if the participant's defined contribution fraction as of the last day of the 1987 limitation year is in excess of .1111, the combined plan limitation of section 415(e) will be exceeded for 1987. (This may occur even if no annual addition is made for the participant for 1987.) If this occurs, the defined contribution plan will cease to be qualified in 1987.

Q-18 Do the notice requirements of section 204(h) of the Employee Retirement Income Security Act of 1974 (ERISA) apply to plan amendments to qualified plans that are made due to the changes to section 415 of the Code made by TRA'86?

A-18 No. Section 204(h) of ERISA requires that the plan administrator provide notice to participants and certain other parties whenever a plan is amended to provide for a significant reduction in the rate of future benefit accruals. Because amendments to qualified plans incorporating the TRA'86 section 415 limitations are required for plans to maintain qualified status, such amendments are not subject to the notice requirements of section 204(h) of ERISA. However, if other significant reductions in the rate of future benefit accruals are made in addition to the reductions in the rate of future benefit accruals required due to the changes in section 415 made by TRA'86, the notice requirements of section 204(h) of ERISA may apply.

Q-19 If a defined benefit plan is terminated prior to the effective date of the TRA'86 amendments to section 415, is the denominator of the defined benefit fraction for limitation years beginning on or after the TRA'86 effective date determined using the dollar limitation under the law in effect at the time the plan is terminated?

A-19 No. For limitation years beginning on or after December 31, 1986, the denominator of the defined benefit fraction is determined using the dollar limitation under section 415 as amended by TRA'86 even if the plan terminated in a prior limitation year.

This may be illustrated by the following example. A participant receives a lump sum distribution in 1986 of an annual accrued benefit of $45,000 pursuant to a plan termination in 1986. At the time of plan termination, the participant is age 62. The limitation year is the calendar year. For the 1986 limitation year, the participant's defined benefit fraction is $45,000 divided by the product of 1.25 times $90,000, or .4. (The plan is not top-heavy and the participant's high three-year average compensation is greater than $90,000). If the dollar limitation (as adjusted by section 415(b)(5)) applicable to the participant for benefits commencing at age 62 under TRA'86 is $72,000, the participant's defined benefit fraction for 1987 is .5, computed as $45,000 divided by the product of 1.25 and $72,000.

Q-20 If an accrued benefit of $90,000 is paid from a defined benefit plan pursuant to a qualified domestic relations order (QDRO) within the meaning of section 414(p) of the Code to an alternate payee of a participant at the participant's social security retirement age, may an additional benefit of $90,000 be provided to the participant?

A-20 No. Benefits provided to alternate payees of participants pursuant to QDRO's must be aggregated with benefits provided to participants from all defined benefit and defined contribution plans in applying the limitations of section 415.