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Defined Benefit Pension & IRS Testing
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Defined Benefit Pension & IRS Testing
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My question is regarding pensions and IRS discrimination testing for highly compensated individuals. I understand the gov wanting to be sure businesses don't discriminate against non-highly compensate
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Forums » Topic Forums » Benefits & Compensation » Defined Benefit Pension & IRS Testing
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Defined Benefit Pension & IRS Testing
posted at 10/26/2008 1:21 AM EDT
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Posts: 2
First: 10/26/2008 Last: 11/2/2008 |
My question is regarding pensions and IRS discrimination testing for highly compensated individuals. I understand the gov wanting to be sure businesses don't discriminate against non-highly compensated individuals when building or creating new pension programs, but it would seem counter-intuitive for the government to drive businesses to reduce legacy program benefits to match market-driven current/future programs, just because legacy program participants are highly compensated due to years of service. I would appreciate any guidance or thoughts. Here's background for context of inquiry....
A friend is employee in company for nearing 20 years which has had a very nice defined benefit pension that is now apparently undergoing some changes in early-retirement calculations. As I understand it, over time this large company has purchased and integrated a number of other companies, and has really only done minor integration of legacy pension programs to this point. Over the years one of the older legacy pension versions (the one she is in) has gotten down to just ~700 employees still in it (rest have retired, etc). Not surprisingly, since they've been around a long time, on average these remaining 700 employees -- mostly engineers and managers -- are very well compensated (I'm not sure of definition of "highly compensated"). Apparently her company is concerned about how this 700-person segment will be viewed (specifically the early retirement benefit) in IRS testing of the total company-wide pension program. To better standardize the legacy program with the current pension program, they're rolling out a modification in 2009 that reduces the early-retirement benefit for this legacy group. Previously for this group, early retirement had a 2% reduction for every year before 62. The new plan will have 5% reduction for same period -- which is consistent with what the majority of other legacy company pensions have. For retirement at 62 and beyond, the pension benefit calculates as the same. For retirement before 62 -- with worse case being at 55 -- the pension benefit is very much reduced (max />20% annually). To further make the point to her, I NPVed her pension benefit, retiring at 55, and living nominally to 85-90 age range; the difference is a bit staggering. I would think the government would have things in place (grandfathering?) that would avoid driving businesses to do such brutal reductions in employee pension benefits. From what she describes, it is all because of this IRS testing and high-comp/non-high-comp discrimination. But to the extent discriminations could be assessed, it's not a going-forward created situation, it's the result of a normal years-of-service, folks rising-up-in-management situation. Thanks in advance for forum member insights on pension benefits and IRS testing objectives/results. -M |
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Defined Benefit Pension & IRS Testing
posted at 10/26/2008 4:49 PM EDT
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Posts: 2442
First: 2/12/2000 Last: 9/14/2011 |
Normally changes to retirement plans are only on a go forward basis. However if this change is really required by IRS qualification requirements you can be fairly certain that the company would not deliberately antagonize its highly compensated staff unless it had no choice.
Plan changes like this must be formally communicated to participants. So when the formal documents are issued they will be able to read it carefully to determine the true nature of the changes. From a benefit standpoint, based on how you described the reduction the maximum change would be 3% per year less. So at 55 the difference is 21% not insignificant but manageable. The shortfall can be made up by additional personal savings between now and retirement. Of course each additional year of work will reduce the gap. The gap will also be reduced by more than the 3% difference as the pay used at actual retirement will increase each year as well. |
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Defined Benefit Pension & IRS Testing
posted at 10/27/2008 5:59 AM EDT
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Posts: 2146
First: 2/15/2006 Last: 9/14/2011 |
I agree with Howard...Plans have to meet the nondiscrimination standards. And most don't like to cutback HCEs for any reason. So most only do it when required.
Often companies will setup a "Nonqualified" plan called a SERP ..that doesn't receive the same tax advantages, has a higher risk of forfeiture, and comes after creditors in priority during a bankruptcy....that provides a "makeup" for the difference they are losing in the qualified pension plan. Your friend might ask if they are doing so. When pension plans make changes, they often grandfather certain groups of employees. Often those that are closer to retirement age. But they have to draw the line somewhere and no matter where it is, someone will be unhappy that they didn't fall on the other side of the line. And sometimese that line is drawn for them based on the population of the control group (all the companies that share common ownership). |
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Defined Benefit Pension & IRS Testing
posted at 11/2/2008 11:22 AM EST
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Posts: 2
First: 10/26/2008 Last: 11/2/2008 |
Thanks for responses.
More data: Originally I thought she said her company had been told by the gov that the plan had to change because it wasn't testing well. I guess actually it is company who says it's worried that they *might* fail testing unless they impact these 700 employees. So to preempt anything, they are chosing to make the change. SERP concept is interesting. I'll suggest she query about that. We've talked a lot and she knows she's sure she won't go destitute with a 20-25% NPV reduction in pension benefit, it's just part of the reason she says she stayed with that company and I guess she even made pension option selection decisions along the way based on the original plan (with a couple of the company purchases, they asked people pick their individual going-forward plan "old or new"? She picked "old" because it *was* better at the time). Surprised that for such things that the company and gov wouldn't work together to support riding out this better benefit as this small minority of the pension population retirees over the next handful of years. Not clear what the upside is for either party to do otherwise. -M |
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