SunGard Relius

The Treasury has released the final 415 regulations, providing a much needed update to the 1981 regulations. The final regulations incorporate and expand upon much of the material in the May 2005 proposed regulations, and add new provisions to deal with PPA changes. This technical update will focus on those changes applicable to qualified defined contribution plans, and then briefly highlight some of the defined benefit plan changes.

Post-severance Compensation. The final rules limit a plan’s ability to count compensation after a participant severs employment. In general under the new regulations, compensation does not include compensation paid after an employee severs employment. However, there are 2 exceptions:

1. A plan can count compensation paid to former employees who are in the US military or permanently and totally disabled.
2. A plan can count compensation paid by the later of 2½ months after severance of employment or the last day of the limitation year in which the employee severed employment if:
   1. The payment was for services rendered (e.g., salary, commissions, overtime, bonus, etc.) which the employer would have paid if employment had continued.
   2. The payment was for unused accrued sick leave, vacation pay, or other leave which the employee could have taken if employment had continued, or
   3. The payment was from an unfunded nonqualified deferred compensation plan, to the extent includible in income, if the employee would have received the payments at the same time if employment had continued.

Payments in 2.b. and 2.c. count as compensation only if they would have been compensation if the employment had continued. Compensation does not include any of the following amounts paid after employment termination: severance pay, parachute payments, or payments from unfunded deferred compensation plans which are “triggered” by severance.

Other Compensation Issues: The 415 regulation definition of compensation now includes income from deferred compensation plans under Code §§409A or 457(f)(1) or the constructive receipt doctrine. The regulations also deal with foreign compensation.

Deferrals. 401(k) and 457(b) plans cannot accept deferrals from amounts which are not compensation under the revised rules. Presumably, the final 403(b) regulations, when issued, will include a similar restriction.

The preamble to the regulations clarify that although the new rules apply the Code §401(a)(17) compensation limit (currently $225,000) to Code §415 limits (see below), a plan need not determine compensation based on the earliest payments during the year. Effectively, this means that a participant making more than the 401(a)(17) limit can continue to defer all year long, subject to any applicable plan limit.

Plan Aggregation Rules. Like the proposed rules, the final regulations address controlled and affiliated service groups and predecessor employers. Additionally, the final regulations address, for the first time, what happens when an affiliated group breaks up. The final regulations correct an erroneous interpretation of 415(h) in the proposal.

In a change from existing law, the new rules provide that when two plans are aggregated for 415 purposes midyear (perhaps because of the formation of a controlled group), the effect of aggregation is immediate. If an individual participates in both plans, and already has total annual additions in excess of the 415 limits, the individual cannot have any further annual additions until the next limitation year.

Annual Addition Timing. Generally, an amount is an annual addition for a given limitation year only if the employer contributes it to the plan no later than 30 days after the due date of the employer’s tax return (including extensions). In the case of a tax-exempt or governmental employer, the deadline is the 15th day of the 10th month following the end of the limitation year. This is the extended Form 5500 filing deadline. After-tax employee contributions count for a limitation year only if the employee makes the contribution within 30 days after the end of the limitation year.

Correction. As expected, the final regulations no longer include authorization for correcting excess annual additions under the terms of the plan. Instead, the preamble directs plan sponsors to use the EPCRS program for correction of these operational defects. The IRS is considering further guidance on this issue. Until then, the corrective methods available under the 1981 regulations can be used for EPCRS correction, but only if all of the rules of EPCRS are satisfied. See Rev. Proc. 2006-27.

Defined Benefit Plans. The most significant changes affect defined benefit plans. The final regulations follow the PPA mandate to count all years of service to determine a participant’s high 3 years of compensation, not just years of participation. However, the final rules retain the controversial provision from the proposed regulations to apply the Code §401(a)(17) compensation limit to Code §415, effectively cutting-off benefits for highly compensated individuals who retire after age 65.

The Treasury did not finalize its 15 pages of proposed rules dealing with multiple annuity starting dates. The Treasury will spend more time evaluating that issue, and will reissue that proposal, along with a revised 401(a)(9) rules for defined benefit plans.

Effective Date. The final regulations are effective for limitation years beginning after June 30, 2007. For calendar year plans, this means that the new rules will be effective in 2008. Plans have the option of applying the post-severance compensation rules earlier than the regular effective date. There is a delayed effective date for governmental plans.

If a defined benefit plan complied with existing law prior to the effective date, and accrued benefits exceed those allowable under the final rules, the plan can pay those benefits. In doing so, the plan must disregard amendments adopted or effective after April 5, 2007. The final regulations provide that a plan will be able to use this grandfather rule even though the plan provided for benefits in excess of the 401(a)(17) limit.

To quickly get up-to-speed on the final 415 regulations, attend our Web Seminar, The Final 415 Regulations: What You Need to Know Now. This program takes place at 2:00 p.m. Eastern Time on Thursday, April 26.

Upcoming 401(k) Plan Workshop. The 415 regulations were not released until after the agenda was prepared for the 401(k) Plan Workshop. Nevertheless, we will incorporate and review these new regulations, as well as PPA, and the impact of both on 401(k) plans. The 401(k) Plan Workshop and Form 5500 Workshop will be conducted in several cities during April and May. Visit our Web site to review the program agenda and register online.