3719 / How are Section 415 limits applied to defined benefit plans?

In a defined benefit plan, the highest annual benefit payable under the plan must not exceed the lesser of (a) 100 percent of the participant’s average compensation in the high three years of service or (b) $280,000 in 2025 ($275,000 in 2024, $265,000 in 2023, $245,000 in 2022, $230,000 in 2020-2021, as indexed).¹ Regulations specify that this limit also applies to the annual benefit payable to a participant.² The regulations referenced throughout this question were issued April 5, 2007, and generally are effective for limitation years beginning after June 30, 2007.³ For general rules affecting the application of the Section 415 limits, see Q 3868; for the defined contribution plan limits, see Q 3728.

In plan years beginning after 2005, a participant’s high three years of service is the period of three consecutive calendar years during which the participant had the greatest aggregate compensation from the employer.⁴ Regulations state that a plan may not base accruals on compensation in excess of the Section 401(a)(17) limit ($350,000 in 2025, $345,000 in 2024, $330,000 in 2023, $305,000 in 2022, $290,000 in 2021, $285,000 in 2020, as indexed).⁵ For plan years beginning prior to January 1, 2006, a participant’s high three years of service had to be three consecutive years in which he or she was both an active participant in the plan and had the greatest aggregate compensation from the employer.

For purposes of defined benefit limits, “annual benefit” means a benefit that is payable annually in the form of a straight life annuity. If the benefit is payable in a form other than a straight life annuity, the annual benefit is determined as the straight life annuity that is actuarially equivalent to the form in which the benefit is paid.⁶ The application of the Section 415(b) limit to a benefit that is not payable in the form of an annual straight life annuity is explained in Treasury Regulation Section 1.415(b)-1(c). Earlier guidance appeared in Revenue Ruling 2001-51.⁷ The “annual benefit” does not include employee contributions and rollover contributions.⁸

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Planning Point: In Revenue Ruling 2012-4,⁹ the IRS ruled that a qualified defined benefit plan that accepts a direct rollover of an employee’s or former employee’s benefit from a qualified defined contribution plan maintained by the same employer does not violate Sections 411 or 415 if the defined benefit plan provides an annuity resulting from the direct rollover that is determined by converting the amount directly rolled over into an actuarially equivalent immediate annuity using the applicable interest rate and applicable mortality table under Section 417(e). If the plan were to provide an annuity using a more favorable actuarial basis than required under Section 411(c), the portion of the benefit resulting from this more favorable treatment would be included in the annual benefit. This interpretation applies to rollovers made on or after January 1, 2013.

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The annual benefit does not include employer contributions to an individual medical account under IRC Section 401(h) ( Q 3836) of any individual under a defined benefit pension plan. Such amounts are treated as annual additions to a separate defined contribution plan ( Q 3728).¹⁰

There are special rules requiring an adjustment of the annual benefit where a participant has more than one annuity starting date (for example, where benefits under one plan are aggregated with benefits under another plan from which distributions have already commenced, or where benefits are increased under a cost of living adjustment).¹¹

The $280,000 limit (as indexed for 2025) is adjusted downward if the annuity starting date occurs before the participant reaches age 62.¹² If the annuity starting date occurs after the participant reaches age 65, the limit is adjusted upward.¹³ The calculation of the adjustments is explained at IRC Section 415(b)(2)(E) and Treasury Regulation Section 1.415(b)-1(d) and (e). Earlier guidance on implementing these adjustments was provided in Revenue Ruling 2001-51.¹⁴

An adjustment also is required for certain other forms of benefit, as well as for employee contributions and rollover contributions ( Q 3996 to Q 4019), so that such benefits are converted to the actuarial equivalent of a straight life annuity.¹⁵ Under earlier guidance this adjustment was more complex, generally following the manner in which Social Security benefits are reduced for Social Security purposes. The interest rate assumption used for making this adjustment must be no less than the greater of 5.5 percent or the rate specified in the plan.¹⁶ In the case of benefits subject to IRC Section 417(e)(3), the interest rate must be the rate set forth in IRC Section 417(e)(3).¹⁷ Guidance and detailed rules for making this calculation appear in Notice 2004-78¹⁸ and in Treasury Regulation Section 1.415(b)-1(c)(3). Simplification for amounts not subject to minimum present value rules of IRC Section 417(e)(3) is set forth in Treasury Regulation Section 1.415(b)-1(c)(2).

Adjustments to the ceiling do not need to be made for ancillary benefits not directly related to retirement benefits (such as preretirement death and disability benefits and postretirement medical benefits).¹⁹ If the benefit is paid in the form of a joint and survivor annuity for the benefit of the participant and the participant’s spouse, the value of the feature will not be taken into consideration in reducing the ceiling unless the survivor benefit is greater than the joint benefit.²⁰

The 100 percent of compensation limit generally does not apply to governmental plans, multiemployer plans, or certain collectively bargained plans.²¹

The dollar limit and 100 percent compensation limit are subject to a 10 year phase-in rule. The $280,000 limit (as indexed for 2025)²² is reduced by multiplying it by the following fraction: the numerator is the participant’s years of participation in the defined benefit plan, and the denominator is 10.²³ The 100 percent of compensation limit is reduced in the same manner, but based on years of service, rather than years of participation.²⁴ “Years of service,” for this purpose, includes employment with a predecessor employer, including affiliated employers.²⁵ Neither reduction will reduce the limitation to less than 10 percent of the otherwise applicable limitation amount.²⁶

A benefit of up to $10,000 in any limitation year may be provided to a participant without violating the IRC Section 415 limits, notwithstanding the 100 percent limit or required adjustments for ancillary benefits. This benefit, however, is subject to the 10 year phase-in rule described above, based on years of service. The participant must not at any time also have participated in a defined contribution plan maintained by the employer.²⁷

A plan may incorporate by reference the automatic adjustments of plan benefits to the extent of the annual cost-of-living increases provided under the IRC. The scheduled benefit increases may not take effect earlier than the year in which the dollar limit adjustment becomes effective.²⁸ Regulations state that the annual increase does not apply in limitation years beginning after the annuity starting date to a participant who previously has commenced receiving benefits unless the plan so specifies.²⁹ Earlier regulations stated that a plan could provide for automatic freezing or reduction of the rate of benefit accrual to prevent the limitations from being
exceeded.³⁰

A defined benefit plan may maintain a qualified cost-of-living arrangement under which employer and employee contributions may be applied to provide cost-of-living increases to the primary benefit under the plan. This kind of arrangement is qualified if the adjustment is based on increases in the cost-of-living after the annuity starting date, determined by reference to one or more indexes prescribed by the IRS (or a minimum of 3 percent). The arrangement
must:

(1)  be elective;

(2)  be available to all participants under the same terms;

(3)  provide for such election at least in the year the participant attains the earliest retirement age under the plan (determined without regard to any requirement of separation from service) or separates from service; and

(4)  exclude key employees.³¹

Toward the end of 2016, the IRS released two significant sets of proposed regulations on issues important to defined benefit plans. In November, 2016, the IRS proposed a regulation³² that would update minimum present value requirements applicable to certain distributions and also to take account of final IRS regulations³³ released earlier in the fall addressing the minimum present value requirements for pension benefits payable partly as an annuity and partly in an accelerated amount.

The second set of proposed regulations³⁴ updates the mortality tables to be used for single employer defined benefit plans.³⁵ Those regulations were effective for plan years beginning on or after January 1, 2018. In 2022, the IRS released proposed regulations updating the mortality tables to be used to calculate required minimum distributions for single-employer defined benefit pension plans. The new tables are effective beginning in 2023.³⁶

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Planning Point: The change in required mortality tables is expected to increase plan funding liabilities;³⁷ hence PBGC variable rate premiums and also lump sum distributions. Plan sponsors had only until the end of 2017 to offer lump sum distributions utilizing the old mortality assumptions, and also avoid future PBGC premium increases based upon increased plan liabilities.

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