Effect of lower compensation ceiling for employee retirement plans.

Section 212 of the Revenue Reconciliation Act of 1993 (RRA) reduces the $235,840 compensation ceiling in 1993 for a defined benefit plan accrual and defined contribution plan allocations to $150,000 in 1994. Thus, a profit-sharing allocation in 1993 at 12.72% multiplied by $235,840 yields the maximum $30,000 deductible contribution, while in 1994 an allocation at the same ratio produces a contribution of only $19,081 (12.72% x $150,000).

For a plan integrated with social security benefits, the integration disparity factor is 5.7%. A 1993 contribution of $30,000 could be obtained using an 8.42% base contribution rate as follows: Compensation

  ceiling                   $235,840
FICA wage base                57,600

Disparity

compensation 178,240

Incremental profit-sharing

allocation

at 5.7% 10,160

Compensation at

base rate of 8.42%

  on $235,840                 19,858
Total contribution            30,018

Maximum

contribution $ 30,000

With the lower compensation ceiling of Sec. 401 (a)(17) in 1994 a 16.5% base rate contribution will be required: Compensation

  ceiling                   $150,000
FICA wage base                57,600

Disparity

compensation 92,400

Contribution at

incremental rate

of 5.7% 5,267

Base rate compensation

  at $150,000 of 16.5%        24,750
Total contribution            30,017

Maximum

contribution $ 30,000

If a highly compensated employee wants a maximum $30,000 contribution, the base rate must increase from 8.4% to 16.5% for a social security integrated (disparity) plan.

Also, the $150,000 limitation will apply for a defined benefit pension plan, as well as making it more difficult for Sec. 401(k) plans to pass the discrimination tests. The RRA did not affect these plans directly by reducing the $8,994 annual limit on elective deferrals. However, the practical effect is to limit highly compensated employees to contributions of no more than 6% of compensation (6% of $150,000 is $9,000, which is roughly the same as the Sec. 401(k) annual limit). The actual deferral percentage (ADP) must use $150,000 as the denominator, rather than the $235,840 used for the highly compensated employees' elective contribution in 1993.

Consideration should be given to an age-weighted defined contribution plan inasmuch as highly compensated employees (HCEs) usually have a longer period of service. Note, however, that the Treasury has recommended that age-weighted plans be forbidden for new plans after Sept. 30, 1993, and, for plans in existence on that date, effective for plan years beginning after Dec. 31, 1994.

Another approach would be to supplement tax qualified plan contributions with nonqualified deferred compensation plans for the HCEs. A difficulty with the nonqualified plan supplement is that FICA and hospital insurance taxes are applied to the deferred compensation as it is earned, or if later when there is no substantial risk of forfeiture, rather than paid. In addition, the RRA has removed the compensation ceiling for the hospital insurance tax ($135,000 in 1993).