One of the advantageous provisions of the Pension Protection Act (PPA) is that it removed some technical obstacles limiting the ability of certain plan sponsors to make large deductible contributions to their defined benefit (DB) and defined contribution (DC) retirement plans. The issue in question is the overall “25% of compensation” limit which is intended to limit the combined deductible contributions to a plan sponsor’s retirement plans to 25% of the overall compensation for covered employees.
PPA introduced several exceptions to this rule, which became effective a couple of years ago.
1. Only DC plan contributions in excess of 6% of payroll are counted towards the 25% overall limit.
2. Contributions to PBGC-covered DB plans are excluded from the 25% overall limit.
Total covered payroll = $2M
Employer DB contributions = $400K
Employer DC contributions [401(k) & profit-sharing] = $120K
Overall contribution limit is 25% x $2M = $500K
Total retirement plan contributions = $520K, but the DC contributions are only equal to 6% of $2M, so they are excluded from the 25% overall limit calculation. Thus we only have to consider the DB contributions, and they are below the $500K threshold. If the DB plan is covered by the PBGC, then even the $400K contribution does not count towards the 25% limit.
Many large employers will never run into the 25% of compensation limit, especially if their DB plans are covered by the PBGC. However, small pension plan sponsors could encounter this obstacle.
The reason is that single-person pension plans and professional service firm pension plans with 25 or fewer employees are exempt from PBGC coverage under Title IV of ERISA. Often these plan sponsors want to make large deductible contributions to both their DB pension plans and their DC plans. Since their DB pension plans are not covered by the PBGC, these contributions count towards the 25% of compensation limit.
So, one possible question would be: Can small pension plans opt to pay PBGC pension insurance premiums in order to obtain PBGC coverage (and thus not have their DB contributions count towards the 25% overall limit)?
The PBGC answer is clear on this one: No. According to a Q&A with the PBGC (2008 PBGC Blue Book Question #21), PBGC regulations prohibit excluded pension plans from voluntarily purchasing PBGC pension insurance coverage. Presumably the PBGC believes that the only plans who will optionally elect PBGC coverage are those who are at a higher risk of going bankrupt.