Understanding Section 401(a)(17) Limits
This chapter provides an overview of Section 401(a)(17) limits and discusses how to establish Section 401(a)(17) parameters.
Understanding Section 401(a)(17) Limits
Section 401(a)(17) limits are the maximum amounts that the Internal Revenue Service (IRS) sets for the annual earnings that can be used in pension benefits (these limits are also called "pay limits"). The IRS changes these limits every year or so.
There are a number of ways to apply these limits. You set up 401(a)(17) parameters to reflect your plan's interpretation of how these limits are used.
Three of the Pension Administration core functions incorporate earnings data and thus may need to apply 401(a)(17) limits:
Final average earnings (FAE).
Cash balance accounts, which calculates credits as a percentage of earnings.
Employee accounts, which uses projected earnings to estimate future contributions.
You apply 401(a)(17) limits after consolidating earnings; therefore, consolidation rules do not use limit rules.
When you use 401(a)(17) limits for final average earnings, the limits are applied before the system determines the periods of highest earnings. For example, if a final average earnings definition averages the five years of highest earnings, the system applies the limits to the consolidated earnings before determining which years have the highest earnings. Additionally, the final average earnings cannot be higher than the 401(a)(17) limit in effect on the event date.
If your consolidated earnings use a payroll special accumulator that is already set up to conform to 401(a)(17) limits, you do not need to set up or apply these limits in the pension system. However, if you sponsor a nonqualified limit plan that gives participants the difference between their limited and unlimited benefit from a qualified plan, you will find that there are advantages to using the pension system's 401(a)(17) functionality. If you incorporate 401(a)(17) limits into pension rather than payroll, the system can calculate both limited and unlimited values for final average earnings and cash balance accounts. When you build your nonqualified plan, therefore, you can simply reference existing results; there's no need to clone the entire qualified plan.
Establishing Section 401(a)(17) Parameters
To set up Section 401(a)(17) parameters, use the 401(a)(17) Parameters (401(A)17_PARMS) component.
This section provides an overview of Section 401(a)(17) parameters, lists the page used to set up Section 401(a)(17) parameters, and discusses how to:
Set up Section 401(a)(17) parameters.
Limit by period or year.
Use a 12 consecutive month basis with annual consolidations.
Understanding Section 401(a)(17) ParametersWhen you apply 401(a)(17) limits, consider the following:
Your earnings periods may be periods other than calendar years. If this is so, you need to determine the appropriate limits to apply.
If the limit applies to earnings from more than one period, either because you use monthly periods or because your limit periods are made up of portions of separate consolidation periods, you have to determine how much to reduce each consolidation period.
Page Used to Set Up Section 401(a)(17) Parameters|
Page Name |
Definition Name |
Navigation |
Usage |
|
PA_401A17_PARMS |
Set Up HRMS, Product Related, Pension, Calculation Rules, 401(a)(17) Parameters, 401(a)(17) Parameters |
Set up 401(a)(17) parameters. |
Setting Up Section 401(a)(17) Parameters
Access the 401(a)(17) Parameters page (Set Up HRMS, Product Related, Pension, Calculation Rules, 401(a)(17) Parameters, 401(a)(17) Parameters).
The 401(a)(17) limits are published annually by the IRS. Because the limits can change over time, it is important to identify the correct limit for each earnings period.
Earnings are Limited on
Besides identifying the limit for each earnings period, you need to specify a method for applying the limit:
|
Period by Period Basis |
With this method, the system divides the limit by the number of periods in a year and then applies it to each period. For annual periods, this is the same as applying the limit directly to the period. For monthly periods, you may have some periods above the limit and others below. In this situation, the months where earnings exceed one twelfth the limit are reduced. You may end up reducing earnings even if the 12-month total is less than the annual limit. |
|
Year to Date Basis (Account Balances Only) |
This method is used only for cash balance accounts. With this method, the system:
|
|
12 Consecutive Month Basis (FAE Only) |
This method is used only for final average earnings. With this method, the system attempts to eliminate short periods by redistributing earnings into allocation periods corresponding to one full year of earnings. The allocation starts with the event date and continues back in time. For example, if the final period is only a third of a year, two thirds of the prior year's earnings are lumped together with the final period. The prior period is now only a third of a year, and it appropriates two thirds of the earnings from the year before. This continues, bridging any other partial years that occur due to leaves of absence or other events. In the end, there may be one final short period at the very beginning of the employee's earnings history. Each consolidation period is divided into segments according to the portion of the earnings that go into each allocation period. After the segments are individually limited, they are added together to get the limited earnings for the consolidation period. The allocation periods almost always encompass multiple consolidation periods and thus span multiple calendar years. The limit is based on the first day of the last consolidation period used. Thus, if you align by calendar year, a limit period encompassing months from 2002, 2003, and 2004 uses the limit for the first day of 2004. If you align by plan year, a limit period encompasses months from the 2002–03 plan year, and the 2003–04 plan year uses the first day of the 2003–2004 period. |
|
Rolling Monthly Average (FAE Only) |
This method is used only for final average earnings. With this method, the system applies limits to "rolling" 12-month periods and then calculates the average earnings in the consecutive months with the highest earnings. The number of consecutive months that it includes in the calculation is specified in the FAE definition (typically, 12, 36, or 60 months). The system uses this method to calculate the final average earnings: Starting at the current month and moving backward, it accumulates the earnings in a 12-month period. It averages these earnings and applies to that average the limit in effect at the beginning of that 12-month period. It then moves back a month (to the month prior to the current month) and repeats this process. It continues this process until it has calculated the average earnings for the entire period (that is, for the number of months specified in the FAE definition). It then selects the average earnings for the period of consecutive months with the highest average earnings (for example, 60 months out of last 120, where the FAE definition specifies 60 months). Note. You specify the number of consecutive months in the Periods field in the Find the Highest group box on the FAE 1 of 2 page. |
|
User Code |
Select this to use your own customized code. |
See Limiting by Period or Year.
To Limit Non-annual Periods
Because the limits cross multiple consolidation periods, you have to indicate which earnings periods to reduce, and how much.
|
Reduce Proportionately |
The system compares total earnings for the allocation period to the appropriate limits to find a reduction ratio. Each segment is reduced using the same factor. For example, an allocation period has two segments that together have earnings of 200,000 USD. The limit is 150,000 USD, so both segments are reduced by a factor of .75. |
|
Limit Each Period |
The system determines the percentage of the allocation period that comes from each segment and reduces the limit for that segment by that percentage. For example, an allocation period has two segments: 60 percent of 2008 and 40 percent of 2007. The limit is 160,000 USD. The first segment is limited to 60 percent of the limit (96,000 USD) and the second segment is limited to 40 percent of the limit (64,000 USD). If the first segment has 180,000 USD of earnings and the second segment has 10,000 USD of earnings, then after limits are applied, the first segment has 96,000 USD and the second still has 10,000 USD. Notice that in this scenario, the total for the allocation period, 106,000 USD, is well below the 160,000 USD limit. |
See Using a 12 Consecutive Month Basis with Annual Consolidations.
Limits
401(a)(17) limits came into effect in 1989. Calculations with an event date prior to 1989 do not use 401(a)(17) limits. If you align by plan year, event dates in the 1988–1989 plan year are also considered exempt from 401(a)(17) limits. If the event date is 1989 or later, however, you can limit all of an employee's earnings, not just earnings after 1989.
|
Limit Table |
The system looks up the limit for each year using the table lookup utility. The table used associates calendar years with limits. The system comes with two predefined table lookups for the most common limit tables:
You can examine both of these tables under 401(a)(17) Limits. To see the table lookup parameters, go to Table Lookup Alias. If you look at either of the delivered table lookups, you can see that they are "program generated." This means that 401(a)(17) processing provides the lookup year for each period. If you decide to develop your own limit table, perhaps one that blends TRA and OBRA limits, be sure to make it a program generated lookup. You can also see that the delivered lookups are set to use the maximum (that is, the latest) value when the lookup year is after the last year in the table. This means that the limit is not projected (projected earnings use the last available limits). |
|
Prorate Over Partial Periods |
Select this to prorate the limits for short periods, including the final period, when you limit on a period by period basis. During partial periods, employees frequently have lower earnings and therefore are less likely to reach the 401(a)(17) limit. For example, an employee with 100,000 USD of earnings in a six-month partial period is under the 150,000 USD limit. If you prorate the limit, the half-year limit is 75,000 USD, and the employee has exceeded that amount. This option is irrelevant for the other limit methods. When you limit on a 12 consecutive month basis, partial periods are irrelevant because the system goes back to previous periods to form only complete periods. You also do not prorate when you limit on a year-to-date basis: The premise of applying the limits on a year to date basis is that your earnings count until you reach the limit, regardless of when during the year you reach that limit. |
|
Prorate Over Short Plan Years |
If you align limits by plan year, a change in plan year results in a partial period. You therefore also have the option to prorate over short plan years. This option only applies when you apply the limits on a year-to-date basis using monthly consolidations. In order for the system to recognize short plan years, the short year must have its own effective-dated row in the Pension Plans (US) table. |
|
Limit Start Year |
Because there are no published limits for years prior to 1989, you must choose what limit, if any, to use for those earlier years. The amount you use is the "carry back" limit. It is applied to all years from the hire date until the limit start year. Beginning with the limit start year, the limits are determined based on the table lookup that you specified in the Limit Table field. Enter a limit start year, then select a carry back option. |
See Understanding Pension Plans.
Carry Back Limits
|
Min TRA86 Limit ($200,000) |
Applies a 200,000 USD limit. |
|
Min OBRA93 Limit ($150,000) |
Applies a 150,000 USD limit. |
|
No Carry Back |
Years prior to the specified threshold are not limited. |
Align Limits by
Regardless of the period being limited (month, calendar year, plan year, or other year), the system determines the limit based on your Align Limits by choice. This setting also determines the limit for the event date, which is used as a final limit for the final average earnings result.
|
Calendar Year |
The system uses the limit for the year that contains the first day of the consolidation period. |
|
Plan Year |
The system uses the limit for the first day of the plan year that contains the first day of the consolidation period. For example, a period beginning January 1, 2007 but falling in the 2006–2007 plan year would use the 2006 limit. |
Aligning by Plan Year Against Calendar Year
If you align by Plan Year, the system uses the limit for the first day of the plan year containing the first day of the consolidation period. For example:
|
Period |
Limit if Aligned by Calendar Year |
Limit if Aligned by Plan Year* |
|
Year beginning January 1, 2002 |
2002: Year containing the first day of the period. |
2001: The first day of the period is in the 2001–2002 plan year. |
|
Year beginning July 1, 2002 |
2002: Year containing the first day of the period. |
2002: The first day of the period is in the 2002–2003 plan year. |
|
Month beginning January 1, 2002 |
2002: Year containing the first day of the period. |
2001: The first day of the period is in the 2001–2002 plan year. |
|
Month beginning July 1, 2002 |
2002: Year containing the first day of the period. |
2002: The first day of the period is in the 2002–2003 plan year. |
* Assume the plan year is from July 1 to June 30.
Limiting by Period or Year
For annual earnings consolidation periods, you get the same results by applying limits on a period by period basis that you do by applying limits on a year-to-date basis. However, for monthly consolidation periods, you can get different results.
If you apply the limits on a period by period basis, the applicable limit is divided by the number of periods in a year (12) and then applied to each period. If some periods are above the limit and others are below, only the ones above the limit are reduced. You may end up reducing earnings even if the 12-month total is less than the annual limit.
If you apply the limits on a year-to-date basis, monthly periods are grouped according to how you align your limits: into calendar years or plan years. Within each group, including the shorter first and last groups, no periods are limited until the year-to-date earnings reach the applicable limit.
The following table applies a 150,000 USD limit to Annie's earnings using each of these methods. The period by period monthly limit is one twelfth of 150,000 USD, or 12,500 USD.
|
Annie's Monthly Earnings |
Period by Period |
Year-to-Date |
|
20,000 |
12,500 |
20,000 |
|
12,500 |
12,500 |
12,500 |
|
25,000 |
12,500 |
25,000 |
|
22,500 |
12,500 |
22,500 |
|
22,000 |
12,500 |
22,000 |
|
20,000 |
12,500 |
20,000 |
|
20,000 |
12,500 |
20,000 |
|
40,000 |
12,500 |
8,000 |
|
8,000 |
8,000 |
0 |
|
20,000 |
12,500 |
0 |
|
20,000 |
12,500 |
0 |
|
20,000 |
12,500 |
0 |
|
250,000 |
145,500 |
150,000 |
Using a 12 Consecutive Month Basis with Annual Consolidations
Marshall earns 200,000 USD per year. He took a six-month leave during 2003 and terminated on March 31, 2004. His earnings were consolidated into calendar year periods.
Annual Consolidated Earnings
|
Year |
Earnings |
Partial Period Fraction |
|
2004 |
100,000 |
.25 |
|
2003 |
50,000 |
.5 |
|
2002 |
200,000 |
1.0 |
|
2001 |
200,000 |
1.0 |
The 12 consecutive month basis method starts with the event date and continues back in time, creating one-year periods. To create the first allocation period, the system gathers his final 12 months of earnings. He had earnings for 25 percent of 2004 and for 50 percent of 2003, so, the system adds 25 percent of the 2002 earnings to produce one year's worth of earnings. This continues back to his earliest earnings period.
Dividing Consolidation Periods into Allocation Periods
|
Year |
Earnings |
Fraction of Year |
Allocation Period |
Amount |
|
2004 |
100,000 |
.25 |
First |
100,000 |
|
2003 |
50,000 |
.5 |
First |
50,000 |
|
2002 |
200,000 |
.25 to period 1 .75 to period 2 |
First Second |
50,000 150,000 |
|
2001 |
200,000 |
.25 to period 2 .75 to period 3 |
Second Third |
50,000 150,000 |
The first allocation period includes earnings from 2004, 2003, and 2002. Because the limit is based on the first day of the last earnings period, the limit is the one as of January 1, 2004. This is true even though you used earlier earnings, as well.
Depending on how limits are aligned, the applicable limit could be the 2004 limit or, if January 1, 2004, falls into a 2003–2004 plan year, the 2003 limit. You simply assume limits of 150,000 USD throughout the example.
There are two possible methods for applying the limits: reduce proportionately or limit each period.
If you reduce proportionately, total earnings for the allocation period are compared to the appropriate limits to find a reduction ratio and each segment is reduced accordingly. In Marshall's case, his total earnings for both the first and second allocation periods are 200,000 USD, and the applicable limit for both periods was 150,000 USD, so each segment's earnings are reduced by a factor of 75 percent. After the earnings are reduced, segments are recombined into the original calendar year consolidation periods.
Applying Limits by Reducing Proportionately
|
Year |
Allocation Period |
Amount |
Limit Factor |
Limited Segment |
Limited Year |
|
2004 |
1 |
100,000 |
.75 |
75,000 |
75,000 |
|
2003 |
1 |
50,000 |
.75 |
37,500 |
37,500 |
|
2002 |
1 2 |
50,000 150,000 |
.75 .75 |
37,500 112,500 |
150,000 |
|
2001 |
2 3 |
50,000 150,000 |
.75 * |
37,500 * |
* |
* The reduction factor depends on total earnings for third segment, which includes earnings from the previous year.
If you limit each period, the system determines what percentage of the allocation period comes from each segment and reduces the limit for that segment with the same factor. Marshall's 2004 consolidation only includes a quarter of a year, so his 2004 earnings are limited to a quarter of 150,000 USD, or 37,500 USD. His 2003 segment is reduced to half of the limit, and so on.
Applying Limits by Limiting Each Period
|
Year |
Allocation Period |
Amount |
Limit Factor |
Limit |
Limited Segment |
Limited Year |
|
2004 |
1 |
100,000 |
.25 |
37,500 |
37,500 |
37,500 |
|
2003 |
1 |
50,000 |
.5 |
75,000 |
50,000 |
50,000 |
|
2002 |
1 2 |
50,000 150,000 |
.25 .75 |
37,500 112,500 |
37,500 112,500 |
150,000 |
|
2001 |
2 3 |
50,000 150,000 |
.25 .75 |
37,500 112,500 |
37,500 112,500 |
150,000 |
After you're past the partial periods, it might look like the 12 consecutive month method is the same as applying the limit to the total earnings for the consolidation period. However, do not forget that the example unrealistically assumed a constant limit of 150,000 USD. When segments from one consolidation period fall into two allocation periods with different limits, the limited earnings for the period are somewhere between the two limit amounts. The exact limited amount depends on what portion of the period uses each amount.
Using a 12 Consecutive Month Basis with Monthly Consolidations
The 12 Consecutive Month Basis option works the same for monthly periods as it does for annual periods, but there are more consolidation periods per limit period.
The following table shows how the Reduce Proportionately and Limit Each Period options might be applied to a monthly consolidation. In this example, Nina worked through the last day of the month and then retired, so there are exactly twelve whole consolidation periods in a single limit period. You use your usual 150,000 USD limit.
The factor for the Reduce Proportionately option is the limit divided by the total earnings, or 150,000 / 250,000, which equals .6. The monthly limit under the Limit Each Period options is one twelfth of 150,000 USD, or 12,500 USD.
|
Monthly Earnings |
Reduce Proportionately |
Limit Each Period |
|
20,000 |
12,000 |
12,500 |
|
12,500 |
7,500 |
12,500 |
|
25,000 |
15,000 |
12,500 |
|
22,500 |
13,500 |
12,500 |
|
22,000 |
13,200 |
12,500 |
|
20,000 |
12,000 |
12,500 |
|
20,000 |
12,000 |
12,500 |
|
40,000 |
24,000 |
12,500 |
|
8,000 |
4,800 |
8,000 |
|
20,000 |
12,000 |
12,500 |
|
20,000 |
12,000 |
12,500 |
|
20,000 |
12,000 |
12,500 |
|
250,000 |
150,000 |
145,500 |