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IRS Issue Snapshot discusses deduction limits for “combination” retirement plans

The IRS occasionally publishes “Issue Snapshots” to provide an overview of a tax topic for its employees. Recently, the tax agency released “Issue Snapshot: Combined Limits under IRC Section 404(a)(7).” The publication discusses the limits on contribution deductions when an employer provides both a defined contribution (DC) and defined benefit (DB) retirement plan — commonly referred to as a “combination” plan.

Qualified plan rules

Generally, an employer’s contributions to a qualified retirement plan are deductible if they’re ordinary and necessary expenses of carrying on a trade or business and are compensation for services rendered.

However, an employer’s qualified plan contributions are limited. For example, an employer sponsoring a DC plan, such as a 401(k), is allowed a deduction for contributions of up to 25% of the compensation paid or accrued to plan beneficiaries during the employer’s tax year.

If the employer contributes to two or more DC plans, those plans are considered a single plan for purposes of applying the 25% limit. Meanwhile, the tax code provides a separate maximum deduction for contributions to a DB plan (often called a “pension plan.”)

Combo plan limits

If an employer has a combination plan, Section 404(a)(7) of the tax code limits that employer’s contribution deductions. These limits apply only in a tax year when:

  • At least one participant benefits under both plans and receives allocations other than elective deferrals in the DC plan (called “overlapping coverage”),
  • The DB plan is exempt from Pension Benefit Guaranty Corporation coverage, and
  • Both the DB and DC plans are single-employer plans.

If a DB and DC plan have overlapping coverage and employer contributions to the DC plan (other than elective deferrals) don’t exceed 6% of the aggregate compensation of DC plan beneficiaries, the limit on combination plans doesn’t apply.

However, if there’s overlapping coverage and the employer contributions to the DC plan (other than elective deferrals) do exceed 6% of aggregate compensation of the DC beneficiaries, then the combination plan limits are applied by considering only those DCs that exceed 6%.

Calculating the limit

According to the Issue Snapshot, the separate deduction limits for the DB and DC plans should be calculated before applying the Sec. 404(a)(7) limits. Thus, the combined deduction limit on contributions to a single-employer DB plan and a single-employer DC plan that have overlapping coverage is the greater of:

  • 25% of the compensation otherwise paid or accrued during the tax year to beneficiaries, or
  • The greater of the minimum required contribution to the DB plan for the plan year or the excess of the funding target over the plan’s assets for that plan year.

IRS insight

According to the IRS, “Issue Snapshots may not contain a comprehensive discussion of all pertinent issues, law or … interpretation of current law.” However, they do provide insight into what the tax agency is looking at. If your organization offers a combination retirement plan, we can help you assess the tax impact.

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