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Plan Amendments to Comply with Final Regulations Under Code Section 415: The Sooner The Better

On April 5, 2007, the IRS and the Department of Treasury issued final regulations regarding the limitations, under Section 415 of the Internal Revenue Code (the “Code”), on contributions and benefits under qualified retirement plans. Although plan sponsors generally have until the due date (including extensions) of their 2008 tax return to amend their plans to comply with these regulations, there are very good reasons to amend plans before that deadline. In many cases, the sooner the better!

Section 415 limits the annual benefits payable under a defined benefit plan to the lesser of an indexed dollar amount ($185,000 for limitation years ending in 2008) or 100% of the participant’s “high three-year average” compensation. Section 415 limits the total annual additions to a defined contribution plan to the lesser of an indexed dollar amount ($46,000 for limitation years ending in 2008) or 100% of the participant’s compensation for that year.

These limits apply to all qualified plans (including 401(k) plans), Section 403(b) tax-sheltered annuities, simplified employee pensions (“SEPs”), and certain medical benefit accounts. The changes made by the final Section 415 regulations have even broader significance because their definition of “compensation” is also used for a number of other purposes under the Code, including determining whether an employee is a “highly compensated employee” for purposes of discrimination testing, which employees are “key” employees for top-heavy purposes, the limit on deductible contributions, and whether the definition of compensation used in the ADP, ACP, and general nondiscrimination tests is nondiscriminatory.


The final regulations make several important changes to the operation of the Section 415 limits, including:

Amounts Includible in 415 Compensation – Under the final regulations, “compensation” for purposes of the Section 415 limitations now includes (or in some cases, may include) certain amounts received after severance from employment, so long as those amounts are received within 2 1/2 months after severance from employment or by the end of the limitation year that includes the severance from employment (if later).

  • For example, “regular pay” (salary, overtime, shift-differential, or bonus payments) that is received within that time period must be included in 415 compensation. Certain other types of pay (such as payouts of sick or vacation pay, certain distributions from nonqualified plans, and certain military continuation and disability pay) may be included in 415 compensation, but only if the plan specifically provides for it.

  • However, severance pay that is paid after the last day of employment may not be included in Section 415 compensation. Conforming changes to the regulations under Sections 401(k), 403(b), and 457(b) clarify that salary deferrals may be made only from 415 compensation, as defined by the final regulations. Therefore, a participant may make deferrals from certain post-separation “regular pay,” but may not make elective deferrals from post-separation severance pay. (For additional information, see “New Rules on Deferrals From Post-Severance Compensation” in our May 2007 issue of Benefits in Brief.)

Effect of Compensation Limitation Under Section 401(a) (17) – The final regulations provide that the amount of compensation taken into account for each of the high three years (in determining the “average” compensation for purposes of the limit on benefits under a defined benefit plan) must be limited to the indexed dollar amount under Code Section 401(a)(17) applicable to that year ($230,00 for plan years beginning in 2008).

  • Because this is a departure from the prior generally accepted method of calculating “high three year” compensation, the final regulations “grandfather” benefits accrued or payable under a plan as of the end of the limitation year immediately prior to the effective date of the regulations.

Correction of Section 415 Excesses – The prior regulations (issued in 1981) provided several methods for correcting excess annual additions, including the distribution of  excess annual additions that were either pre-tax elective deferrals or employee after-tax contributions, and the maintenance of “suspense accounts” for excess annual additions attributable to employer contributions. These correction methods no longer appear in the     regulations. However, the preamble to the final regulations provides that, pending further guidance, Section 415 excesses may be self-corrected under the Employee Plans Compliance Resolution System (“EPCRS”) using the correction methods set forth in the prior regulations.

Pension Protection Act Changes – The final regulations reflect changes to Section 415 made by the Pension Protection Act of 2006, including changes to the interest rate assumptions used for converting certain forms of benefit to a straight life annuity and the elimination of the “active participation” requirement in determining a participant’s high-three years of compensation.

Incorporation by Reference Rules – If a defined benefit plan incorporates the dollar limit on annual benefits and any annual cost-of-living adjustments to that dollar limit by reference to Code Section 415(b) (rather than spelling out the limit in the plan), the final regulations provide that any annual cost-of-living adjustments that become effective after a participant’s severance from employment (or, if earlier, after the annuity starting date in the case of a participant who has commenced receiving benefits) will not apply unless the plan specifically so provides.

The final regulations are effective for limitation years beginning on or after July 1, 2007. For most plans, the limitation year is the plan year, so the regulations are generally effective for plan years beginning on or after July 1, 2007. For calendar year plans, this means that the regulations are first applicable for the 2008 plan year.


Under applicable IRS guidance, qualified plans must be amended to comply with regulatory changes (such as the final 415 regulations) by the later of (i) the last day of the plan year in which the change is first effective, or (ii) the due date (including extensions) for the employer’s tax return for the tax year that includes the first day of the plan year in which the change is effective. Thus, employers whose tax year and plan year are both the calendar year must adopt an amendment to comply with the final 415 regulations by the due date (including extensions) for their 2008 tax year (generally March 15, 2009, unless the employer’s 2008 tax return is extended to September 15, 2009). There are reasons, however, why a plan sponsor may wish to adopt an amendment to comply with the final 415 regulations before that deadline.

Because the final regulations now require certain regular pay that is paid after termination of employment to be included in “415 compensation,” and because many plans base their definition of “compensation” for allocation purposes on 415 compensation, an amendment that changes 415 compensation under a profit sharing plan will also change the allocation of certain employer contributions. This could result in an impermissible “cutback” in accrued benefits if the amendment is adopted after participants have accrued a right to a profit sharing contribution for the plan year.

Similarly, if benefits under a defined benefit plan were previously accruing on the basis of a definition of compensation (such as W-2 compensation) that included post-separation severance pay, and the plan is amended after a participant accrues benefits for the year to provide that compensation (for both benefit accrual purposes and the 415(b) limit) excludes post-separation severance pay, this could constitute an impermissible cut-back.

In many defined benefit plans, participants do not accrue a benefit for the year until they complete 1,000 hours of service during the year. Unlike defined contribution plans, defined benefit plans cannot require employment on the last day of the plan year to accrue a benefit for that year. Therefore, in order to prevent an impermissible cut-back in accrued benefits, defined benefit plans should be amended for the 415 final regulations before benefits accrue for the 2008 plan year. If the amendment cannot be adopted before benefits accrue, then any change to the plan’s definition of “compensation” for benefit accrual purposes should be delayed until the first day of the following plan year.

In short, plan amendments to comply with the final 415 regulations should ideally be adopted before benefits accrue for the 2008 plan year, i.e., before participants have satisfied the applicable conditions to share in the allocation of employer contributions, or to accrue a benefit under the plan, for the 2008 plan year. If that is not possible, then the amendment must be carefully drafted so that any change to the plan’s definition of “compensation” (for allocation or benefit accrual purposes) does not cause an impermissible cut-back in benefits. Plan sponsors that have not yet adopted interim amendments to comply with the final 415 regulations are advised to contact their employee benefits counsel as soon as possible to determine the appropriate course of action for their plan.