RETIREMENT SERVICES DIVISION MEMORANDUM NO. 2016-01

January 28, 2016

TO THE HEADS OF ALL STATE AGENCIES

I. INTRODUCTION

On February 22, 2011, the Retirement Services Division ("Division") issued a Memorandum with regard to the limit on annual benefits under Section 415(b) of the Internal Revenue Code ("Code") and the limit on annual compensation imposed under Section 401(a)(17) of the Code. A second memorandum specifically addressing the limit under Section 415(b) was issued on August 2, 2011. The purpose of this memorandum is to update the August 2, 2011 memorandum.

Important: The information included within is purposely general in nature. The State Employees Retirement System (SERS) and the Internal Revenue Code are complex and subject to change. The regulations issued by the IRS in 2007 to "clarify" benefit and compensation limitation issues were over 200 pages in length. If there is a conflict between the law and the information in this document, the law will supersede the information in this document. This information is not legal advice or opinion.

II. COMMONLY ASKED QUESTIONS

1. What is purpose of Section 415(b)?

Section 415(b) of the Code is a federal tax law that limits the amount of benefits that an individual can receive from a tax-qualified defined benefit plan, such as SERS, in a given year. The law was enacted to prevent employers from using tax-qualified defined benefit plans as tax shelters. The Section 415(b) limit applicable to a governmental plan is expressed as a dollar amount, but that amount is subject to a number of adjustments based on the retiree's age at the time benefits begin, the nature of the retiree's pre-retirement employment and, in some cases, the length of the member's participation in SERS.

SERS must comply with Section 415(b) to maintain its tax-qualified status, which allows SERS members to accrue benefits over many years with no taxation until the member begins receiving retirement payments. SERS' tax-qualified status also allows members to make member contributions on a pre-tax basis.

2. What is the Section 415(b) Limit on Benefits for 2016?

Basic Benefit Limit

The 2016 Section 415(b) annual benefit limit (based upon a calendar year) is $210,000. This limit may be adjusted by the IRS each year to reflect changes in the cost of living. No adjustment was made to the limit for calendar year 2015.

Adjustment Due to Age

The $210,000 basic Section 415(b) limit is adjusted as follows based on the member's age at the time of his or her retirement:

• Younger than age 62-Limit is adjusted downward for early commencement of benefits
• Between age 62 and age 65-No adjustment
• Older than age 65-Limit is adjusted upward for late commencement of benefits

The reduced limit for retirements before age 62 is determined by:

• Taking the Section 415(b) limit for the year in which the member retires ($210,000 for 2016)
• Assuming for purposes of adjusting the limit ONLY that the member's benefit payable at age 62 as a single life annuity is equal to the Section 415(b) limit ($210,000 for 2015)
• Adjusting that assumed single life annuity amount to the actuarially equivalent single life annuity payable at the member's actual age at retirement.

Example: John is 57 years old at the time he retires in 2016. The Section 415(b) limit for 2016 is $210,000. For purpose of calculating John's reduced limit, the Plan's actuary assumes that his benefit at age 62 in the form of a single life annuity is $210,000. The actuary then adjusts that amount payable that would be payable at age 62, $210,000, to reflect the fact that John will begin receiving benefits at 57. The reduced limit is equal to $148,807.

Special Adjustment Rule for Police, Fire and Emergency Medical Personnel

The Code does not require a downward adjustment for early retirement if a member who retires before age 62 was "a full-time employee of any police department or fire department which is organized and operated by the state . . . to provide police protection, firefighting services, or emergency medical services" who provided services in that capacity for at least fifteen (15) years ("Special Police/Fire/EMS Group").

The IRS has interpreted this provision to include all employees of a police or fire department, even if they provide services in a position other than police officer, firefighter or emergency medical technician, but does not include employees providing police, fire or emergency medical services as employees of an entity other than a police department or fire department.

NOTE: Many of the employees who are considered "hazardous duty" employees under SERS will not be eligible for inclusion in the Special Police/Fire/EMS Group because they are not employed by a police department or fire department. Examples of employees who are hazardous duty employees for purposes of SERS, but who are not Special Police/Fire/EMS Group members, include, but are not limited to: corrections officers; forensic head nurses, psychiatrists, and probation officers.

Downward Adjustment if Less than Ten Years of Participation

A member's Section 415(b) limit may also be adjusted downward if the member has less than ten (10) years of participation in SERS at the time he or she retires. If a member has fewer than ten (10) years of participation, the Section 415(b) limit is determined by:

• Calculating the member's age-adjusted Section 415(b) limit;
• Multiplying that amount by the number of the member's years of participation divided by ten (10).

Example: Eric is 62 years old with five years of participation in SERS at the time he retires in 2016. The 2016 Section 415(b) limit is not adjusted for age because Eric has attained age 62. Eric's Section 415(b) limit is determined by multiplying $210,000 (the 2015 Section 415(b) limit) by 50% (5 years of participation divided by 10). Eric's limit for 2015 is $105,000.

3. How Does the Division Determine if a Retirement Allowance Must Be Limited?

The Division examines each retirement application to determine if the member's benefit may be limited by Section 415(b). Part of this analysis depends on what form of benefit the member has elected. Please see Section 6 below for a description of the impact of various forms of benefit.

In determining if a benefit must be limited, the Division will:

(1) Determine the Section 415(b) limit for the member given his or her age, years of participation in SERS, and eligibility for the Special Police/Fire/EMS Group

(2) Determine whether the member has elected to receive his or her benefit in an optional form (benefit form other than a single life annuity or qualified joint and survivor annuity)

(3) If the member has not elected to receive his or her benefit in an optional form, determine if the amount of that annual benefit exceeds the member's Section 415(b) limit determined in step (1)
 

(4) If the member has elected to receive his or her benefit in a form other than a single life annuity or qualified joint and survivor annuity: (i) convert the value of the optional form of benefit selected by the member into a straight life annuity using the actuarial factors set forth in SERS; and (ii) determine if that amount exceeds the member's adjusted Section 415(b) limit determined in step (1)

If a member's benefit exceeds the Section 415(b) limit, the SERS actuaries will reduce the member's benefit to the extent required to comply with the limit. Benefits will subsequently be tested on an annual basis to ensure continued compliance with the Section 415(b) limit.

4. Are Disability Retirements or Death Benefits Subject to the Section 415(b) Limit?

Disability benefits and death benefits are subject to the Section 415(b) limit, but are not subject to adjustment due to disability retirement or death before age 62 or prior to the completion of ten (10) years of participation in SERS.

Example: Donna is 38 years old when she receives a disability retirement benefit. Donna's benefit is $50,000 per year, which exceeds the age-reduced Section 415(b) limit for a 38 year old of $47,368. However, because Donna is receiving a disability retirement benefit, she is treated as if she is age 62 and the age 62 limit of $210,000 is applied. Accordingly, Donna's benefit does not exceed the Section 415(b) limit.

5. Do Cost of Living Adjustments (COLAS) Affect the Limitation?

Yes. SERS is required to test a member's benefit on an annual basis to ensure that the benefit does not exceed that year's Section 415(b) limit. The testing will reflect the increase in the member's benefit due to the COLA, as well as any applicable increases in the Section 415(b) limit made by the IRS. Because the maximum Section 415(b) limit only increases in $5,000 increments, it may not increase every year. As a result, a member who received an unreduced benefit in one year may see his or her benefit reduced in the next year if the amount of his or her SERS COLA exceeds the change, if any, in the IRS limit.

Example: Assume Enid retired at age 65. Her pension is $195,000 in 2012, which is under the Section 415(b) limit for that year. The Section 415(b) benefit limit is $205,000 in 2013, $210,000 in 2014, and $210,000 in 2015. Assume that the SERS COLA increase is 3% in each of those years. Enid's pension will be $200,850 in 2013 and be under the limit. Enid's 2014 pension of $206,876 will also be under the limit for 2014. However, Enid's pension will exceed the limit in 2015, as her pension will rise to $213,082 without any increase in the Section 415(b) limit, which remains at $210,000. As a result, Enid's pension will be limited to $210,000 for 2015.

6. How Do Optional Payment Election Forms Impact the Measurement of the IRC Section 415(b) Maximum Benefit?

As described in Section (3) above, a member's adjusted Section 415(b) limit can be applied directly to the member's benefit without additional calculations if the member elects to receive benefits in the form of a single life annuity or qualified joint and survivor annuity (QJSA) of between 50% and 100%, provided that the member's spouse is the survivor annuitant.

However, if a member elects to receive his or her benefit in a form other than a single life annuity or qualified joint and survivor option (an "optional form of a benefit"), additional steps must be taken to ensure that the value of the optional form of benefit does not exceed the Section 415(b) limit. Any optional form of benefit must be converted to a straight life annuity for testing purposes. The member's straight life annuity for this purpose is the greater of: (i) the straight life annuity the member could have received from SERS if he or she elected that form of benefit; or (ii) the straight life annuity that results from the conversion of the optional form into a straight life annuity using an interest rate of 5% and the then-current IRS mortality table ("IRS Factors").

Example: Tony is 58 years old and is not in the Special Police/Fire/EMS Group. He is married and his wife is 54 years old. His Section 415(b) limit is reduced to $159,129 because his benefit is commencing before he attains age 62.

• His pension is estimated at $160,000 for 2015 if he chooses a straight life annuity payment election (SERS Option D). The limit for his age in 2015 is $159,129, so he will exceed the Section 415(b) limit if he chooses Option D and his benefit will be limited to $159,129.
   
• If Tony elects a 50% joint and survivor payment option with his spouse as the contingent annuitant (SERS Option A), his retirement benefit will be $148,560 per year. As the $148,560 50% joint and survivor annuity is less than Tony's 2015 Section 415(b) limit of $159,129, Tony's 50% joint and survivor benefit does not need to be reduced.
   
• If Tony instead takes the 10 year certain option (SERS Option C) as his payment option election, naming his daughter as the contingent annuitant, a more complex calculation will need to be performed. To determine whether Tony's benefit exceeds the limit, his straight life annuity benefit under SERS is compared to the value of his 10 year certain option converted into a life annuity using IRS factors (these amounts differ, even though the form of benefit is the same, because SERS and the IRS use different actuarial factors). Tony's single life annuity benefit under SERS is $160,000. The SERS actuaries determine that the value of Tony's 10 year and certain benefit, when converted to a single life annuity using IRS factors, is $157,344. As the greater of these two amounts, $160,000, exceeds the Section 415(b) limit, Tony's benefit must be reduced. His 10 year certain benefit will be determined by converting his maximum straight life annuity of $159,129 into a 10 year certain benefit using the SERS actuarial factors.

7. How is my Tier I, Plan B reduction treated for purposes of Section 415(b) limitation purposes?

Tier I, Plan B members are subject to a small reduction in their benefit when they reach full Social Security retirement age. This is because Tier I, Plan B members make a reduced employee contribution on their salary amounts subject to Social Security. As a result, Tier I, Plan B members will have two different benefit amounts-one amount applicable to the period from the member's retirement date to the day before their full Social Security retirement date, and a smaller amount applicable from their full Social Security retirement date forward.

For purposes of applying the limits of Section 415(b), a plan is required to take into account any social security supplements. The SERS actuaries will combine a Tier I, Plan B member's two benefit amounts and convert those amounts into a single life annuity amount using the required actuarial assumptions. The Section 415(b) limit will be applied to this combined, actuarially adjusted amount.

EXAMPLE: Nancy, a Tier I, Plan B member retires at the age of 62. She will receive her retirement benefit, plus a social security supplement, from age 62 to her "full" social security retirement age. She elects to receive her benefit as a straight life annuity and her calculated benefit is $196,000 broken down as follows: $194,200 retirement benefit and $1,800 social security supplement ($150 per month). Upon reaching age 65, her "Plan B reduction" will be $150 per month bringing her benefit down to $194,200 plus whatever COLAs she received throughout this time. The entire allowance of $196,000 is used in determining whether the IRC 415(b) dollar limitations apply to Nancy's benefit at the time of retirement, although the actuaries will take into account the fact that, given her projected life expectancy, Nancy will receive the larger monthly benefit for a far shorter time than the reduced post-Social Security retirement age benefit.

8. Are payments from other State defined benefit retirement plans or deferred compensation plans used in determining my benefit for Section 415(b) limitation purposes?

If you are also eligible to receive a benefit from the Teachers Retirement System (TRS), your SERS benefit and TRS benefit will be combined for purposes of applying the Section 415(b) limit.

Separate Section 415 limits on contributions (rather than the limit on distributions that applies to SERS benefits) apply to ARP and the State's Section 403(b) plan. Contributions to these plans, or the State's Section 457(b) plan, will not affect the Section 415(b) limit applied to your SERS benefit.

9. Other governmental employers seem to have plans that allow for "replacement" of the portion of a member's pension that cannot be paid because it exceeds the Section 415(b) limit with wages. Does anything similar currently exist for State employees?

Some governmental employers have opted to use "qualified excess benefit arrangements" (QEBA) to provide additional benefits to employees whose qualified retirement plan benefits are limited by Section 415(b). These arrangements, which are funded from the employer's general assets rather than a trust, provide an additional benefit equal to the difference between the employee's retirement benefit before reduction for Section 415(b) and the amount of his or her benefit after that reduction is applied. At this time, the State of Connecticut does not offer any such arrangement and there is no plan to offer such an arrangement in the future.

III. CONCLUSION

Any questions you have concerning the information provided herein or any individual employee who feels that they may be affected by these limits may be addressed to the Retirement Services Division, at 860-702-3480.

Very truly yours,

BY:

Brenda K. Halpin, Director
Retirement Services Division

BKH/bb

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