Internal Revenue Code Section 415(b) & Excess Benefit Arrangement
This page summarizes the limits set forth in IRC 415(b) and the SURS Administrative Rule 80 Ill. Admin. Code § 1600.145 (Compliance with Final 415 Treasury Regulations).
What is Internal Revenue Code Section 415(b)?
Internal Revenue Code Section 415(b) (IRC 415(b)) is a federal tax provision that limits the amount of an “annual benefit” that an individual can receive from a tax-qualified defined benefit pension plan, such as the State Universities Retirement System (SURS) Tier I and Tier II Traditional and Portable plans. The annual benefit payable from SURS retirement plan is subject to dollar limits imposed by IRC 415(b). This law was enacted to prevent employers from using tax-qualified defined benefit plans as tax shelters for highly compensated employees.
In order to protect the tax-exempt status of the plan, it is important that SURS maintain compliance with the limits set forth in IRC 415(b). In order to maintain compliance and protect member benefits, the SURS Excess Benefit Arrangement (EBA) was created. Benefits payable to a member in excess of the IRC 415(b) limits are paid through the SURS EBA, which is funded by the state of Illinois on a pay-as-you-go basis. The rules for the EBA are found at 80 Ill. Admin. Code § 1600.430 (Excess Benefit Arrangement).
What are the IRC 415(b) limits?
- The IRC 415(b) annual benefit limit is published by the Internal Revenue Service (IRS) for retirees aged 62 and older and may be periodically adjusted based on inflation in $5,000 increments. This limit was $230,000 in 2020; $225,000 in 2019; and $220,000 in 2018. It is $230,000 for 2021.
- For members who retire before the age of 62, the annual benefit limit is a lower, age-adjusted limit that is actuarially equivalent to the dollar limit for retirees aged 62 and older.
- The IRC 415(b) annual dollar limit is used instead of the actuarial age-adjusted limit for members retiring before age 62 if:
- The retiree was a police office or firefighter with 15 or more years of service.
- The annual benefit is for a survivor’s annuity payable due to the pre-retirement death of a member.
- The annual benefit is for a disability retirement before age 62.
- Special IRC 415(b) limits are used in the following situations:
- The retirement benefit is treated as meeting the IRC 415(b) limit if all combined benefits from the employer’s retirement plan do not exceed $10,000 annually, and the retiree has not participated in a defined contribution plan offered by the employer.
- If the retiree participated in SURS for less than 10 years, then the IRC 415(b) limit is reduced by 10% for every year of participation less than 10 (but not lower than 10% of the 415(b) limit).
How is a retiree’s “annual benefit” for IRC 415(b) limit purposes determined?
- Once the original annuity has been calculated, SURS begins the process of determining the portion of the annuity designated as the “annual benefit” for IRC 415(b) limitation purposes.
- All retirement benefits are screened at retirement and annually thereafter to identify those that meet criteria for testing for the IRC 415(b) limit.
- In addition to the amount of the monthly retirement annuity, any lump-sum payments such as a refund of survivor contributions and a refund of excess contributions are also considerations in determining whether or not the member meets the testing criteria. Lump-sum payments are actuarially converted into annuities for testing purposes.
- If staff determines that a member’s benefit meets the criteria for IRC 415(b) limit testing, the accounting staff uses a custom-built actuarial tool that calculates the annual benefit amount that is payable under the SURS qualified trust.
- If the annual benefit exceeds the IRC 415(b) limit, it is split into two portions:
- Dollar Limited Benefit: The maximum annual amount of the retirement benefit payable to the retiree from the SURS qualified trust. Payments from the SURS qualified trust are reported on IRS Form 1099-R.
- Excess Benefit Arrangement: The amount in excess of the IRC 415(b) limit that is payable to the retiree through the EBA. Payments from the EBA are reported on IRS Form W-2 as nonqualified deferred compensation plan payments. As such, if paid as a lump-sum benefit, they may not be rolled over to an eligible retirement plan to avoid taxation.
How are EBA payments taxed?
Excess Benefit Arrangement (EBA) payments are taxable gross income under federal tax law and are treated as distributions from a nonqualified deferred compensation plan of a taxable corporation per Section 415(m)(2) of the Internal Revenue Code. IRS Publication 957 characterizes nonqualified deferred compensation plan distributions as special wage payments that are reportable on IRS Form W-2. EBA payments may not be rolled over to an eligible retirement plan (such as a 401(a) plan, 403(b) plan, 457(b) plan or an IRA). SURS remits taxes to the IRS based on the withholding instructions provided by each retiree under Form W-4 (do not use Form W- 4P). At the end of the tax year, SURS issues to the retiree a Form W-2 to reflect payments and tax withholdings on the EBA portions of the retirement benefit. This Form W-2 will be issued in addition to any Form 1099-Rs issued for the portion of the retirement benefit that is less than the annual benefit limits of Internal Revenue Code Section 415(b).
Illinois tax law excludes all SURS benefit payments from taxable income for state income tax purposes.
As a retiree subject to the EBA, what should I take away from this information?
Your retirement benefit exceeds (or is expected to exceed) the amount that SURS can pay from the trust fund on an annual basis. Therefore, a portion of your retirement benefit will be paid from SURS EBA fund. The total amount of your retirement benefit is not affected. However, your payment will come from two sources, SURS trust and the EBA fund.
The total benefit is considered taxable gross income for federal income tax purposes, and it is not subject to state income tax. The portion of your benefit payable from the SURS trust will be taxed according to your W4-P form and will be reported on a Form 1099-R. The EBA portion of your retirement benefit will be taxed according to the W-4 form on file and will be reported on a Form W-2.
SURS will determine what portion of your benefit is payable from the SURS trust and from the EBA fund at retirement and on an annual basis thereafter.