Special Compensation Limit for Governmental Plans

“I recently starting working for a public university that sponsors a 403(b) plan. I am familiar with the 401(a)(17) compensation limit ($285,000 in 2020, $290,000 in 2021). But someone here told me that there is actually a “special” 401(a)(17) limit that applies to certain employees. Sounds fishy to me; does it sound fishy to the Experts?”

Charles Filips, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:

No, it does not sound fishy to the Experts! The 401(a)(17) compensation limit is primarily used to determine the dollar amount of an allocation of employer contributions to a retirement plan, and there is indeed a special grandfathered limit that can apply to certain public employees. The reason that you have not heard of it is that it is quite possibly one of the least publicized limits in the entire universe of defined contribution retirement plans!

The limit applies ONLY to governmental plans, and it works like this: If permitted in the plan document, a governmental plan can apply an older, higher indexed 401(a)(17) limit that was in place back on July 1, 1993, but ONLY for any individuals who first became a participant in the plan prior to the first day of the first plan year beginning after the earlier of—(1) the last day of the plan year by which a plan amendment to reflect the 401(a)(17) limit reduction made by section 13212 of OBRA ’93 was both adopted and effective; or (2) December 31, 1995.

You can find this grandfather rule in Treasury Regulation § 1.401(a)(17)-1(d)(4)(ii)(B). This grandfathered 401(a)(17) compensation limit is MUCH higher than the limit that would normally apply (in 2020 it is $425,000 and in 2021, it is $430,000). However, this higher limit can only be applied to a relatively small group of individuals (those who were participants in the plan over 25 years ago, and who remain participants today), that will continue to shrink over time as participants in the grandfathered group retire.

In addition, the 415 limit still applies, which makes the higher compensation limit less valuable than it might be otherwise. And, in order for the grandfathered limit to be used, plan sponsors should be able to furnish proof that the participant meets the grandfather in the event of an IRS audit.

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.