Was your/my pension plan contribution calculated correctly (for a Defined Contribution Plan)?

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palindrome
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Joined: Mon Oct 19, 2015 5:16 am

Was your/my pension plan contribution calculated correctly (for a Defined Contribution Plan)?

Post by palindrome » Tue Jun 30, 2020 9:08 am

A more complete title (which unfortunately wouldn’t fit) is:

Did the Third Party Administrator (TPA) of your/my discretionary Defined Contribution Pension/Profit Sharing Plan - a plan that uses the Integrated (Permitted Disparity) Method - calculate contributions correctly?

The longer title is a mouthful, and the topic is not going to be either pertinent to, or of interest to, the majority of participants in this forum. But it could be very helpful to some of you, particularly if you own or are employed by a small business or professional (e.g. medical, dental) practice with just a few people covered by the plan.

Intent of this post:

1. Asking you to help me determine if the pension plan contributions for my place of work have been correctly calculated.

2. To help you perform your own calculation so that you can confirm that your company’s/employer’s pension contributions are correct. It might just help your own bottom line.

3. To share a pertinent Excel spreadsheet. The spreadsheet examines/compares two different methods of calculating the pension plan contributions. Method 1 is the one that has been used by our TPA. I suspect that Method 2 is the correct way, however. I am concerned that our entity may have overpaid/over-contributed over a period of years. Hence my request for help.

4. To preempt an obvious question: Did you ask your Third Party Administrator (TPA)?

Yes.

We had initially been in communication with the TPA about a different issue, in the course of which we cited the plan language, and asked the TPA to review their calculations and methodology => No change.

I then sent essentially the same spreadsheet comparison presented here to them (though with our specific numbers), asking for their review and rationale for their method over mine.

The entire response from our pension consultant at the TPA was an e-mail saying:

“Again, please use the original calculation spreadsheet to calculate the employer contributions as I had previously said. Thank you.”

That was all. No explanation – zip, nada.

At that point I decided to seek out the collective wisdom and experience of the Bogleheads community.


This post is divided into several parts, as described below. But feel free to just skip ahead and look at the linked Excel spreadsheet now to get the idea. It should be understandable on its own.

1: Applicability (would it be pertinent to you)

2. Background (how the question arose)

3. Language of the Pension Plan Document (Summary Plan Description)

4. Questions posed to the forum: What do you think? Which method is correct in our situation? Further thoughts/suggestions?

5. Appendix: Terms and Definitions used (some of these are obvious, some less so



Applicability:

This post is really pertinent only to someone whose pension plan fits into the above niche, i.e. a discretionary Defined Contribution Plan that uses the Integrated (Permitted Disparity) Method to calculate the contributions. And within that niche, there are additional sublevels/nuances complicating things.

If you are like me (i.e. DISCLAIMER: I am not even close to being a pension expert), that description would not mean much. You would likely have to consult your pension plan’s Summary Plan Description to know for sure. But in general terms, it is the type of plan that allows a maximum contribution of $57,000 in 2020 ($56,000 in 2019) and is designed to give a disparately higher amount (i.e. unequal, but within permitted IRS limits) to more highly paid participants (e.g. favoring a business owner or a few highly compensated employees).

If this is obviously not your situation, there is no need to read any further.

Background:

My place of employment has such a defined contribution type profit sharing pension plan.

Recently, a situation came up that prompted me to want to know exactly how to calculate the contribution myself. The calculation has always been left up to the TPA. After spending a considerable amount of time on the question, I believe I have developed a better handle on how it is done, but have found a definitive answer elusive. I searched the Bogleheads forum and elsewhere, and (though it is possible I missed a pertinent thread) did not find an answer. I decided to write this post in order to get some help and to help others in the future.

Language of the Pension Plan Document (Summary Plan Description)

Here is the exact language in our Summary Plan Description describing the calculation of the contribution made by the employer for any covered individual:

“The contribution will be allocated to your account in the same proportion that your compensation plus your compensation in excess of the Social Security Taxable Wage Base (also called "excess compensation") bears to the total compensation plus "excess compensation" of all eligible Participants. However, the maximum amount which can be allocated to you in this first step is 5.7% of your compensation plus your "excess compensation."

If after the first step of the allocation process there still remains a portion of the contribution which has not yet been allocated, then the remainder will be allocated to you in the same proportion that your compensation bears to the total compensation of all Participants.”

Clear as mud, right? That might as well have been written in Greek, for all it helped me at first (and second, and third) glance. But the precise phrasing is very important. Suggestion: get a copy of your Summary Plan Description and compare it to the wording above. There are variations from plan to plan that could alter your specific situation.


Questions posed to the forum: What do you think? Which method is correct in our situation? Do you have a similar plan, and how have your contributions been calculated? Further thoughts/suggestions?

The general question has to do with the mechanics of exactly how to perform the contribution calculation given the parameters prescribed by the Summary Plan Description and pertinent IRS related limitations.

The quandary is how to deal with “proportionality” in the Summary Plan Description, i.e. the “proportion that your compensation plus your compensation in excess of the Social Security Taxable Wage Base (also called "excess compensation") bears to the total compensation plus "excess compensation" of all eligible Participants” and the “proportion that your compensation bears to the total compensation of all Participants”

There is nothing I can see that takes that plan language into account in the TPA’s calculations (Method 1).

After long consideration, I suspect that our TPA did not use the correct calculation method, and that the alternative method is correct (Method 2).


Appendix: Terms and Definitions (see the linked spreadsheet)
In order to keep this post from being overly long, these are in the spreadsheet.

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