Types of Retirement Plans - Integration with Social Security/disparity limits
Qualified plans may be integrated with Social Security to balance the benefit bias toward lower paid employees that is inherent in the Social Security system. Integration allows the employer's retirement plan to be combined with Social Security to result in an overall retirement scheme. Under an integrated plan, greater contributions or benefits are provided for higher paid employees whose compensation exceeds than the Social Security wage base.
The "permitted disparity" places a limit on the allowed difference between either benefit accruals or contributions for highly paid employees vs. lower paid ones.
A. Defined benefit plans
An integrated defined benefit plan must be based on average annual compensation, defined as an average of at least three years' consecutive pay.
Two methods to integrate defined benefit plans with Social Security:
- Excess method - Plan provides a higher level of benefits for compensation above what is called the "integration level." The integration level typically is what is known as the Social Security covered compensation, which is the average Social Security wage base for the 35 years up to and including the employee's Social Security retirement year.
- Offset method - Plan formula reduced by fixed or formula amount designed to take into account Social Security benefits.
Defined contribution plans may utilize only the excess method to integrate with Social Security.
In general, for a defined contribution plan:
- the maximum spread between the two contribution levels must be no more than 5.7% and
- the contribution rate above integration level may be no more than twice the rate below it.