3865 / What are the permitted disparity requirements applicable to defined benefit plans?
A defined benefit plan may be structured to use permitted disparity and satisfy the safe harbor provided by the Treasury regulations under IRC Section 401(a)(4). A defined benefit plan will not be considered discriminatory merely because the plan provides that a participant’s retirement benefit may not exceed the excess of (1) the participant’s final pay with the employer, over (2) the retirement benefit, under Social Security law, derived from employer contributions attributable to service by the participant with the employer.1 The participant’s final pay is the highest compensation paid to the participant by the employer for any year that ends during the five year period ending with the year in which the participant separated from service.2 Compensation in excess of $350,000 (for 2025) may not be taken into account.3
A defined benefit plan may provide for disparity in the rates of employer-provided benefits if it meets all of the following requirements:
(1) The disparity in benefit accruals for all employees under the plan must not exceed the maximum excess allowance (in the case of an excess plan) or the maximum offset allowance (in the case of an offset plan).4
The maximum excess allowance is the lesser of .75 percent (subject to reduction as described below) or the base benefit percentage for the plan year.5 The maximum excess allowance cannot exceed the base benefit percentage.6
The maximum offset allowance is the lesser of (1) .75 percent (reduced as described below) or (2) one-half of the gross benefit percentage multiplied by a fraction (not to exceed one) of which the numerator is the employee’s average annual compensation and the denominator is the employee’s final average compensation up to the offset level.7 The maximum offset allowance may not exceed 50 percent of the benefit that otherwise would have accrued.8 For plans meeting the maximum offset allowance limitation, the “PIA Offset” safe harbor described below may be available.
(2) The disparity for all employees under the plan must be uniform.9 To be uniform, an excess plan must use the same base benefit percentage and the same excess benefit percentage for all employees with the same number of years of service. An offset plan is uniform only if it uses the same gross benefit percentage and the same offset percentage for all employees with the same number of years of service. The disparity provided under a plan that determines each employee’s accrued benefit under the fractional accrual method in IRC Section 411(b)(1)(C) is subject to special uniformity requirements.10
(3) The integration level under an excess plan or the offset level under an offset plan for each participant must be the participant’s “covered compensation,” a uniform percentage above 100 percent of covered compensation, a uniform dollar amount, or one of two intermediate amounts specified in the regulations.11
Regulations under IRC Sections 401(a)(4) and 401(l) provide a “PIA offset” safe harbor for those defined benefit plans that limit the offset to the maximum offset allowance described above. Under the safe harbor, a defined benefit plan that satisfies any of the existing safe harbors provided in the regulations under IRC Section 401(a)(4) will not fail to be a safe harbor plan merely because it offsets benefits by a percentage of PIA.12
Covered compensation, which is similar to the integration level in defined contribution plans and only applies to permitted disparity in defined benefit plans, means the average of the taxable wage bases for the 35 calendar years ending with the last day of the calendar year an individual attains Social Security retirement age.13 The IRS publishes tables annually for determining employees’ covered compensation.14
Average annual compensation is the participant’s highest average annual compensation for any period of at least three consecutive years or, if shorter, the participant’s full period of service.15
Final annual compensation is the participant’s average annual compensation for the three consecutive year period ending with the current year, or, if shorter, the participant’s full period of service, but not exceeding the contribution and benefit base in effect for Social Security purposes for the year.16
Final regulations require certain reductions in the .75 percent factor if the integration or offset level exceeds covered compensation or if benefits begin at an age other than Social Security retirement age. These reductions may be determined on an individual basis by comparing each employee’s final average compensation to the employee’s covered compensation.17
1. IRC § 401(a)(5)(D)(i); Treas. Reg. § 1.401(a)(5)-1(d)(2).
2. IRC § 401(a)(5)(D)(ii).
3. Treas. Reg. § 1.401(a)(5)-1(e)(2); IRC § 401(a)(17).
4. Treas. Reg. §§ 1.401(l)-3(a)(3), 1.401(l)-3(b)(1).
5. Treas. Reg. § 1.401(l)-3(b)(2).
6. IRC § 401(l)(4)(A).
7. Treas. Reg. § 1.401(l)-3(b)(3).
8. IRC § 401(l)(4)(B).
9. Treas. Reg. § 1.401(1)-3(b)(1).
10. Treas. Reg. §§ 1.401(l)-3(a)(4), 1.401(l)-3(c)(1).
11. Treas. Reg. § 1.401(l)-3(d). See IRC § 401(l)(5)(A).
12. Treas. Reg. § 1.401(l)-3(c)(2)(ix).
13. Treas. Reg. § 1.401(l)-1(c)(7)(i).
14. See Rev. Rul. 2024-1 for the 2024 covered compensation table. See also Rev. Rul. 2022-24, Rev. Rul. 2022-02, Rev. Rul. 2021-03, Rev. Rul. 2020-02 and Rev. Rul. 2019-06 for earlier years.
15. IRC § 401(l)(5)(C). Treas. Reg. §§ 1.401(l)-1(c)(2), 1.401(a)(4)-3(e)(2).
16. IRC § 401(l)(5)(D); Treas. Reg. § 1.401(l)-1(c)(17).
17. Treas. Reg. §§ 1.401(l)-3(d)(9), 1.401(l)-3(e).