7. Compensation formulas

Statement of Requirement: Treas. Reg. § 1.401(a)(4)-3(e)(2); Rev. Proc. 2017- 41, sec. 5.16(3) 2023-37, 9.03

181 | Defined Benefit Plan LRM Package 08/2020 06/2026

Document Provision: _____

Sample Plan Language:

Average annual compensation. Average annual compensation means the average of a participant’s annual compensation, as defined in section____ of the plan, over the three consecutive plan years (or 12-month periods) ending in the current year or in any prior year that produces the highest average. If a participant’s entire period of service for the employer is less than three consecutive years, compensation is averaged on an annual basis over the participant’s entire period of service.

(Note to reviewer: The blank should be filled in with the plan section number that corresponds to LRM #6.)

(Note to reviewer: The election of the plan year or 12-month period for Compensation is made in LRM #6.)

(Note to reviewer: The plan may provide for an averaging period that consists of more than three years or may permit the employer to select an alternate period (not less than three years)).

(Note to reviewer: In an accumulation plan (a plan providing that the participant’s total retirement benefit consists of the sum of the participant’s benefits separately calculated for each plan year using compensation earned for the year), a participant’s retirement benefit may be determined using a participant’s annual compensation (as defined in LRM #6) in place of average annual compensation.)

(Note to reviewer: In the sample plan language above, the participant’s compensation history consists of the participant’s entire period of service. However, a participant’s compensation history may be limited to a period no shorter than the averaging period, as long as it is continuous and ends in the current plan year. For example, a plan may provide that average annual compensation is determined based on the 5 consecutive year period that produces the highest average out of the last 10 years. Note also that in determining a participant’s compensation history, certain years may be disregarded. See Treas. Reg. § 1.401(a)(4)-3(e)(2)(ii)(B).)