Workshop 7 IRC Section 401(a)(26)

Transcription

1 Workshop 7 IRC Section 401(a)(26) Kevin Donovan, MSPA, CPA Pinnacle Plan Design, LLC Tucson, AZ Rick Block, ASA, MSPA, MAAA Block Consulting Actuaries, Inc. El Segundo, CA

2 Acknowledgement We thank Larry Deutsch for allowing us to use his presentation from the 2012 ASPPA Annual Conference

3 IRC Section 401(a)(26) This session will cover The 401(a)(26) test on an active plan Arrangements creating separate plans What happens if a plan is frozen Testing a former benefit structure Offset arrangements

4 What is the 401(a)(26) test 401(a)(26) tests that a plan benefits a sufficient number of employees 401(a)(26) does not test whether benefits, or coverage are non-discriminatory

5 What is the 401(a)(26) test Prior to 401(a)(26) it was common that a law firm would have one defined benefit plan covering each partner, known as an IDB or individual defined benefit plan, and then a plan covering the staff. While these arrangements met the nondiscrimination requirements. The concern was that the IDBs would become overfunded, while the staff plan was underfunded Similarly, the individual lawyers would have control over the investment of the assets in their individual plan (whether a DB or DC plan) while the staff did not

6 What is the 401(a)(26) test This potential disparity in funding and investing was viewed as inappropriate, and it was the intent of 401(a)(26) to eliminate this type of disparity To this end, 401(a)(26) requires that the plan benefit the lesser of 50 employees, or 40% of the non-excludable employees But, in no event, less than 2 employees, unless there is only one non-excludable employee

7 What plans are exempt from 401(a)(26) The 401(a)(26) regulations exempt from 401(a)(26) testing (or deem plans to satisfy 401(26)) if the plan meets either of 2 conditions No highly compensated employee benefits rule Certain underfunded frozen plans Multi-Employer plans Plans of Governmental entities Entities with Separate Lines of Business test each plan separately for each line of business Note the law was ultimately changed to exempt DC plans from 401(a)(26) but the regulations have not been updated

8 No highly compensated employee benefits rule Under this rule a plan is exempt from 401(a)(26) if: The plan is not top heavy The plan benefits no highly compensated employee or former highly compensated employee The plan is not aggregated with another plan in order to allow the other plan to satisfy 401(a)(4) (other than then the average benefit percentage test)

9 What plans are exempt from 401(a)(26) It is possible for an employer to maintain multiple plans, some of which are top heavy and some of which are not In particular, if a plan covers no key employees, and is not part of a top heavy aggregation group then the plan could be not top heavy, while another plan of the sponsor is top heavy

10 What plans are exempt from 401(a)(26) The 401(a)(26) regulations define an employee as benefitting if the employee is benefitting under the 410(b) rules, thus, generally, an employee is benefitting only if their accrued benefit increases during the plan year Thus, a highly compensated employee could have a benefit but not be benefitting

11 Underfunded frozen plan rule A plan is deemed to satisfy 401(a)(26) if The plan is covered under Title IV of ERISA The plan does not have sufficient assets to pay all benefits The plan is frozen (other than receiving Top Heavy minimums) Alternatively, a plan is deemed to satisfy 401(a)(26) if The plan is covered under Title I of ERISA The plan is not Top Heavy The plan does not have sufficient assets to pay all benefits The plan is frozen (other than receiving Top Heavy minimums) Note that the apparent conflict in Top Heavy has to do with effective date of rule changes

12 Who is a non-excludable employee The concept of which employees are counted (to take 40% of) is similar to the 410(b) concept of a non-excludable employee, but viewing the DB plan only Thus, a non-excludable employee for 401(a)(26) purposes is any employee who meets the age and service requirement of the DB plan

13 Who is a non-excludable employee A plan may be permissively disaggregated into those employees above and below the maximum minimum age and service requirements of 410(a)(1)(A) A plan may exclude terminated employees in a manner similar to the 410(b) rules

14 What is a meaningful benefit under 401(a)(26) The rules require that for an employee to be treated as benefitting in a DB plan, the benefits must be meaningful It is fairly well established (as a practice, but not a regulatory rule) that a participant has a meaningful benefit if their accrual rate is at least 0.5% of pay

15 What is a meaningful benefit under 401(a)(26) June 6, 2002 Paul Shultz Memo Internal memo to reviewers not subject normal vetting process 401(a)(26) becomes a non-discrimination test Compares the benefits of shareholders with nonshareholder not the benefits of HCEs vs. NHCEs Seems to preclude floor offset arrangements if the Service does not like the results Mandates ½% of pay as a minimum for 401(a)(26)

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20 Determining the 401(a)(26) Accrual Rate For purposes of 401(a)(26), the accrual rate is determined in the same manner as an EBAR under 401(a)(4), with these exceptions The accrual rate only reflects the plan tested for 401(a)(26) purposes The testing age is the NRA (even if not uniform) Only the normal EBAR is used Permitted disparity may not be imputed No adjustment for normal forms of payment other than a life annuity

21 Determining the 401(a)(26) Accrual Rate So consider the following example Assume the following: Compensation of $120,000 (2011), $130,000 (2012) and $140,000 (2013) Entered the plan in 2011 Prior accrued benefit of $200 Current accrued benefit of $250

22 Determining the 401(a)(26) Accrual Rate The accrual rate on an annual basis is ($250 - $200) X 12 / $150,000 = 0.40% Alternatively, the accrual rate can be calculated using a 4 year average ($250 - $200) X 12 / $135,000 = 0.44% Therefore under either method, this example would generally not be considered to have a meaningful benefit on an annual basis

23 Determining the 401(a)(26) Accrual Rate The accrual rate may be determined on an accrued to date basis $250 X 12 / $140,000* / 4 = 0.53% Therefore this methodology shows the plan to provide meaningful benefit on an accrued to date basis *high 3 year average

24 401(a)(26) in a cash balance plan Consider the following: Interest crediting rate is 3% Actuarial equivalency is 5% (e) mortality table NRA is 65 Participant has pay of $50,000, has a pay credit of $1,250 (2½% of pay) and is 45 years old.

25 401(a)(26) in a cash balance plan The monthly benefit at NRA is $1,250 x 1.03^(65-45)/ = $15.51 The 401(a)(26) accrual rate is $15.51 x 12 / $50,000 = 0.37%

26 Arrangements creating separate plans 1.401(a)(26)-2(d) (iii) Defined benefit plans with other arrangements (A) In general. A defined benefit plan is treated as comprising separate plans if, under the facts and circumstances, there is an arrangement (either under or outside the plan) that has the effect of providing any employee with a greater interest in a portion of the assets of a plan in a way that has the effect of creating separate accounts.

27 Arrangements creating separate plans Separate plans are not created, however, merely because a partnership agreement provides for allocation among partners, in proportion to their partnership interests, of either the cost of funding the plan or surplus assets upon plan termination.

28 Arrangements creating separate plans Examples. The following examples illustrate certain situations in which other arrangements relating to a defined benefit plan are or are not treated as creating separate plans:

29 Arrangements creating separate plans Example 1. Employer A maintains a defined benefit plan under which each highly compensated employee can direct the investment of the portion of the plan s assets that represents the accumulated contributions with respect to that employee s plan benefits.

30 Arrangements creating separate plans In addition, by agreement outside the plan, if the product of the employee s investment direction exceeds the value needed to fund that employee s benefits, Employer A agrees to make a special payment to the participant.

31 Arrangements creating separate plans In this case, each separate portion of the pool of assets over which an employee has investment authority is a separate plan for the employee.

32 Arrangements creating separate plans The key point is the question of controlling the investments creating the effect of an IDB. This does not preclude different benefit levels for different employees

33 What happens if a plan is frozen If a plan is frozen, but does not meet the exceptions, then under the regulations the plan must satisfy testing under the prior benefit structure rules Under this rule testing may be done only on current employees or on the combination of current and former employees

34 What happens if a plan is frozen The requirement is restricted to testing current (or current and former) employees have a meaningful benefit (i.e. without regard to the fact that they have no current year accrual)

35 What happens if a plan is frozen The regulations have the further requirement at 1.401(a)(26)-3(c)(2) that A plan does not satisfy this paragraph (c) if it exists primarily to preserve accrued benefits for a small group of employees and thereby functions more as an individual plan for the small group of employees or for the employer.

36 What happens if a plan is frozen So consider a doctor plan that is frozen 95% of the value of plan benefits is for the doctor Benefit are frozen At what point is the primary purpose of the plan for the preservation of the previously accrued benefit for the doctor (and thereby not satisfy 401(a)(26))?

37 Testing a former benefit structure If the plan is testing the prior benefit structure then first the people included in the test must be determined Which ones of those people who have a meaningful benefit must be determined (i.e. have an EBAR (by definition, using accrued to date) of at least 0.5%)

38 Testing a former benefit structure If the test is based upon current employees, then the determination of who is included is done as described previously If the test includes former employees, then non-excludable former employees must be determined (1.401(a)(26)-6(c)

39 Testing a former benefit structure The test then requires that the plan satisfy the 50 employee or 40% test, or The plan benefits at least 5 former employees AND EITHER The plan benefits 95% of the former employees with a vested benefit, or At least 60% of the former employees who benefit under the plan are NHCEs

40 Testing a former benefit structure Under the regulations, all former employees must be included, except The plan may optionally exclude employees terminated Before January 1, 1984 prior to the 10 th calendar year prior to the calendar year in which the current plan year begins

41 Testing a former benefit structure Under the regulations, all former employees must be included, except The plan may optionally exclude employees who never met the plans age and service requirement

42 Testing a former benefit structure Under the regulations, normally when testing benefits for former employees, employees who were below the 411(c)(3)(ii) mandatory distribution limit (which under 411(c)(3)(ii) is determined at the time of termination) are excluded, but under 1.401(a)(26)-4(d)(2), if the participant was vested, then they are not excludable

43 Testing a former benefit structure In applying this rule, the first problem is the distinction between benefit and benefitting. While benefitting is a well defined term, benefit is not. It would seem that in the phrase a plan that is subject to this section must benefit means that the individual is owed a benefit (i.e. previously earned and not yet paid)

44 Testing a former benefit structure Logically, any individual who was not covered by the plan, has a benefit less than the 411(c)(3) limit (because it is zero), but are they vested? There are three possible interpretations, but only two seem to make sense

45 Testing a former benefit structure Under the first interpretation, vesting is determined independent of whether an individual was a participant, so an individual who was never a participant could only be excluded if they had insufficient service to vest. This seems to be wrong, because they still don t have a vested accrued benefit.

46 Testing a former benefit structure Under the second interpretation, 411(c)(3) only applies to participants, so an individual can only be excluded from being under the 411(c)(3) if they were actually in the plan. Of course, the entire exception precluding the use of 1.401(a)(26)-6(c)(4) is worded in a way that makes no sense, since it only applies if the person was not owed a benefit.

47 Testing a former benefit structure Under the third interpretation, since all nonparticipants have no accrued benefit, they are under the 411(c)(3) limit (and have no vested accrued benefit), and so are excludable. This makes no sense, in that it would render the rule for excluding people below the age and service limit moot.

48 Testing a former benefit structure Ultimately, it would appear that the process is like this First, assemble a list of all former employees Second, optionally eliminate those who terminated over 10 years prior to the current year Third, optionally eliminate those who never met the age and service requirement Fourth optionally eliminate those who had no vested accrued benefit (but, only those who were actually participants)

49 Testing a former benefit structure What is left is the non-excludable employees Within that group determine how many have an EBAR on an accrued to date basis, of at least.5% of average compensation Test the group with a meaningful benefit to see if an acceptable percentage or count

50 IRC 401(a)(26) and Offsets 1.401(a)(26)-5 tells us who benefits for purposes of passing IRC 401(a)(26) 1.401(a)(26)-5(a)(2) describes offset arrangements that will be taken into account for such purpose 1.401(a)(26)-5(a)(2)(i) provides that an employee is treated as benefiting if such employee would be benefiting if certain offsets or reductions were disregarded

51 IRC 401(a)(26) and Offsets 1.401(a)(26)-5(a)(2)(ii) describes offsets by sequential or grandfathered benefits An offset or reduction satisfies this requirement if the formula provides that an employee will not accrue additional benefits under the plan until the employee has accrued a benefit in excess of their benefit under one or more formulas (under same or other plan) in effect for prior years

52 IRC 401(a)(26) and Offsets Ex. of application of 1.401(a)(26)-5(a)(2)(ii) Dr X is a solo practitioner (no other ees) and has now-termed DB Plan A with accrued benefit of $9K. Dr. Y joins practice and wishes to accrue benefits under a DB plan at time when Dr X is not interested. Plan B is adopted that provides that benefits are offset by benefits under prior DB plan. Dr X is treated as benefiting under Plan B even if he is not entitled to benefits under the plan.

53 IRC 401(a)(26) and Offsets 1.401(a)(26)-5(a)(2)(iii) describes rules for concurrent offset arrangements Under such an arrangement the formula is offset by contributions or benefits under another plan the employer currently maintains Three conditions must be met

54 IRC 401(a)(26) and Offsets 3 conditions under 1.401(a)(26)-5(a)(2)(iii) (1) Contributions or benefits under plan used to offset benefits being tested actually accrue under such other plan (2) Employees who benefit under the plan being tested must benefit under the other plan on a reasonable and uniform basis (3) Contributions or benefits used to offset not used to offset benefits under any other plan May test gross benefit where all 3 conditions met

55 IRC 401(a)(26) and Offsets RR / IRS Phone forum 4/23/2013 DB plan must provide actuarial basis to be employed to determine benefit deemed provided by DC plan DB plan must specify time as of which such determination is made date ( determination date ) in manner which precludes employer discretion Offset to benefit otherwise payable from DB plan equal to amount deemed provided on determination date by vested portion of account balance DC plan

56 IRC 401(a)(26) and Offsets IRS Phone forum 4/23/2013 / Bad design Cash balance plan provides definition of principal credits as (a) (b) where: (a) = 10% of compensation (b) = the employer discretionary allocation in the Profit Sharing Plan for the same plan year This type of benefit offset is not allowed because per Rev Ruling , the offsetting accrued benefit has to be related to the (DC) account balance, NOT the annual allocation of the DC plan.

57 IRC 401(a)(26) and Offsets IRS Phone forum 4/23/2013 / Good design Cash balance plan provides the definition of principal credits as 10% of compensation However, the annuity benefit payable is defined as (a) (b) where: (a) = annuitized value of cash balance account (b) = the actuarial equivalent annuity based on the vested account balance of the profit sharing plan that is attributable to the discretionary employer contributions.

58 What is a meaningful benefit under 401(a)(26) July 7, 2007 Follow up memo to the Shultz Memo Another Internal memo to reviewers not subject normal vetting process Clarifies what is considered to be an allowable offset arrangement.

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