Benefits, Rights and Features. Optional Forms of Benefits

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1 Agenda What are benefits, rights and features (BRFs)? Protecting benefits, rights and features Nondiscrimination testing of benefits, rights and features Correcting failed nondiscrimination tests for benefits, rights and features Special rules and situations 1

2 Benefits, Rights and Features General rule Benefits, rights and features must be available on a nondiscriminatory basis Effective availability test Current availability test What are benefits, rights and features (BRFs)? Optional forms of benefits and ancillary benefits Other rights and features are defined by example in the regulations Optional Forms of Benefits Optional form of benefit - a distribution alternative available with respect to payment of benefits under the plan Different optional forms exist if distribution alternatives are not payable on substantially same terms Common examples of optional forms of benefit Forms of payment = lump sum, annuities, installments Timing of distribution = immediate or delayed Medium of payment = cash or property Eligibility requirements for a distribution option 2

3 Optional Forms of Benefits Other examples of optional forms of benefit Hardship distributions In-service distributions at stated age In-kind distributions Survivor annuity percentage for QJSA Not different vesting schedules! Subject to separate rules Social security supplements Disability benefits Life insurance and health benefits Death benefits Ancillary Benefits 3

4 Protected Benefits Plans generally cannot be amended to retroactively eliminate accrued benefits or optional forms of benefit [Code 411(d)(6)] Applies to benefits accrued as of amendment date = later of adoption date or effective date EE does not accrue right to benefits until he/she has satisfied any allocation conditions on such benefits May be amended to prospectively eliminate benefits Code 411(d)(6)(B) only protects optional forms of benefit Other benefits, rights and features are not protected BRFs are subject to nondiscrimination testing Protected Benefits Code 411(d)(6) is qualification requirement under Code 401(a) = applies only to qualified plans No similar rule applies under Code 403(b), Code 457 or Code 408 (for IRA plans, including SEPs and SIMPLE-IRAs) For Code 403(b) plans subject to ERISA = protected benefits rule is made applicable under ERISA 204(g) 4

5 Protected Benefits Code 411(d)(6)(B) allows for prospective elimination of optional forms of benefit Prospective elimination only applies with respect to benefits not yet accrued May have to protect optional form of benefit to extent benefit already accrued Example - Plan allows immediate distribution upon termination of employment. ER would like to delay distributions until plan year following termination Could eliminate immediate distribution for future benefits Would have to retain immediate distribution option for benefits accrued prior to amendment Mergers / Acquisitions When two or more plans are being merged, or assets are being transferred, some participants or beneficiaries may have already accrued protected benefit rights Also possible that optional forms of benefit, or other rights and features, under merged plans are different from those under one or more of the plans being merged Optional forms of benefit may not be eliminated due to merger or transfer of assets to extent such benefits have accrued at time of merger or transfer 5

6 Mergers / Acquisitions Common optional forms of benefit problems that might arise under merger of plans: One plan provides for installment or annuity payments One plan provides for distribution upon termination and other plan provides for distribution in year following termination Plans may have different in-service distribution options e.g., hardship, age 59½ distributions Exceptions to Protected Benefits DC plan may be amended to retroactively eliminate periodic payment option (e.g., annuity or installment payments) Can only be eliminated if, after amendment, a lump sum distribution is available at same time as eliminated option QJSA cannot be eliminated under MP plan If three or more joint and survivor annuity options, may amend plan to eliminate any options other than the ones with the highest and lowest survivor percentage 6

7 Exceptions to Protected Benefits Hardship distribution options not protected Hardship distributions can be eliminated retroactively Plan may be amended to increase or decrease plan s involuntary distribution threshold amount Plan may amend default method by which distributions are made, such as by changing from cash distribution to direct rollover to IRA, provided all distribution options are protected Rights and Features Examples of rights and features Availability of participant loans Right to direct investments Right to make employee after-tax contributions Right to make elective deferrals Right to each rate of matching contributions Right to a particular form of investment Right to make rollovers to and from plan Allocation dates and valuation dates Rights and features (which are not optional forms of benefit) are not protected and may be eliminated 7

8 Effective Availability Effective availability test is a facts-and-circumstances test Failure to communicate right Minimum dollar amount required for investment option Current Availability Test availability using nondiscriminatory classification test (first part of average benefit test) used for coverage Reasonable classification and nondiscriminatory classification test Probably cannot make BRF available based on name Don t run the average benefit percentage test (second part of average benefits test) Must calculate percentage of NHCEs and HCEs for whom BRF is currently available NHCE availability ratio (number of NHCEs to whom the BRF is currently available/ total NHCEs) divided by HCE availability ratio (number of HCEs to whom the BRF is currently available/ total HCEs) 8

9 Current Availability Current availability test automatically satisfied if availability percentage is at least equal to the safe harbor percentage (see table) 50% or better always satisfies safe harbor percentage If availability percentage is less than unsafe harbor percentage, current availability is not satisfied If availability percentage is in between safe harbor and unsafe harbor, a facts and circumstances test applies Test availability using nondiscriminatory classification test (first part of average benefit test) used for coverage Current Availability BRF is currently available only if the employee has satisfied all conditions to receive BRF Utilization is not relevant In determining whether a BRF is currently available, certain conditions are disregarded For testing the availability of an optional form of benefit, age and service conditions are disregarded 9

10 Current Availability For testing all BRFs, the following conditions are disregarded: Specified vesting percentage (e.g., must be 100% vested) Termination of employment Death Disability Hardship Ministerial acts Current Availability Loan features Maximum dollar limits are permitted May not disregard minimum dollar limits Exception - $1,000 minimum allowed Issues relating to participant-directed investments 10

11 Example #1 The ABC Corp Plan provides for direction of investment only for EEs with account balances above $50,000. Of the 4 HCEs, all have account balances above $50,000. Of the 10 NHCEs, only 6 have account balances above $50,000. Does the plan pass the current availability test? HCE benefiting % = 4/4 = 100% NHCE benefiting % = 6/10 = 60% Availability test = 60% / 100% = 60% NHCE concentration percentage = 10/14 = 71.14% Nondiscriminatory Classification Test NHCE concent. SH % UH % Midpoint NHCE concent. SH % UH % Midpoint , , ,

12 Example #1 Since 60% availability percentage exceeds 41.75% safe harbor percentage from chart = passes current availability test Doesn t matter if NHCEs actually utilize self-direction option = looking at availability Suppose instead the plan imposes a $100,000 minimum amount and fails current availability. How should ER correct? Corrective Amendments Corrective amendment cures discriminatory availability if group of employees to whom BRF is available is expanded so that BRF satisfies the current availability test Alternately, the corrective amendment may eliminate the BRF Amendment must be adopted by the last day of the plan year of discriminatory availability Corrective amendment must remain in effect until the end of the first plan year beginning after the date of the amendment 12

13 Example #2 XYZ Plan provides a matching contribution equal to 50% of deferrals up to 4% of compensation and 100% of deferrals between 4% and 8% of compensation. All 4 HCEs defer at least 8% of compensation and no NHCE defers above 4% of compensation. Does XYZ Plan satisfy current availability test? Does XYZ Plan satisfy effective availability test? Would your answer change if the matching contribution formula is 50% of deferrals for EEs with up to 10 YOS and 100% of deferrals for EEs with more than 10 YOS? Example #3 ABC Corp 401(k) plan permits EEs to take an in-service distribution at age 50. The only participant who is currently age 50 is Jack, the owner of ABC. Does the ABC plan violate the current availability test? No, can ignore age and service conditions when testing optional forms of benefit ABC plan also limits ability to direct investment to EEs who are age 50. Does ABC plan fail current availability? Yes, cannot ignore age / service conditions when testing rights and features 13

14 Special Rules and Situations Governmental plans exempt from BRF testing Availability of catch-up contributions universal availability rule applies Availability of each rate of matching contributions Matching pre-tax contributions, but not Roth contributions Prospective Elimination Can ER eliminate benefit, right or feature on a prospective basis without violating current availability testing? Example. Plan X and Plan Y are merged. Plan X provides for direction of investment and Plan Y does not. ER wishes to eliminate the right to self direct but continue to allow self-direction for EEs of X BRF deemed to satisfy nondiscrimination if BRF satisfied current availability at time it was prospectively eliminated For DC plans, if BRF is optional form of benefit = must apply BRF to subsequent earnings 14

15 Automatic Contribution Plans Can plan s automatic enrollment feature apply to only a subset of eligible EEs? Example. ER Y establishes an automatic contribution arrangement effective January 1, Under the plan, the automatic contribution feature only applies to certain NHCEs. Must plan be tested for nondiscrimination? Right to automatically enroll is not a BRF = just a different procedure for enrolling in plan No BRF testing required for automatic contribution option Won t qualify for special 6-month ADP correction under EACA Slide 29 Change in Eligibility Conditions Can a plan be amended to change eligibility during the year? Eligibility provisions not protected benefits Example Plan X is merged with Plan Y. Plan X has immediate eligibility for deferrals and match. Plan Y has 1 YOS requirement. After merger, Plan is amended to apply 1 YOS eligibility. Bill worked part-time for ER X and participated in the X Plan. May Bill be excluded from Plan for both deferrals and match (assuming he has not earned a YOS)? 15

Correcting 401(k) Testing and Errors The New EPCRS. Charles D. Lockwood, J.D., L.LM ASC Avaneesh Bhaget, Group Manager, IRS

Correcting 401(k) Testing and Errors The New EPCRS Charles D. Lockwood, J.D., L.LM ASC Avaneesh Bhaget, Group Manager, IRS 1 Charles D. Lockwood, J.D., L.LM ASC Charles D. Lockwood, J.D., and LL.M. (Taxation),