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First Year DB/DC Combo, DB Counts Prior SVC


Guest pension222

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Guest pension222

Here is the scenario:

2003 is the first year of a new defined benefit and profit sharing for the plan sponsor (plan effective dates are 1/1/2003).

The defined benefit plan credits a maximum of 5 years of service prior to 1/1/2003 to calculate accrued and projected benefits.

The PS plan only covers 3 HCEs and the DB plan covers 3 different HCEs and 10 NHCEs. Both plans have safe harbor formulas under 401(a)(4). No one participants in both plans.

My questions are:

1. Is there any need to test the combined accruals and allocation under the general test of 401(a)(4)? I don't think there is since each plan is a safe harbor plan.

2. When testing the aggregated plans for coverage under the Average Benefit Percentage test of 410(b) for 2003 (using 2003 as the measurement period) what do I use as the increase in accrued benefit in the DB plan since everyone enters with an accrued benefit as of 1/1/2003 (as a result of counting pre-participation service)?

It makes sense to me to use the total DB accrued benefit as of 12/31/2003 instead of just the increment from 1/1/2003 to 12/31/2003. This especially makes sense to me since accruals to the HCEs in the DB plan are limited to 1/10 of the 415 dollar limit at 1/1/2003 and 12/31/2003 and would have no increment during 2003.

Thanks.

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Just some initial comments/questions.

1. If you pass coverage separately, you can test separately under 401(a)(4) and if they are each safe harbors, then you are done.

2. If you aggregate for coverage, then you must aggregate for 401(a)(4), and then you have non-uniform benefits that would require the general test. And you may be subject to the DB/DC combo gateway rules.

And I have to wonder how you get these eligiblity exclusions. If the criteria is not reasonable, for bonafide business reasons as defined in the 410(b) regulations, then you would be required to pass the ratio/percentage test for each plan for coverage. Do you pass that? I assume not since you mentioned the average benefits percentage test.

I think you need to clarify these issues first before getting into the measurement period question.

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Guest merlin

Andy,

With regard to your item 2. above, I seem to remember other posts on these boards that said inclusion of plans in the avg ben % test, in and of itself, does not constitute aggregation. Can you elaborate for me please?

As for eligibility classifications, here's a possibility:

PS plan covers only non-owner physicians.

DB plan covers owner-physicians and all staff.

Do you agree that these are reasonable classifications? For testing they may or may not have to be aggregated, depending on the HCE/NHCE status of the n-o drs.

pension222's stuation may be entirely different, but you get my point.

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good description Andy.

So now lets look at the DC plan

It has a safe harbor formula and covers 3 HCEs.

Ratio % = 0 since no NHCE benefit. (You still have to treat them as includable and not benefiting)

This implies that to pass coverage it will have to pass nondiscrimination classification test.

Assuming you have a reasonable classification I don't see how

with a ratio % of 0...hmmmm. I see no way that will be greater than any safe harbor or even any unsafe harbor, possibly Benton Harbor.

I don't see how you can avoid aggregating the plans for testing.

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It may be that no testing whatsoever is necessary.

Using Top Paid Group, we have 16 employees. 20% of 16 is 3.2, so we need 3 in the TPG. Assuming the Owner/Drs all make more than the Non owner drs, then regardless of income, the Non-owner drs just aren't HCEs.

The devil is in the details, and we don't have all the details yet.

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Merlin, yes, you are right, if the eligibility criteria is reasonable and you can pass the NCT, and yes, your descriptions would seem ok to me.

But Tom is also right of course; if there are no NHCEs in the PS plan, it won't pass anything by itself.

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Guest pension222

First, thanks for all of the meaningful input.

Believe it or not, the doctors in the profit sharing plan are all of the majority owner-doctors, the other doctors and the rest of the staff are in the defined benefit plan.

Since there are no NHCE's in the profit sharing plan, for sure the ratio percentage for this plan is zero so if the three doctors in the defined benefit plan are HCE's then we need to pass the Average Benefit Percentage test of 410(b) by aggregating the plans.

And so if we aggregate under 410(b) then it looks like we need to aggregate under 401(a)(4).

If all of the NHCEs are in the DB plan , and are not in the DC plan, it seems to me that the DB/DC plan is primarily a defined benefit plan under 1.401(a)(4)-9(b)(2)(v)(B).

I will double check to make sure that the doctors in the DB plan are indeed owners because if the are not as rcline46 mentioned, we may not have any HCEs in the DB plan. But wouldn't we need to aggregate the plan's anyway since the ratio percent of the DC plan is zero?

Which brings me back to my original question, what accrual do I test under the DB plan? Because the plan counts service prior to inception, everyone enters the plan with an accrued benefit. Do I test the increase during the plan year or the entire accrued benefit as of the end of the first plan year?

The plan will not provide for benefit increases resulting from 415(d)(1) adjustments for former employees so it looks like I should take into account 415 limits.

Another question, most likely more appropriate for another forum but, well, here I am. If the plan pays a lump sum benefit as a disability and death benefit but does not pay lump sums (other than de minimus ones) how does this affect determination of the most valuable accrual rate?

It is my understanding that if the plan pays lump sums then the most valuable accrual rate may be determined by calculating a lump sum at retirement using the accrual being tested and then normalizing this by dividing by an annuity factor (calculated using standard interest and mortality) at retirement age. I admit that I have never been in a position to have to deal with lump sums and MVAR. Is my methodology correct?

Thanks again for all of the responses.

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Lots of good questions. I don't have all the answers without researching them but I have a couple of answers and a couple of educated guesses.

First, for 410(b) purposes, you are not applying the average benefits percentage test to the aggregated DB/DC plans. You apply the ratio/percentage test to the aggregated DB/DC plan. That result is 100%. That is how you pass coverage.

You are applying for 401(a)(4) purposes, the general test to the aggregated plan, and yes, it sounds like you are right about the plan being primarily defined benefit in nature.

Regarding death and disability benefits, I don't think those would be included in the MVAR calc but I would not state this with certainty without reading all the cross references provided in 1.401(a)(4)-(3) with respect to the MVAR. If the plan had a general lump sum upon retirement or termination, that would be included including the 417(e) calculation (this was controversial but I think it is now universally accepted), but if only upon death or disability, I don't think so.

I believe that you would need to use a measurement period equal to the current plan year, and that you would need to include the full DB accrual into one year's calculation. I think this is true only because of the consistency requirement of 1.401(a)(4)-9(b)(iv). I could be wrong, but that is how I read it. But don't accept this without reading all the cross references. I have not run across your particular situation before.

And, yes, you might try posting the MVAR and measurement date questions in the DB forum as well.

If anybody out there interprets this stuff differently I'd like to hear it as well. Mike, are you on vacation?

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Guest pension222

You know, I was so knee deep in the Average Benefits Test that it honestly never occurred to me that I could aggregate the two plans for the ratio percentage test.

However, if we do pass the Average Benefits Test for the aggregate DB/DC plan, then we get a lower passing threshold for the general test of 401(a)(4) so if we can it might be best to pass the ABP test.

I agree that we should test the entire accrued benefit at the end of the first year as opposed to just testing the increase during the year.

Thanks again for the response.

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Guest pension222

Maybe I have this wrong but if the plan passes 410(b) through the ratio percentage test then doesn't each rate group have to pass at 70% but if the plan passes 410(b) through the ABP test, then each rate group can pass at the safe-unsafe harbor midpoint which, depending on the NHCE concentratioin % may be much less than 70%.

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Guest jody303

Blinky, I agree with pension222. It's always been my understanding that if the plan passes the average benefit percentage test, then each rate group under 401(a)(4) need only have a ratio percentage equal to or greater than the midpoint between the safe and unsafe harbor percentages to pass 401(a)(4). Otherwise, each rate group would have to have a ratio percentage of at least 70% in order to pass the 401(a)(4) general test. See Example 4 under 1.401(a)(4)-2©(3).

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Guest jody303

Blinky, I'm a little under the weather today - head congestion - so maybe my brain's not working, because I'm not following you.

If the plan passes 410(b) by ratio % only and fails ABT, then the 401(a)(4) general test must be passed by ratio %. Isn't that right? On the other hand, if the plan passes 410(b) by ABT, then you have the ability to use ABT for the rate groups in your 401(a)(4) testing, if necessary. Therefore, isn't it correct to say that the way you pass 410(b) has a bearing on how you do your 401(a)(4) testing? Are the words "need" and "must" the issue? As I said, I'm a little slow today!

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Guest RSNOW

I agree with Blinky and Andy. It sure is easy to get confused by the wording of the regs though, especially given 1.401(a)(4) borrows so many "tools" out the the 410(b) tool box by name, that you have to stay focused on the context under which you're applying the tools, and don't confuse the name of the tool itself (e.g., 410(b) ratio/percentage test) with the specific test you are running.

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Jody, let me try and do a surface walkthrough. I am not trying to sound condescending, but am spelling out some basics so nothing is lost in the explanation.

Coverage testing under 410(b) - here we are just trying to compare who is benefiting under the plan, not the amount of benefits.

If 70% of the NHCE's benefit versus the HCE's, you pass the ratio percentage test. Stop - you've passed coverage. If less than 70% of the NHCE's benefit versus the HCE's you may perform the average benefits test. If you pass, stop. If you fail, you need to have more NHCE's receive a contribution.

Nondiscrimination testing under 401(a)(4) - only needed if the benefit forumla is not a safe harbor. Here were are measuring the amount of benefits.

If each rate group is over 70%, Stop - you've passed. If not, move to the average benefits test for 401(a)(4).

So, there are 2 separate ratio and average benefits tests, one for coverage and one for nondiscrimination. How you pass on one does not affect how you pass the other.

"What's in the big salad?"

"Big lettuce, big carrots, tomatoes like volleyballs."

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Well stated, but you also must be careful because there are subtle differences between applying the "tools" for one purpose versus another.

For example, for nondiscrimination testing under 401(a)(4) you get a "free pass" past the requirement that the eligibility criteria be reasonable for purposes of satisfying the Nondiscriminatory Classification Test for nondiscrimination (401)(a)(4) purposes.

For example, if your plan excludes people who are left handed then you will never satisfy the average benefits percentage test for COVERAGE purposes because you cannot get by the reasonability standard of the NCT part of the test.

But if only 20% of NHCEs are left handed and you then cover 80% of the NHCEs, then you can pass coverage under the ratio/percentage test, and the average benefits percentage test would be available to you under 401(a)(4) testing because the reasonability criteria does not apply for purposes of the 401(a)(4) nondiscimination test.

And there are other differences as well.

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Guest merlin

Andy,

Could you please explain how the consistency rules would require the recognition of the full accrued benefit at 12/31/03, rather than the increment from 1/1 to 12/31? Thanls.

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Merlin, I don't see Blinky's answer, so here are my thoughts. I could be wrong, so I welcome comment.

Under 1.401(a)(4)-8, the Equivalent accrual rate is defined as the normalized "increase in the participant's account balance during the measurement period, divided by the number of years in which the employee benefited under the plan during the measurement period".

So, in the case of a new cross tested DC plan, the measurement period is clearly one year.

But under the DB general testing rules, it seems clear that the number of years of service "as defined in the plan for purposes of applying the benefit formula" is acceptable, i.e. 6 years.

But under the consistency rule of 1.401(a)(4)-9 (b)(2)(iv), it says that rates

"must be determined in a consistent manner for all employees for the plan year. Thus, for example, the same measurement periods and interest rates must be used, and any available options must be applied consistently, if at all, for the entire DB/DC plan. Consequently, options that are not permitted to be used under section 1.401(a)(4)-8 in cross testing a a defined contribution plan or a defined benefit plan (such as measurement periods that include future periods, ......) may not be used in testing a DB/DC plan on either a benefits or contributions basis, because their use would inevitably result in inconsistent determinations under the defined contribution and defined benefit portions of the plan"

So, for purposes of 401(a)(4), can you use a different measurement period for a db component of a db/dc aggregated plan? I can read the above as prohibiting it.

In contrast, the 410(b) regulations allow the employee benefit percentages to be the sum of separately determined rates, but I don't see this option as being available under 401(a)(4). Again, this is just one person's interpretation. Dissenting views are welcome.

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Guest merlin

Andy,

Your answer is kind of what I thought, but you were able to crystalize it for me. I think your reasoning is sound, and unless someone can point else where to a different conclusion, it works for me. But what about after year 1? Would you always be restricted to the current year as the measurement period (i.e., the annual accrual method) because of the disparity between the past service in the two plans?

BTW, Blinky's reasoning was much simpler. At 12/31/02 there was no plan, therefore ab=0, which means that the full ab must be recognized at 12/31/03.

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Right, Merlin, except that I don't think that the plan needed to exist 12/31/2002. It appears to me that you could use an accrued to date measurement with a divisor of 6 if those prior 5 years "are taken into account" under the plan's benefit formula.

But if you add the new DC plan then you have a consistency issue, because if you add one year DC and 6 years of DB and divide that by 6 you have a result that makes no sense, so unless you separately determine the rates as in 410(b), it would seem that one year is the only option.

I don't know what you would do after one year of DC experience. Maybe you can argue that the effective date of the DC plan is a "fresh start" date and always have that period available??

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Guest pension222

OK I misspoke.

You are all right about nondiscrimination and coverage testing being done separately.

What I meant to say is that if you are going to go to the trouble to pass nondiscrimination by the APB test then you might as well apply this to 401(a)(4) testing and vice versa ,but for sure the two are independent. One could calculate the numbers under the ABP test and use this to pass nondiscrimination but then choose to pass coverage under the ratio percentage test.

Once again, thanks for all of the input. It has been a while since I had to think about all of this.

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