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Unfreezing DB Plan


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Suppose you have a 1 participant DB with unit benefit of 8% per year, where the participant will have 10 years of participation at NRA. Furthermore, lets assume he accrues $1,200/mo. each year. If they froze the plan in year 3 and want to unfreeze in year 5, does the 133 1/3 rule apply to his prior accrued benefit or the last increase in accrued benefits before the freeze?

They would like to increase the benefit going forward.

Thanks much.

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If we have an 8 year fence, the lesson then is to never freeze a small DB. Instead, consider amending to reduce the benefit formula. Then, if by chance the employer is fortunate enough to ramp up the plan in future years, the 415 issue will not apply.

I guess the question is whether a participant is considered to have participated in a frozen plan. Does "participating" mean only an increase in accrued benefits? What about an increase in vesting?

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Good comments. I doubt vesting by itself would equate to 415 participation service though.

I guess the first "fence" that I was questioning is whether we all agree that freezing a plan and then restarting it with prospective service only, effectively skipping one or more years is in fact a violation of the accrual rules.

I agree SoCal's approach seems to avoid the issue but I would like to know if we agree that otherwise it is a problem to unfreeze prospectively.

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Andy, I am not sure I understand your concerns about a prospective unfreeze. With any change in the benefit formula there should be a fresh-start date, so there is no need to be concerned with a situation without one. Now of course I have seen amendments that have fluctuating benefit formula percentages with no reference to a fresh-start date. Those are terribly crafted and are clear 411 violations.

As for the 415 issue, you can easily craft the amendment to make it so all years of participation are counted in the benefit formula. Then we can all be on one side of the proverbial fence.

"What's in the big salad?"

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

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A colleague told me he understands that a plan that was frozen but is subsequently reactivated must be reactivated effective, or at least grant credit, back to the year after the freeze. This was news to me so I am trying to determine whether this is true or not.

Is my colleague misinformed?

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As for the 415 issue, you can easily craft the amendment to make it so all years of participation are counted in the benefit formula. Then we can all be on one side of the proverbial fence.

So then in the example if an amendment were adopted in year 5 to unfreeze the plan and provide benefits of 8% of pay per year of participation, the participant would have a projected benefit of 80% of pay at NRA. He would then be considered to have 10 years of participation at NRA and no reduction in the 415 dollar limit?

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Andy, I have never heard of such a position. Does he have any reasons for his thoughts? Is he just concerned with 411(b) or does he have other concerns. If 411(b), why does he not think a fresh-start date will suffice?

Doug, that amendment would certainly recapture the lost years of participation.

"What's in the big salad?"

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

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I don't think that amendment recaptures the "lost" years. The 415 $ limit is reduced if you have less than ten years plan participation, not if you are credited with less than ten years of benefit accrual service. Thus if you don't get credit under 415 for years when the plan is frozen, this amendment won't help.

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I really appreciate all the great comments here.

What if this were five years ago when we had to provide top heavy minimum benefits even if a plan was frozen? Certainly back then years of participation for the 415 dollar limit would have included years when the plan was frozen. How could it not? Did the definition of years of participation for 415 purposes change between then and now? Or did the definition always only include years in which a participant was eligible for an increase in accrued benefits?

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I really appreciate all the great comments here.

What if this were five years ago when we had to provide top heavy minimum benefits even if a plan was frozen? Certainly back then years of participation for the 415 dollar limit would have included years when the plan was frozen. How could it not?

Was he a key employee? If he was, I think the rules back then would have worked the same as now

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I'm with ak2ary on this. No benefit accrual service in a year, no 415 participation credit.

This is from the 2002 415 audit guidelines, IRM 4.72.6. The bold is my emphasis.

In determining a participant’s years of participation for these purposes, Q&A-7 of Notice 87-21 provides that a participant is credited with a year of participation (computed to fractional parts of a year) for each accrual computation period for which the following conditions are met:

a. The participant is credited with at least the number of hours of service (or period of service if the elapsed time method is used for benefit accrual purposes) required under the terms of the plan in order to accrue a benefit for the accrual computation period, and 

b. The participant is included as a plan participant under the eligibility provisions of the plan for at least one day of the accrual computation period.

c. If these two conditions are met, the portion of a year of participation credited to the participant is equal to the amount of benefit accrual service credited to the participant for such accrual computation period. Thus, where the terms of a plan provide that a participant with 50 hours of service earns a year of service for benefit accrual purposes, a participant with 50 hours of service could be credited with a year of participation for purposes of IRC 415(b)(5).

d. Additionally, for a participant to receive a year (or part thereof) of participation for an accrual computation period, the plan must be established no later than the last day of such accrual computation period.

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Andy

This participant:

a. worked more than 1,000 hours each year the plan was frozen.

b. had met the eligibility requirements two years prior to the plan being frozen.

The document defines benefit accrual service as an accrual computation period during which an employee completes 1,000 or more hours of service. An accrual computation period is defined as the 12 consecutive month period commencing with the plan year in which occurs the employee's entry date and each plan year thereafter.

We could really take this:

Thus, where the terms of a plan provide that a participant

with 50 hours of service earns a year of service for benefit accrual

purposes, a participant with 50 hours of service could be credited

with a year of participation for purposes of IRC 415(b)(5).

And replace it with this:

Thus, where the terms of a plan provide that a participant

with 1,000 hours of service earns a year of service for benefit accrual

purposes, a participant with 1,000 hours of service could be credited

with a year of participation for purposes of IRC 415(b)(5).

In this case the document indicates the participant earned a year of service for benefit accrual purposes because he worked more than 1,000 hours during an accrual computation period.

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I agree that you need a YOP for plan purposes to get a YOP for 415 purposes. So, are we differing on what is considered a YOP for plan purposes?

Back to the original post, the formula was 8% per YOP and frozen in year 3 and then unfrozen in year 5. Well if the unfreeze amendment credits those YOP for the first 5 years, you have met the requirement and have effectively "recaptured" the lost years.

If they didn't want the increases to happen for the "lost years", the amendment could be worded differently. For example, if participants just earned YOP for the first 2 years, the unfreeze amendment could be worded , with a proper fresh-start date with wear-away, so that benefits are now 3.2000001% per YOP (3.2000001% x 5 years > 8% x 2 years). Now they have recaptured the lost years IMHO. Agree or disagree?

"What's in the big salad?"

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

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I think a more conservative course is to consider a YOP for 415 purposes to be something that is impossible to credit retroactively. If you can get to your goal with that interpretation, I think that is the route I would go.

Other than that, submit, submit, submit.

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I agree if there's no need to recapture, then no need to get creative.

If someone has a cite or even an conference opinion that says this is wrong/aggressive, I would love to see it. I am just going by the rules as they are laid out by 415 as my guideline for what is possible.

"What's in the big salad?"

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

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Not exactly on point, but it may illustrate the IRS perspective:

GRAY BOOK QUESTION 2002-24

Section 415: Effect of Plan Amendment on Adjustment for Participation Less than 10 Years

A calendar plan year defined benefit pension plan is amended in July of 2001 to liberalize eligibility effective January 1, 2000.

1) For purposes of the reduction of the §415-dollar limitation for participation less than 10 years under IRC §415(b)(5), does a participant who enters the plan in 2000 on account of this amendment receive a year of participation for 2000?

2) Does the answer change if the amendment was executed before March 15, 2001 to satisfy IRC §412©(8)?

RESPONSE

1) While a grant of past service is permissible, it is not possible to amend a plan to start participation after the year has closed. A plan may adopt a corrective amendment pursuant to §1.401(a)(4)-11(g) in order to expand participation to satisfy nondiscrimination, minimum coverage or minimum participation failures. However, participation is recognized retroactively only for these limited purposes, and not for purposes of §415.

2) No.

Copyright © 2002, Enrolled Actuaries Meeting

All rights reserved by Enrolled Actuaries Meeting. Permission is granted to print or otherwise reproduce a limited number of copies of the material on the diskette for personal, internal, classroom, or other instructional use, on the condition that the foregoing copyright notice is used so as to give reasonable notice of the copyright of the Enrolled Actuaries Meeting. This consent for free limited copying without prior consent of the Enrolled Actuaries Meeting does not extend to making copies for general distribution, for advertising or promotional purposes, for inclusion in new collective works, or for sale or resale.

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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