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At What Point Does a Restricted HCE Drop Out of the Top 25?


Guest merlin

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Guest merlin

I have a new client which improperly made distributions to 5 restricted HCEs from 2002-2005. They went through the VCP, repaid about $1M to the plan, and got a compliance statement. Now several other HCEs have terminated and want lumps sums. Some or all may be in the top 25, depending on whether or not the previous 5 HCEs have to remain in the count or not.

I can't find anything in the regs or the EOB, but common sense would say that, since their benefits of the prior 5 HCEs have been distributed, they're out of the count. However, I was told by another actuary that this question was asked in the 1993 and 1996 Gray Books, and the answer was that they stay in until they are replaced by HCEs with higher comps. She doesn't have the Gray Books themselves, just her notes.

Can anyone verify this?

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I don't have grey book but I do have CCH online..........

Per Pension distribution answer book Q14-7

Who is a restricted employee?

The term restricted employee refers to any HCE or HCFE if the employee is one of the 25 (or a larger number chosen by the employer) nonexcludable employees and former employees of the employer with the largest amount of compensation in the current or any prior year. Plan provisions defining or altering this group can be amended at any time without violating the anti-cutback provision of Code Section 411(d)(6). [Treas. Reg. §1.401(a)(4)-5(b)(3)(ii)]

In a private letter ruling, the Treasury has opined that the "high 25" limit is determined on an employer-by-employer basis in a multiple employer plan, where none of the members are in a controlled or affiliated service group (under Section 414(b), ©, (m), or (o)) with another employer in the plan. [Ltr. Rul. 200449043]

In another private letter ruling, the Treasury has opined that the "high 25" limit is determined on an employer-wide basis, regardless of the fact that a QSLOB election has been made by the plan sponsor. [Ltr. Rul. 200248029]

Example 14-2

Art is an HCE for the plan year ending December 31, 2007, because he earned more than $100,000 working for Wagner Plumbing Supplies, Inc. in 2006. Art terminates employment in 2008. Wagner Plumbing Supply wants to determine if Art is a restricted employee. Toby, the benefits manager, makes a list of all highly compensated employees for the years 1995 (the year the business started) through 2008. This list is arranged in order of compensation, using the highest compensation earned for each HCE. Art is number 30 on the list and is, therefore, not a restricted employee.

So based on example 14-2 I would leave them in even if they have been paid out.

JanetM CPA, MBA

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The more interesting example would be if any of your former HCEs had received a total distribution (at a time lump sums weren't restricted). In such case, suppose you had 25 former HCEs each of who had received a total distribution and each of who had compensation of $200,000. Now, you have an HCE with compensation of $125,000. Can this employee receive a lump sum distribution, assuming the AFTAP is 80%. That is, is a $200,000 floor established and someone is bumped only from the high 25 when there is an HCE of greater pay?

The material provided and the opinions expressed in this post are for general informational purposes only and should not be used or relied upon as the basis for any action or inaction. You should obtain appropriate tax, legal, or other professional advice.

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Guest merlin
The more interesting example would be if any of your former HCEs had received a total distribution (at a time lump sums weren't restricted). In such case, suppose you had 25 former HCEs each of who had received a total distribution and each of who had compensation of $200,000. Now, you have an HCE with compensation of $125,000. Can this employee receive a lump sum distribution, assuming the AFTAP is 80%. That is, is a $200,000 floor established and someone is bumped only from the high 25 when there is an HCE of greater pay?

Andy's example is what I had in mind when I talked about common sense. If I'm Former HCE #25 and my benefit has already been distributed, what is there to restrict? The resilt seems contrary to the intent of the regulation.

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Indeed, if your high 25 group is from years ago, it speaks nothing of the spirit of the law and regulations -- namely, to prevent HCEs from depleting the pension fund and leaving nhces to bear the brunt. Concurring with Mr. Merlin, It would appear to make any sense, you'd need to exclude from your high 25 those HCEs who no longer have an undistributed benefit and start considering those who still have an interest in the plan.

The material provided and the opinions expressed in this post are for general informational purposes only and should not be used or relied upon as the basis for any action or inaction. You should obtain appropriate tax, legal, or other professional advice.

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Common sense and actual practice are at odds here.

I read the rules to say that you tabulate the entire history of compensation and pick your 25 who have been both HCE and among the highest paid.

Then you look at your plan valuation before & after a proposed lump sum.

If you still get to 110%, no restrictions apply at that time. If the amount is below 1% of the total, no restrictions apply.

At a later time, any undistributed benefits could again become restricted.

If someone previously received payments at the point in time they had no restrictions, then that just reduces any potential benefits/service credits they would have now.

I see nothing here that allows you to stop counting the top 25 historic HCEs until you know that they have all had their benefit discharged by lump sum or death.

Of course, if you have no HCEs, you don't need to bother.

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Mr. SCA, agree. However, I feel strongly both ways. Besides, not since my Towers Perrin days nearly 20 years ago have I had a plan that had a history of 25 HCEs!

The material provided and the opinions expressed in this post are for general informational purposes only and should not be used or relied upon as the basis for any action or inaction. You should obtain appropriate tax, legal, or other professional advice.

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Guest merlin
Common sense and actual practice are at odds here.

I read the rules to say that you tabulate the entire history of compensation and pick your 25 who have been both HCE and among the highest paid.

Then you look at your plan valuation before & after a proposed lump sum.

If you still get to 110%, no restrictions apply at that time. If the amount is below 1% of the total, no restrictions apply.

At a later time, any undistributed benefits could again become restricted.

If someone previously received payments at the point in time they had no restrictions, then that just reduces any potential benefits/service credits they would have now.

I see nothing here that allows you to stop counting the top 25 historic HCEs until you know that they have all had their benefit discharged by lump sum or death.

Of course, if you have no HCEs, you don't need to bother.

SoCal,

In my case all 5 prior HCEs received total distributions in the form of lump sums. If I read your penultimate sentence correctly you're saying they're no longer considered in the top 25, and that conflicts with the Gray Book answers (if in fact that's what the answers were). Is that right?

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One other wrinkle to consider is that the top 25 applies to the Controlled Group (if applicable). I remember a plan we had for a small subsidiary of a large insurance company. On the face, most of the folks in the plan were HCEs (only about 20 people in the group in all) and what we considered high-end earners. However, when you went to the CG they were small fry in the scheme of things so the top 25 didn't apply to any of the participants.

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My reading of the top 25 restriction is that the top 25 is the top 25 of all time. You drop out of the top 25 when there are 25 HCEs who made more money than you. The top 25 is not impacted by whether or not you were ever in the plan or whether or not anybody got paid out.

Take all of the employees of all time, line them up in reducing pay order, draw a line below the 25th person. Thats your top 25. If you are above the line and you were an HCE you are subject to the restrictions.

Of course the plan can expand the restrictions, by its terms, to a larger subset of the HCEs, but only has to apply the restriction to those 25 people.

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In Janets example 14-2, a correction is necessary. You do not limit your list to HCEs. If you had a salesman in 1957 make $2 million, he is on the list but he is not an HCE. You determine the Top 25 before you apply the HCE definition. Then you limit the restrictions to only the HCEs that are on the top 25 list.

The example only listed HCEs first and then grabbed the top 25 from among the HCEs.

Of course, in the example, the company started in 1995, making the distinction unimportant in that case.

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Common sense and actual practice are at odds here.

I read the rules to say that you tabulate the entire history of compensation and pick your 25 who have been both HCE and among the highest paid.

Then you look at your plan valuation before & after a proposed lump sum.

If you still get to 110%, no restrictions apply at that time. If the amount is below 1% of the total, no restrictions apply.

At a later time, any undistributed benefits could again become restricted.

If someone previously received payments at the point in time they had no restrictions, then that just reduces any potential benefits/service credits they would have now.

I see nothing here that allows you to stop counting the top 25 historic HCEs until you know that they have all had their benefit discharged by lump sum or death.

Of course, if you have no HCEs, you don't need to bother.

SoCal,

In my case all 5 prior HCEs received total distributions in the form of lump sums. If I read your penultimate sentence correctly you're saying they're no longer considered in the top 25, and that conflicts with the Gray Book answers (if in fact that's what the answers were). Is that right?

No, I intended to say that you track the top 25 forever. You just stop worrying about them if they have all been paid out.

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In Janets example 14-2, a correction is necessary. You do not limit your list to HCEs. If you had a salesman in 1957 make $2 million, he is on the list but he is not an HCE. You determine the Top 25 before you apply the HCE definition. Then you limit the restrictions to only the HCEs that are on the top 25 list.

The example only listed HCEs first and then grabbed the top 25 from among the HCEs.

Of course, in the example, the company started in 1995, making the distinction unimportant in that case.

Interesting difference here. But the HCE definitions go back a long time, so it is unusual to consider your fact pattern, and I have no recent experience with plans where the pre-ERISA compensation history is even available to review. This would make takeovers of plan administration even more complex.

On a tangent, when do you track back the pay of merged and acquired companies, including ones with prior DB benefit histories? Do you need to know that the owner of a merged business made$2m before he sold his stock to your client?

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The rules are written so that you can include more than the technical top 25, so if you wanted to modify to top 25 after a certain date the plan can do that as long as the prior owners are long gone and paid out.

In stock transactions I think you absolutely get to track back to prior owners if you want to and you have the data

On another note the HCE rules only go back to TRA 86...so you dont have to restrict prohibited group members who never made HCE status...but you get to count them in the 25

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