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latest info on eliminating 3% safe harbor mid year

Tom Poje

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The EOB section you cite in your post #22 is in Chapter 3B, Part 2, Section X, Part B, 2.g.1)a) in the on-line version. The argument it references is in the prior paragraph, 2.g.1. That argument is that the match formula can be changed as long as the reduced matching formula applies only to contributions made after the amendment’s effective date. The opposing view is that some advisors take the position that once the requirements to receive the contribution have been satisfied, the participant has accrued a benefit for the entire year's compensation, even the compensation not paid until after the amendment is in effect. Your citation supports the first interpretation. The text also refers you to paragraph 1.e. Paragraph 1.e starts off with: "Compensation taken into account. If a benefit has accrued at the time the amendment is effective, presumably the protected benefit would be based on the compensation earned through the effective date of the new formula, but the IRS has not issued any formal guidance on this issue."

You should look at another section in the EOB. In the on-line version, it is in Chapter 3B, Part 2, Section II, Part D, paragraph 5, Final allocation in plan year in which plan terminates. He says the IRS has not directly addressed the issue of how the compensation dollar limit applies and lists two primary interpretations. He says the more conservative interpretation, to prorate the compensation limit based on the termination date, was expressed in Q&A 16 from the 2001 ASPPA annual conference IRS Q&A session. The more aggressive interpretation is to not prorate the compensation limit unless the plan termination results in a short plan year.

You have an interesting argument for why the amendment triggered 401(a)(17) proration might not cause a 411(d)(6) problem. To me, treating a retroactive effect of the amendment as if it applies to accrued benefits prior to the amendment defeats the purpose of determining if the amendment reduces accrued benefits. I also see guidance that suggests 411(d)(6) protection can apply to amounts accrued under the terms of a plan that exceed statutory limits. One of the requirements in 1.411(d)-4, Q&A 2, (b)(i) for a 411(d)(6) exemption for amendments reflecting statutory changes is that the amendment be timely adopted. If accrued benefits don’t included any amounts that could exceed a statutory limit if other events occur, why is this exemption needed?

I agree with you that the IRS's statement regarding the 401(a)(17) proration issue makes it look like it would apply in circumstances other than just changing or suspending a SH contribution. It appears to me that if it applies when a SH contribution is reduced mid-year, it would apply any time a fixed contribution level is changed mid-year after participants have earned the right to receive the contribution. It also looks to me that their argument would apply to mid-year formula increases as well as decreases. I’m just not convinced that their statement is consistent with their published guidance. If they want 401(a)(17) proration to only apply to suspended or reduced SH contributions, they need to incorporate it into the 401(k)/401(m) regulations. Either way, we need some formal guidance on the issue.

And finally, if the 401(a)(17) proration issue for a formula change is so clear cut, why didn’t the IRS include it in their LRM’s? LRM 6 – Definition of Compensation says “If a determination period consists of fewer than 12 months, the annual compensation limit is an amount equal to the otherwise applicable annual compensation limit multiplied by a fraction, the numerator of which is the number of months in the short determination period, and the denominator of which is 12.” Then, it lists adoption agreement choices to define the Compensation determination period as either 1) the plan year, or 2) a 12 month period ending with or within the plan year. If a document follows the LRM’s, the only time it will provide for 401(a)(17) proration is when there is a short plan year. What are we supposed to do if the IRS says to prorate and the document says the opposite?

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Kevin --

Seems like there is no easy solution to the conservative/aggressive dichotomy in the potential approaches to this topic, at least at this time. As usual, I can support either position, but would take the conservative approach when advising a client.

With your approach, however, I don't know how certain hypos would come out, for example (& I'm not asking for anyone to suggest answers):

  • E'ee A earns $250,000 for first 6 months of plan year. Match is maxed at 2% of compensation and plan document determines match on basis of plan year comp. Match is revised upwards, prospectively, to 4% of compensation for the last half of the year. If A already has maxed out his comp, then, using your approach, I assume that the 6% match does NOT apply to him for the rest of the year. If it does apply to him, then how do you figure it? (For someone with only $40,000 earned during the first 6 months, then I assume that the 2% match would apply to those $$, and the 4% match would apply to earnings in the second half of the year.) [Perhaps, in this hypo, you would allocate the match based on compensation which is limited in each 6-month period to the product of the annual limit times a fraction equal to the compensation earned in the specific 6-month period divided by the total compensation earned by the individual during the full year--but I believe there would have to be some limit for each 6-month period.] Does it matter if A defers nothing for the second half of the year and therefore ought not be eligible for the higher match at all?
  • Same question, but with a mid-year change of the 2% MP allocation to a 4% allocation.
  • Same MPPP question, but, instead of an upward change in mid-year, the employer gives a timely 204(h) Notice so that no MPP allocation is made post-June 30. (This one may be easier to answere.)

The anti-cutback exception you note (Treas. Reg. Section 1.411(d)-4, Q&A-(b)(2)(i)) covers a situation where a full cutback is allowed by IRS pronouncement, in spite fo the regs, following the applicability of new legislation (e.g., eliminating a permissible form of benefit), but a requirement for permitting such a true cutback is that the amendment must be made timely as per statutory or regulatory time-lines. That reg does not stand for the proposition that you may not cutback benefits which exceed current statutory limits.

Also, I don't think that the subsequent use of proportional compensation for a partial year is a retroactive change which cuts back an accrued benefit. Rather, what I'm saying is that any accrued benefit based on compensation is contingent on sufficient time passing that allows the compensation to be permissibly considered under the regs--such as is the case in the event of plan termination resulting in a short plan year.

The LRMs are instructive, perhaps, but I have not seen an IRS-approved document which defines the term "determination period" as it is used in most plans' compensation definition with regard to periods of less than 12 months. I think "determination period" means any period of less than 12 months for which compensation comes into play for benefit accrual purposes. So, I don't think the IRS says one thing and the plan says something different.

In any event, I agree that it would be nice to have some official IRS pronouncement on the subject. Absent that, I guess we'll just have to take our chances.

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