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Guest raintrain19

401(a)(26) and Frozen Plan

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Guest raintrain19

I have a plan that is both frozen to new entrants AND benefit accruals are frozen (hard freeze). When the freeze occurred back in 2008, there were 8 participants with a vested benefit in the plan. Today (12/31/2012 val date) there are 3 ppts left with a vested benefit. In looking through the census, there are 9 total non-excludable employees for 2012. A few more facts about the plan: it is not PBGC covered, it is greatly overfunded (think 160%), it is top heavy and there were quite a bit of formula changes during the years prior to the freeze. So here's my dilemma:

It would appear that since only 3 ppts have a benefit under the plan, this plan fails 401(a)(26) for 2012, as 40% of 9 is rounded up to 4. When I've researched the definition of "benefiting", I read that it is defined as earning an accrual. First off, if this definition is correct, wouldn't freezing a plan be considered a disqualifying event, as there are no additional accruals???

Two questions:
1. Are frozen plans really required to pass 401(a)(26)?
2. If the answer is yes, which I believe it is, am I supposed to give a minimal (0.5%) accrual to 4 participants in the plan, or am I supposed to give 0.5% accrual to 1 ppt in the plan and the other 3 that are already in will be considered benefiting, therefore making the total number of participants now in the plan equal to 4.

And finally, the second I give an accrual, I guess I have to go through all other non-discrimination testing, as the plan is technically no longer frozen.

Thanks in advance for your help.

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First, a frozen plan does have to pass 401(a)(26). It is usually accomplished by using the prior benefit structure (enabling proof that the .5% has been met - although that rule is not in the law).

You technically only have to bring a single participant into the plan and give them .5% for the current year.

However, since your plan is funded to the 160% level, I would just reactivate the plan and switch to a career average of .5% as I do not believe the cost would be onerous (if anything).

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Guest raintrain19

When I read the prior benefit structure section, I read it as you needed to have a single benefit structure prior to the plan freeze. This plan had been amended quite a few times prior to freezing, so I took that literally and figured it failed this facts and circumstances test.

  • Did all participants who were in the plan while it was accruing receive at least 0.5% while they were in the plan? Yes.
  • Are they still receiving 0.5%? No, as the plan is frozen.

The sponsor would rather not give 0.5% to everyone in the plan, and it appears as though I can take one employee who would otherwise be in the plan had it not been frozen, and give them the 0.5% accrual. This brings up the question: is there a non-discriminatory way to pick and choose who will receive that .5%? The owner would obviously prefer someone who is young, makes little $$ and maybe even terminated after "entering" the plan so that their vesting is less than 100%.

Any thoughts?

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Perhaps my understanding is too imperfect, but the following is how I understand these things to work when one is talking about a hard frozen plan:

1. As no participants are accruing any additional benefits other than any possibly required top-heavy minimum accruals (and since no key employees have benefitted under the plan since 2008, at the very least no top-heavy service since then would be recognized for anyone; I had understood that the top-heavy minimum itself would have been frozen after that year), the 401(a)(26) regulations clearly provide that the plan is considered to automatically satisfy all the requirements of 401(a)(26) with the possible exception of the prior benefit structure requirements.

2. It doesn't matter how complicated the plan's history has been. With respect to the prior benefit structure requirements, a plan is explicitly deemed by the regulations to have one prior benefit structure. It doesn't matter at all if the accrued benefits were developed under a dozen different formulas. Whatever the accrued benefits are is what the prior benefit structure determination is based on.

3. The determination as to whether the prior benefit structure requirement is met is primarily a facts and circumstances test. As the plan had provided at least top-heavy minimum accruals prior to the freeze (which would have meant that at least the non-key employees would have accrued meaningful benefits) and is providing nothing further to anyone, how could the plan be considered to not pass the prior benefit structure requirements?

4. Personal opinion - except in really unusual circumstances, when one is talking about hard frozen plans, it would not be necessary to give anyone any current accruals, even if one is talking about plans not subject to Title IV and/or plans with top-heavy ratios over 60%.

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I don't know if there have been more responses to this post from a few years ago or there have been new posts on this topic. But if a plan is frozen, overfunded, top heavy and not covered by PBGC it has to pass 401a26. If a plan had a formula before the freeze that gave some participants a de minimus benefit equivalent to 0.5% of pay, then even using the average accrual method, you would fail 401a26 at some point after the freeze. Maybe you get a technical pass the first year of the freeze if you test at the beginning of the year on the average accrual method. But after that you will fail if you accept the 0.5% as the minimum necessary.

Note that if a plan is not covered by PBGC and is UNDERFUNDED it still does not seem to get an automatic pass on 401a26.

It seems that frozen plans in some circumstances must be unfrozen?

Am I wrong in the above? Has anybody had an audit where this issue came up?

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On 7/20/2018 at 9:24 AM, Ted Munice said:

If a plan had a formula before the freeze that gave some participants a de minimus benefit equivalent to 0.5% of pay, then even using the average accrual method, you would fail 401a26 at some point after the freeze.

This might be one of those annoying technicality posts I'm about to make - but my response to the above is "not necessarily." Keep in mind that the 0.5% of pay is not law. Even if a plan offers benefits that are lower than 0.5% of pay, it could still be possible to justify such benefits as "meaningful" and pass 401(a)(26).

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My question is whether if the prior benefit structure gave accruals of greater than .50% for all participants prior to the freeze would allow the plan to satisfy a(26) after the freeze date. In my case, the 2 participants have benefits at the 415 limit, and so any attempt to add a .5% accrual after the freeze would be defeated. I assume the regs permit this, I hope.

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Is there any guidance on testing the prior benefit structure for a hard frozen plan?  1.401(a)(26)-3 doesn't have much detail.  The preamble isn't much help. It just says that "...an ongoing defined benefit plan will typically satisfy the prior benefit structure requirements concurrently with satisfaction of the general plan requirements."  There is plenty out there on soft frozen plan issues with 401(a)(26).  I did find the attached transcript of a 2016 IRS presentation on soft frozen plans that says freezing the plan is one option to fix it if you hit the 401(a)(26) "wall" (pgs 1, 4 & 17).  That seems an odd thing for the IRS to suggest if a hard frozen plan would have the same issues going forward.  If anyone can point to some applicable guidance, even informal, it would be greatly appreciated.

 

Transcript - Nondiscrimination Coverage and Participation for Closed Retirement Plans webcast 7-21-16 .pdf

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