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Change Non-SH Allocation Formula?


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401(k) Plan with no safe harbor provisions. Current NEC PS allocation is an integrated allocation. Participants employed at the end of the year have a 0 hours service requirement. Participants that are not employed at the end of the year have a 500 hours of service requirement.  

As of today no participant has terminated employment in 2017 with greater than 500 hours.

Can the plan sponsor do an amendment now to change the allocation formula to individual classes?

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Presumably, most or all participants have 500 hours of service by now.  So if they terminate between now and end of year, they would be get a contribution under the existing language.  I've always understood that to mean it's too late to amend the formula.  You could, however, start a new plan with the language you want and just not make a contribution to the old plan.

Ed Snyder

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I have been known to be a bit less restrictive.  It gets complicated but as long as everybody gets at least as much as they would have gotten without the amendment, then recognizing an amendment works out fine.  Obviously, some participants have to have a minimum of zero or else it is much ado about nothing.

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I might be missing something; it seems that there is a requirement to be employed at the end of the year, or if not, have over 500 hours before being terminated.  No one currently has been terminated with over 500 hours so no one falls into that category for an allocation.  That leaves only those employed at the end of the year with 0 hours.  HOWEVER, it SOUNDS like there IS a requirement that in order for everyone else to get that allocation who is still employed, they have to be employed at the end of the year.  That means you have an end of the year employment rule for everyone who is still working, and why can't you then amend the plan to now have individual classes?  

There are only two classes of participants for allocation prior to the amendment; those who terminated with over 500 hours (there aren't any) and those who are employed at the end of the year (the end of the year hasn't happened so there aren't any of those YET are therefore no on is YET entitled to a contribution).

It might be considered a tortured explanation, but I think it works.

Mike: what do you think?

Lawrence C. Starr, FLMI, CLU, CEBS, CPC, ChFC, EA, ATA, QPFC
President
Qualified Plan Consultants, Inc.
46 Daggett Drive
West Springfield, MA 01089
413-736-2066
larrystarr@qpc-inc.com

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10 hours ago, CuseFan said:

Agreed. If anyone has worked 500 hours they have become entitled to a contribution without any further requirements and so you are precluded from amending the formula.

I'm not sure that is true. There is no one yet in the category of "terminated with over 500 hours", and there is no one who has met the requirement of being employed at the end of the year YET. Therefore, there is no one who is entitled to an allocation at this point.  You are adding another category; those who MIGHT terminate, but that is not a category that exists in this plan definitions of who is entitled to a contribution TODAY.  See my other response above.

Lawrence C. Starr, FLMI, CLU, CEBS, CPC, ChFC, EA, ATA, QPFC
President
Qualified Plan Consultants, Inc.
46 Daggett Drive
West Springfield, MA 01089
413-736-2066
larrystarr@qpc-inc.com

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I think I might have been mixing up my fact patterns.  I was thinking about the situation where the plan sponsor makes a contribution to the trust between the first day of the year and the date the plan's formula is amended.

The reason I put a client through the tortured calculation is that there is this old TAM (that I forget the number and can't put my fingers on it at the moment (we are approaching 7/31, y'know!) that stood for the position that Bird and CuseFan put forth: if, no matter what happens between xx/xx/xx and EOY an individual has a right to share in a contribution, as of xx/xx/xx that individual has a protected right to share in the contribution).

And in my case, you have a contribution having been made to a plan before the allocation formula is amended.  I think a strong argument can be made that there is a protected right of some sort at the moment the contribution is made.

But in the absence of a contribution being made before amendment, I would probably not object too much if the Plan Sponsor's ERISA counsel said to allocate everything with respect to the amended provisions.

Unless, of course, I can find that TAM.

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imagine Fred, planning on quitting in Sept.

he knows he has enough hours to receive a benefit under the current terms of the plan if he quits.

he is simply waiting to tie up a few loose ends, and get the mid year bonus the company pays.

Is his benefit protected or can the company simply change the formula because he 'might' terminate but hasn't?

 

taking it one step further, Fred gives his 2 weeks notice. so company now amends the plan to put everyone into groups and of course Fred's group will get nothing. that smells.

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The gist of the TAM Mike referenced was that once someone (anyone) has earned the right to a benefit under existing plan provisions, the formula can't be changed.  In this case, let's say Mary is still employed with 500+ hours of service. 

  • If she quits, she has 500+ hours of service and gets an allocation. 
  • If she is still working at the end of the year, she gets an allocation. 

There is no scenario in which she does NOT get an allocation, therefore she has satisfied the requirements to get an allocation and the formula can't be changed.

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Ed Snyder

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I think it is TAM9735001

Key language:  " Under section 1.411(d)-4, A-1(d)(8), the conditions for receiving an allocation of contributions or forfeitures for a plan year are subject to section 411(d)(6) after such conditions have been satisfied. That is, once a participant has satisfied the conditions for receiving an allocation, the participant's right to an allocation becomes section 411(d)(6)-protected, and a plan amendment cannot add further conditions. "

Ed Snyder

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Of course, the problem with that TAM is that it is discussing an event not being discussed here: an amendment AFTER the end of the plan year. Here, we have an amendment BEFORE the end of the plan year. Further, the TAM's fact pattern includes a contribution being made to the plan before the amendment changing the formula was even executed. I certainly understand that the quoted section is merely a building block to the overall logic of the analysis. But one always wonders whether different facts would lead to different building blocks.  Sorry I don't have time for a more thorough analysis.  Maybe next week.

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It does seem possible that if the plan amendment in TAM9735001 had been adopted before the contribution was determined and contributed, the result would have been different. If, for example, as is typically the case, the contribution amount could theoretically have been $0 until it had actually been determined by the employer, e.g. in a board resolution adopted after the end of the year, then what the employees had actually accrued as of the date of the amendment was their fractional hare under the formula times $0, which of course was $0. This is suggested by the following paragraph from the TAM:

"The Employer argues that, in the case of a discretionary profit-sharing plan, the employer has no obligation to make a contribution; therefore, participants do not accrue benefits under the plan until a contribution is actually made. We note that, in this case, the contribution had in fact been made at the time of the March 15, 1993 plan amendment. Moreover, as described above, under the terms of the plan, a participant became entitled to his allocable share of any contribution for 1992 as of December 31, 1992. Where a contribution is in fact made for 1992, the participant's protected allocable share of that contribution is determined as of December 31, 1992, under the existing formula."

However, aside from the above paragraph, the general thrust of the rest of the IRS's argument in the TAM seems to be that once an employee had fulfilled the conditions for an allocation, that employee's share of whatever was contributed had accrued, and so no change could be made, regardless of whether the overall contribution amount had been determined or contributed. I'm not sure whether a court would go that far.

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I personally tend to err on the conservative side when this comes up and take the position that once an employee has worked 500 hours he has earned a right to the allocation under the formula in place at the time.  That is the general "rule" that I learned years ago when I was first starting in this industry.

However, I think the key language quoted above from the TAM is just referencing the fact that the sponsor cannot add additional allocation requirements once the person has satisfied the plan's current requirements.   I don't believe it is prohibiting changing the plan's contribution formula.  Our firm has informally discussed this exact scenario with several attorneys and have gotten a pretty consistent answer that they believe that because the employer could always opt to contribute -0-, the employer can amend the formula up until 12/31 to utilize individual classes and put some employees into a -0- class. 

But, again, it is not something I like to do.  I will typically try to convince the employer to wait and make the amendment effective for the next year. 

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In this link from "DWC - the 401(k) experts" they spell out what I believe is the standard industry interpretation and what I believe has been explained by the IRS informally, for this exact situation.  I'm not citing them as the ultimate authority but they didn't make it up either; this has been repeated many, many times and I didn't think there was really any debate about it.  My emphasis in bold.

Profit Sharing Allocation Methods

From time-to-time, a plan sponsor may wish to change the method used to allocate profit sharing contributions — maybe from salary proportional to new comparability. This is one of those situations in which the anti-cutback rule described above must be applied on a theoretical basis to determine when a change can occur. The reason is that participants are considered to have earned the right to share in a profit sharing contribution allocated under the existing plan-specified method once they have satisfied all of the plan’s allocation requirements. This is true even when the profit sharing is discretionary and the employer is not required to make any contribution at all.

Consider these two variations on the theme:

  • A plan that requires participants to be employed on the last day of the plan year to receive a contribution has until December 30th (assuming a calendar year plan) to amend the allocation method.
  • A plan that requires participants to either be employed on the last day of the year or complete at least 501 hours of service can only change the allocation method up until the date on which the first participant works his/her 501st hour for the year. At that point, changing the method would eliminate a right the participant has already earned.

Plans that do not impose any additional requirements on the profit sharing contribution cannot change the allocation method once the year starts.

See IRS Technical Advice Memorandum 9735001 for additional information.

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Ed Snyder

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17 hours ago, Belgarath said:

So why can't the amendment specify that it applies ONLY to participants who have not worked at least 501 hours as of the amendment date, and who terminate employment prior to the last day of the plan year?

They wouldn't get anything anyway.  It's the others that are a problem.

Ed Snyder

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I don't quite get what you are saying. As per original post, "Participants employed at the end of the year have a 0 hours service requirement. Participants that are not employed at the end of the year have a 500 hours of service requirement."

So suppose that, as of this moment, someone does not have 501 hours. It isn't the end of the plan year, so as of this moment they haven't accrued a right to anything. But, between now and when they terminate prior to the end of the plan year, they MIGHT reach 501 hours. So if you amend now to individual classes, these people who attain 501 hours between now and when they terminate could be given zero allocation (assuming you pass testing).

I guess what I'm trying to say is that what I mentioned should negate the underlined sentence below. I don't agree that the first participant attaining 500 hours should then negate the possibility of amending to change for participants that have NOT yet earned the right for an allocation, nor will they because they terminate employment prior to end of plan year. Of course, if the IRS chooses to follow the flawed logic, I don't know how successful it would be to fight it, and it probably applies to so few people that it wouldn't be worth it...

A plan that requires participants to either be employed on the last day of the year or complete at least 501 hours of service can only change the allocation method up until the date on which the first participant works his/her 501st hour for the year. At that point, changing the method would eliminate a right the participant has already earned.

 

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Belgarath, I agree that you could theoretically change the allocation method for participants who haven't earned the right to an allocation.  But I don't know exactly what that means...are you going to say the allocation method is integrated for everyone, except for those who haven't earned the right to an allocation?  And that allocation method is...groups?  How do you have a plan with two allocation methods?  I'm not saying it's impossible*, but it would require some tricky drafting at best, and I don't see that it is accomplishing anything in this case, where it is reasonably assumed that most or all participants have in fact earned the right to an allocation.

*Maybe it is impossible.  Suppose Joe has not earned the right to an allocation, and you carve him out and say "Joe gets whatever we say he gets, and everyone else gets a pro-rata allocation."  Now suppose you decide to give Joe more than everyone else, because it helps with testing.  Haven't you taken something away from the others?  If the employer contribution is "50,000" and you decide that Joe gets $900 because you say so, but someone else gets less than they would  have if you had just allocated the whole $50,000 on an integrated basis, then you've taken something away from them.  I think this is a case where "definitely determinable" comes into play, even though the IRS threw in the towel on that long ago by allowing groups.  Trying to have both integrated and groups in the same year doesn't work (unless it was set up that way from the beginning, but then why bother with two formulas).

I think you could eliminate Joe from an allocation but don't think you could change the allocation method itself when someone else has earned the right to an allocation.

I hope this makes sense...sort of a stream of consciousness post for July 31.

Ed Snyder

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Mine is sort of a ramble as well. I was focusing more on the theoretical possibility of an amendment being allowable for a pretty narrow set of circumstances, rather than the practical testing implications. And I agree, at best, a potential mess for dubious gain, if any. I suppose it really means that you'd blow your design-based safe harbor allocation, and have to general test the whole shebang? Agree that there's no way to cut back on the integrated formula benefit for those who satisfy those allocation requirements. I think the whole purpose of this was to give "Joe" nothing, or less than what would be given under the integrated formula. But maybe it isn't possible - too many end-of-July brush fires to ponder this at greater length.

Mind you, I'd just tell 'em NO, and amend it for the following year anyway.

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