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Terminated employees with no vesting


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I have a plan where all the NHCEs who are eligible for profit sharing have terminated and are 0% vested. I am trying to max out the owner and his wife to their respective 415 limits via a profit sharing contribution using a new comparability formula which I can easily do; however, I have to give the employees a roughly 20% profit sharing contribution. Luckily, they didn’t get paid very much in the current year and the owner and his wife are getting over 95% of the employer contribution. I know I can’t rely on NHCEs for general testing if they don’t have some vesting. What are my options to make the employees somewhat vested so I can rely on them? I have heard of an amendment that you can make to give them testing? If you can do this, do you just list the employees names in the amendment and state what level of vesting you are giving them? Can you just give the employees you are relying on more vesting but exclude others? 

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Was there a partial plan termination? If so, all of the affected employees would become 100% vested.

Free advice is worth what you paid for it. Do not rely on the information provided in this post for any purpose, including (but not limited to): tax planning, compliance with ERISA or the IRC, investing or other forms of fortune-telling, bird identification, relationship advice, or spiritual guidance.

Corey B. Zeller, MSEA, CPC, QPA, QKA
Preferred Pension Planning Corp.
corey@pppc.co

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What C. B. Zeller said is key here.  Whatever you do, it seems possible if not likely that all those terms should be 100% vested.

Having said that, I believe the specific concerns about vesting and contributions relate to amendments, specifically -11g amendments that add contributions that are not part of a formula, which must have "substance."  If your allocations are part of a plan formula, then, in theory, you are ok (ignoring the elephant in the room of partial termination).  

Ed Snyder

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I am pretty sure the terminations were voluntary on behalf of the employee and not employer initiated. If this is the case then it wouldn't be a partial plan termination that would require 100% vesting, right? If this is the case then I could do an 11g amendment to increase vesting of the participants I am relying on in general testing (new comparability allocation)?

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Are they excludable from coverage and NDT or not? That's not clear. Are they excluded from an allocation under the terms of the plan? it seems they are, and that is why an 11g amendment could be needed, in which case you would have to provide some vesting - whether 20% in total, or 100% on just this PS.

BUT - Look at the partial termination rules - it is facts and circumstances. Simple 5500 reporting could certainly lead to a letter of inquiry from DOL or IRS as a PT will be presumed. And it might be a tough case to argue that "yes, believe it or not, all of our NHCEs terminated voluntarily before they were vested, totally unrelated to any actions by the employer." That is why all employees terminating in a year of PT must be fully vested, not just those involuntary terminations (handwriting on the wall ideology). Just my opinion, but I would consider steps now to head off possible future issue, unless other circumstances point to a hard line approach, like bad blood because all employees bolted to a better paying competitor.

 

Kenneth M. Prell, CEBS, ERPA

Vice President, BPAS Actuarial & Pension Services

kprell@bpas.com

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Also... if the owners don't want to fully vest these terminated participants who will be getting a contribution through 11(g), they can just live with the fact that they will not get a contribution this year.  Them's the breaks...

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How many people are we talking?  Two or three NHCEs leaving, could be because a competitor stole them.

More than that, it's a very odd situation indeed when your entire staff quits.

Do they all qualify for the PS already, or will it be all via -11g? 

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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I am allocating them a profit sharing contribution to pass testing. I don’t have allocation conditions in the document so I can’t exclude them. It is only two people but one of them that have terminated I am relying on for general testing; however, they only have one year of vesting service earned and the plan uses a 2-6 year vesting schedule so they are 0% vested so I am allocating them money to give the owners more but they aren’t vested. 

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(I'm curious if anyone else issues with the "this feels like dirty pool" tactic of spiking known-unvested terminated employees' allocations.  It's not really the same as doing an -11g amendment, because the plan already allowed for the allocations, but boy it kinda smells the same.  Does anyone have experience with IRS examinations of this kind of fact pattern, where the employees were eligible but the sponsors knew darned well it was almost an abusive free pass on the testing....)

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It does smell funny, but on the other hand, suppose it was a design-based safe harbor - basic pro-rata allocation, no requirements to receive an allocation. They would receive an allocation, and still be 0% vested and ultimately not receive a dime of it.

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2 hours ago, Bri said:

(I'm curious if anyone else issues with the "this feels like dirty pool" tactic of spiking known-unvested terminated employees' allocations.  It's not really the same as doing an -11g amendment, because the plan already allowed for the allocations, but boy it kinda smells the same.  Does anyone have experience with IRS examinations of this kind of fact pattern, where the employees were eligible but the sponsors knew darned well it was almost an abusive free pass on the testing....)

The IRS might find that this is an abusive plan design relying on "short service employees" to satisfy testing. There is no regulation defining it so it would be up to the agent auditing your plan.

Free advice is worth what you paid for it. Do not rely on the information provided in this post for any purpose, including (but not limited to): tax planning, compliance with ERISA or the IRC, investing or other forms of fortune-telling, bird identification, relationship advice, or spiritual guidance.

Corey B. Zeller, MSEA, CPC, QPA, QKA
Preferred Pension Planning Corp.
corey@pppc.co

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If you are operating within the terms of the Plan Document, no issue whatsoever; the only abusive issue would be if you were constantly using 11(g), or otherwise amending the Plan to allow for early entry or to reduce allocation conditions.  Besides, all those unvested monies are going to reduce your deductible allocation and raise your taxable income.

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On 5/13/2022 at 2:40 PM, Nate S said:

Besides, all those unvested monies are going to reduce your deductible allocation and raise your taxable income.

Not necessarily.  They could use those funds to pay fees.  So, there is a reduction in cost to the ER.  Or the ER can use the funds to supplement the contribution, thus getting a higher allocation with the same deductible contribution.

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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19 hours ago, BG5150 said:

Not necessarily.  They could use those funds to pay fees.  So, there is a reduction in cost to the ER.  Or the ER can use the funds to supplement the contribution, thus getting a higher allocation with the same deductible contribution.

OP was described as a max allocation scenario.  And yes paying fees from forfeiture would also be a tax increase because you aren't getting the deduction otherwise regardless if its the allocation bucket or the fee bucket.

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Wouldn’t doing an amendment to make the employees somewhat vested instead of not vested at all be a step in the right direction? It would give the allocations “substance” and make it not as abusive? I know we are operating in the grey a little here but if I am going to rely on allocations given to non-vested participants who I know have terminated to give more money to the owners I remember reading somewhere that the allocation needs to have “substance” which from what I remember means they need to be somewhat vested in the money they are being allocated. 

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10 hours ago, Will.I.Am said:

I remember reading somewhere that the allocation needs to have “substance”

The "somewhere" you're thinking of is Treas. Reg. 1.401(a)(4)-11(g)(4). This section provides rules for retroactively amending a plan after the end of the plan year to correct a failure of nondiscrimination or coverage testing. If the allocation made under the terms of the plan document satisfies coverage and nondiscrimination, then there is no need to invoke -11(g).

Free advice is worth what you paid for it. Do not rely on the information provided in this post for any purpose, including (but not limited to): tax planning, compliance with ERISA or the IRC, investing or other forms of fortune-telling, bird identification, relationship advice, or spiritual guidance.

Corey B. Zeller, MSEA, CPC, QPA, QKA
Preferred Pension Planning Corp.
corey@pppc.co

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On 5/11/2022 at 4:10 AM, Will.I.Am said:

I am pretty sure the terminations were voluntary on behalf of the employee and not employer initiated. If this is the case then it wouldn't be a partial plan termination that would require 100% vesting, right? If this is the case then I could do an 11g amendment to increase vesting of the participants I am relying on in general testing (new comparability allocation)?

Maybe another consideration is that *all* of NHCE's terminated employment.  I recall that the actual "partial plan termination" concept is that *any* employee that terminated in the partial plan termination year is considered to be equally affected... that is 100% vested, even if they terminated on their own and not part of the employer action.  For example, an employee terminates in February, the employer shuts down a division in August.  I've read that the employee terminated in February should be 100% vested along with the others affected by the shut down.  So in your case, all terminated participants should be 100% vested... and that solves your issue?

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For your partial plan termination question, it might be instructive to review this IRS snapshot, as well as Revenue Ruling 2007-43. See particularly this excerpt - emphasis is mine. Assuming they were in fact voluntary, and that there is no partial termination, it is back to the question of whether an allocation to terminated participants who are 0% vested will satisfy the coverage/nondiscrimination testing. That's a tough one. In a design-based safe harbor plan, I think it is clearly acceptable. When you get into a new comparability plan, certainly a lot of potential for abuse, and I'm not certain there is a bright line standard. For example, even in a new comparability plan that has no allocation requirements, allocating up to the 415 limit for all of the 0% vested terminated participants in order to skew testing results might invite an auditor to put the hammer down.

Facts, Circumstances and Presumption of Partial Termination

The presumption of a partial termination happens when the turnover rate is 20% or greater. If the plan sponsor can provide evidence that the turnover rate was not the result of employer-initiated severance from employment and the severance was purely voluntary, the IRS may find that there was no partial termination. This type of evidence may include information from personnel files, employee statements or other corporate records.

The employer may also provide evidence that the turnover rate is routine. To determine if a turnover rate is routine, the employer must show the turnover rate in other periods and the extent to which terminated employees were actually replaced. The IRS will also consider whether or not the new employees did the same types of work, had the same job classification or title, and received comparable compensation. Rev. Rul. 2002-42 provided that the merger or conversion of a money purchase pension plan, without other indications of a partial termination, does not result in a partial termination.

If the employer cannot provide sufficient evidence to show that the turnover rate was routine or was not the result of employer-initiated severance from employment, the presumption of a partial termination will stand and the affected participants, including those who voluntarily terminated during the applicable period, must be fully vested.

https://www.irs.gov/retirement-plans/partial-termination-of-plan

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