Accelerated eligibility/new employee not yet an HCE

[preErisa]

We have understood that an employer could hire someone and, to support the ‘recruiting package’ could offer that specific person accelerated eligibility for the retirement plan, since a new employee (unless he/she owned more than 5%) could never be an HCE in the first year so there is no discrimination. I’ve seen articles about this in the past but can’t put my hands on one now to answer questions from an attorney who is asking for the legal authority to do that. Has anyone out there heard of this technique and, if so, have you got something specific I can hang my hat on?

[Mike Preston]

I know this doesn't answer the question, but what is the attorney basing the assumption on that it can't be done? If the attorney can't find that citation, isn't is ok to do it? You and I know that he or she won't be able to come up with a cite that says it can't be done.

[pmacduff]

I think it is discriminatory if the NHCE employee that is hired the next day is required to wait the initial eligibility period. I don't know about other practitioners, but I wouldn't want to see what happens when the early entry is discovered and by then the participant IS an HCE!!!! It just doesn't smell right to me....JMHO.

[Blinky the 3-eyed Fish]

Pmacduff, how can it be discriminatory (under ERISA) if the person let in the plan early is an NHCE? The definition of discriminatory for ERISA purposes compares HCE's versus NHCE's, not NHCE's with each other.

Now if you want to argue it's discriminatory under a dictionary definition, then that's another story.

BTW, like mentioned in the first post, it is a very easy determination of HCE/NHCE status, so there shouldn't be an issue there.

[Guest Kevin A. Wiggins]

I think it is discriminatory and I would not recommend it. I don't think it meets the effective availability test of 1.401(a)(4)-4©. Getting into the plan earlier is a BRF. This particular BRF means the NHCE-who-becomes-an-HCE has greater benefits earlier. Thus, because of this BRF, anyone who is now an HCE will have greater benefits because he or she did get in earlier, even though he or she was an NHCE when he or she came in. People who were and are now NHCE's didn't get this BRF, and so their benefits are less. This is discriminiation that substantially favors HCEs. I think this could very well bust the plan's qualification.

[pmacduff]

Sigh...Blinky - I guess you're right, maybe under ERISA it isn't discrimnatory. I just think if the DOL was auditing the plan and saw one employee who entered early and no others, they might look closer. Also - I guess I thought from the tone of the first post that this person was going to be HCE in future years and I didn't think it would look right under examination. We've had a lot of clients want to do this very thing and it was always for a new employee who was going to definately be HCE in future years. I know..that's a lot of "IFs"................I'm just not comfortable unless eligibility was changed for all but it doesn't mean it isn't "doable" .

[Mike Preston]

Kevin, do you have any cites to back up your claim that BRF's are to be viewed historically and not on a current year only basis?

[Blinky the 3-eyed Fish]

Kevin, with your argument you would also have to restrict providing something like a larger contribution one year to an NHCE because he might in the future become an HCE. Personally, I think the rules are pretty clear you do not have to make this consideration and will be interested to hear your response to Mike's query.

[Guest Kevin A. Wiggins]

Mike:

I don't need a cite. The BRF discriminates in favors of HCEs during each current year. Every year each HCE benefits from this BRF, even if the HCE entered the plan in a prior year. But for this BRF, the HCE would not - in the current year - have those extra benefits in the plan. This is what Blinky is alluding to.

This BRF is not effectively available to NHCEs. It does discriminate substantially in favor of HCEs during each year, even for those HCEs who joined the plan in a prior year. In fact, in any one year, it benefits all HCEs (assuming all were let in the plan early) but only benefits those NHCEs who joined the employer that year and whom the employer believes will be a HCE in a later year. During any year, no other NHCE has this right to have greater benefits in the plan. That is enough for the IRS to hang its hat on, and I've heard they might be inclined to do so. I would recommend against it.

Blinky:

You say it follows from my argument that contributions must be limited for those who "might" become HCEs in a later year. I don't think that is true. If, however, you are making larger contributions for those NHCEs whom you know, and whom you intend, to become HCEs next year, then I think yes, the same argument applies. Management can't circumvent the discrimination rules by paying themselves less in one year and saying, "Gee, I'm an NHCE, now I can put in more money into my pension plan," and then next year go back to $400,000 of compensation. That is discrimination under any definition. I think that is exactly why the IRS made the effective availability test so facts and cirumstanced based.

[Blinky the 3-eyed Fish]

I think you do need a cite because I don't think I could agree less.

[Guest Kevin A. Wiggins]

Blinky:

Earlier you said this is not discriminatory under ERISA's discrimination rules. I'm talking about the Internal Revenue Code discrimination rules. Could that be the reason for the difference of opinion?

(FYI, there are no ERISA discrimination rules in this context.)

[Mike Preston]

We all know that bad facts make bad law. And I wouldn't find it surprising that a court would find an intentional pattern of prospective changes intended to disproportionaly benefit current NHCE's albeit future HCE's as compared to current and future NHCE's to be bad facts worthy of bad law. But it would still be bad law and, upon appeal, one hopes that reason would prevail.

The determination of who is an HCE and who is an NHCE is a fact based analysis, not a facts and circumstances analysis. In the plan year an amendment is effective it is imperative to measure the impact of that amendment on those who are then HCE's and NHCE's. There is absolutely no requirement that I am aware of to re-measure the impact of such an amendment during future periods, except with respect to features applicable to those future periods. That is, when measuring the impact of such an amendment in a future period, you look to the benefits rights and features provided in that future period. To assume that retroactive eligibility is a benefit, right or feature that is to be viewed as providing a current benefit, right or feature in a future period strains credibility to the utmost. And without a citation, I am just as confident as you, but obviously headed in the opposite direction, that there is no way the IRS could or would assert a violation of 401(a)(4).

No matter, let's assume that your position is plausible and then look at the regulations in detail.

First, a general comment. If you don't have a cite, you don't have a leg to stand on. The IRS used to have a requirement that a plan needed to pass a "smell test" in order to be non-discriminatory. With the introduction of the 1.401(a)(4) regulations they made it clear that there was no longer such a standard. Ira Cohen is on tape many, many times stating such. To the extent there remains any need to satisfy anybody's olfactory senses there must be a cite within 1.401(a)(4) that requires it. No cite? No legs.

1.401(a)(4)-5(a)(2) discusses the timing of an amendment. "Whether the timing of a plan amendment or series of plan amendments has the effect of discriminating significantly in favor of HCE's or former HCEs is determined *at the time the plan amendment ***FIRST*** becomes effective* for purposes of section 401(a), based on all of the relevant facts and circumstances."

Measure to your heart's content, but on the date that the amendment in question ***FIRST*** becomes effective it is clearly non-discriminatory because it is providing an enhanced benefit to an NHCE.

So, 1.401(a)(4)-5 doesn’t appear to be your cite with respect to the one-time amendment itself.

Even if you consider the effect of the one-time amendment to really be a series of three plan amendments (three separate provisions): 1) the provisions in effect prior to the amendment in years before the amendment; 2) the provisions in effect for the year during which the amendment is effective; and, 3) the provisions in effect for the years after which the amendment is no longer effective - you do not reach the conclusion that the series of "amendments" is discriminatory under 1.401(a)(4)-5(2).

Clearly the plan before the amendment must be assumed to be non-discriminatory or we have a non-starter. The amendment itself, in the year made, as shown above, is clearly non-discriminatory because it is providing additional benefits to an individual that is an NHCE. So the only chance of encountering a problem is in the year(s) following the year that the amendment is made. How is there a problem in such a future year? If I understand you correctly we must first accept your argument that, and I’m paraphrasing here, “the right to receive earnings on an account balance that exists solely because of the one-time amendment” gives rise to a current benefit, right or feature in this now future plan year. Do I have that right? I, for one, certainly don’t accept your argument.

But, if I understand it correctly, how is this circumstance any different from a plan that provides an enhanced benefit to a group on NHCE’s and finds that in a future plan year all of those NHCE’s has terminated except for a group of employees that are now HCE’s?

Or, a new plan that covers 5 HCE’s and two NHCE’s. One of the NHCE’s terminates so the next year you have 5 HCE’s and one NHCE. Is this subject to the same testing you have asked us to perform above? Does it pass? (I really have no idea what your conclusion would be.)

Can you point to any other place in the Code, Regs, Notices, RR’s, RP’s, GCM’s, TAM’s or PLR’s where the Service has held you must analyze the remaining beneficiaries of a past amendment in determining whether a current benefit, right or feature exists?

I’m not trying to be difficult, I’m trying to understand how you reached your conclusion that it is so obviously discriminatory.

[WDIK]

"I fear that we have awakened a sleeping giant

and filled him with a terrible resolve"

Admiral Isoroku Yamamoto

Empire of Japan

December 7th, 1941

[Mike Preston]

The above was the short version!

[Guest Kevin A. Wiggins]

That is a terrific analysis of 1.401(a)(4)-5, but I never mentioned that regulation. Instead, my cite is 1.401(a)(4)-4©.

I went back and looked at the original question and realized, under the facts, they are doing this for one employee only. If they are doing this for everyone whom they know will become an HCE, not only do I not see how anyone can say that would not violate 1.401(a)(4)-4©, but also I have discussed that issue with IRS agents during a 401(k) audit and they agreed with me. That is why I am so confident on that point.

For only one employee, that may be different, but I can't give a citation that supports that it works. To continue your terminology, it is like a glass of bad wine.

I would recommend to the original poster to send the amendment to the IRS and request a determination. Let them say if it is OK or not.

But why bother to go through all this? It is so much easier and so less risky to the pay the target employee outside of the plan. You can even figure out the actuarial value of the early enrollment (including the tax deferrals) and pay the target employee that amount. Then you won't have a plan provision that says something like, "Employee X will enter the plan on Y date," which will stick out like a sore thumb and could very well change the attitude of the auditor for the worse.

[GBurns]

Mike Preston

A lot of your argument seems to rest on "1.401(a)(4)-5 doesn’t appear to be your cite with respect to the one-time amendment itself.". How and Where did this idea of an amendment come from? I see nothing in either the original post nor any subsequent post mentioning that this employer was making any sort of plan amendment. Did I miss it? All I see is a special eligibility being made for a selected employee.

[Mike Preston]

Mike Preston

A lot of your argument seems to rest on "1.401(a)(4)-5 doesn’t appear to be your cite with respect to the one-time amendment itself.". How and Where did this idea of an amendment come from? I see nothing in either the original post nor any subsequent post mentioning that this employer was making any sort of plan amendment. Did I miss it? All I see is a special eligibility being made for a selected employee.

GBurns: How do you suppose they accomplish the following: "offer that specific person accelerated eligibility"? I'm as big a fan of Elizabeth Montgomery as the next guy, but twitching one's nose won't cut it!

[Mike Preston]

Well, at least you are ! (<=Note: That was supposed to show up as the Clickable Smiley that you used in your post, but it didn't!)

That is a terrific analysis of 1.401(a)(4)-5, but I never mentioned that regulation.  Instead, my cite is 1.401(a)(4)-4©.

Ahhhh! A cite! Wonderful!

I went back and looked at the original question and realized, under the facts, they are doing this for one employee only. 

So, a single amendment would not rise to the level that would cause you consternation, right? Therein lies the rub. If the single amendment doesn't give rise to the issue, then it must be a pattern that does so. If it is a pattern, it is dealt with via 1.401(a)(4)-5. If it isn't a pattern, then it must fail on its first application under 1.401(a)(4)-4©(3). Multiple applications of 1.401(a)(4)-4©(3) won't do it.

If they are doing this for everyone whom they know will become an HCE, not only do I not see how anyone can say that would not violate 1.401(a)(4)-4©, but also I have discussed that issue with IRS agents during a 401(k) audit and they agreed with me.  That is why I am so confident on that point.

Did the IRS auditor offer you any beachfront property in Arizona? I admit that it would look like it should be discriminatory to the casual observer, like the IRS auditor you engaged in an informal conversation. Begging the issues of how it was presented and whether the IRS auditor fashioned him/herself as a protector of the downtrodden, there is just no support for the position that a benefit, right or feature extends to eligibility granted to an NHCE in a future year when that individual becomes an HCE. Judge Learned Hand comes to our rescue many times, and this is one of them. I don't care how many amendments are made to a plan that benefits people when they are NHCE's. They will never, ever give rise to a claim that such benefits are discriminatory under the existing Code and Regulations.

For only one employee, that may be different, but I can't give a citation that supports that it works.  To continue your terminology, it is like a glass of bad wine. 

But I can! Look at all of 1.401(a)(4). You won't find anything that says an amendment which benefits an NHCE can possibly give rise to a claim that something, ANYTHING, is discriminatory. Everything therein is about benefits to HCE's. And everything is therefore a cite that proves, by conspicuous absence, that such an amendment is not and can not be discriminatory.

I would recommend to the original poster to send the amendment to the IRS and request a determination.  Let them say if it is OK or not.  

No argument here. I would even be willing to include a paragraph along the lines of: The taxpayer is particularly interested as to whether the proposed amendment, notwithstanding the fact that the benefit being provided is with respect to an individual who is an NHCE in the initial plan year, can lead to a claim by the Service that a violation of 1.401(a)(4)-4©(3), Effective Availability, might arise in a future year when the individual becomes, as expected, an HCE. That is, does the proposed amendment potentially provide a discriminatory benefit, right or feature either in the current year or any future plan year?

But why bother to go through all this?  It is so much easier and so less risky to the pay the target employee outside of the plan.  You can even figure out the actuarial value of the early enrollment (including the tax deferrals) and pay the target employee that amount.  Then you won't have a plan provision that says something like, "Employee X will enter the plan on Y date," which will stick out like a sore thumb and could very well change the attitude of the auditor for the worse.

I'd be interested in your analysis as to how much one should pay to an individual who has proved that the value to the entity in question is $10,000, is age 33, and otherwise makes $150,000 per year, but who only worked for 8 months during the plan year and therefore received $100,000 in compensation in the year in question. If the answer is "greater than $10,000" then how does the entity justify paying more than the amount determined as the "value" of $10,000? And where does it come from? I sense a chicken and egg problem here, if you catch my drift.

I'm hopeful that you don't find this discussion a bother and that we can continue it.

[GBurns]

How do they accomplish it? Simple! Do exactly as the original post stated... you offer it as part of the benefits package. That is what the question pertained to. That is all the post stated. Why assume that something else must be done and why must it be only the way that you assume? If the poster had something else in mind, they would have posted so.

The post and nothing and nowhere else makes mention of or suggests anything else other than offering it in that manner. No mention or implying of any plan amendment. A plan amendment is solely your idea. Why assume that this is the only way that anything can or must be done?

It seems that if the IRS "Step Transaction" doctrine was applied to this situation, it would be easily determined that it was discriminatory. It was known (as per the post) at the time of employment that this employee was going to be a HCE very shortly. The conditions were changed to facilitate this known situation. It seems a simple substance over form issue. It might have been different if this employee had to merit being raised to the status of HCE, but that is not what was posted.

It also seems discriminatory in that at the time of employment, the other NHCEs at that same job level (class) did not have the same eligibility. Remember that at time of employment this employee was the same as all the others, except that his future was already planned and agreed on, but at that time and for some time afterwards he was exactly the same as the other employees in that job category or class or level. Should the benefits not have been the same for all?

[Mike Preston]

GBurns, well if you feel that way, perhaps you can suggest a way to accomplish it other than with an amendment or a nose twitch.

Under what theory do you feel that benefits for NHCEs must be the same for all?

Wow!

[Blinky the 3-eyed Fish]

It takes a lot to bring out the wow.

FWIW, I agree with Mike's assessment completely. His arguments are more concrete than having some IRS agent "say so". With all due respect, there are good and bad within the IRS, so having one or two opinions is worth very little. I mean I have had an IRS agent argue with me that you couldn't offset DB benefits with DC employer contributions.

Lastly, if the plan is a 401(k) plan, there is no way to make the participant whole outside the plan without the employer taking the hit. If the employee wishes to defer his own money, how does the employer make up for that without costing itself? If the original post is not talking about a plan amendment, then they are talking about operating the plan outside of the document provisions.

[GBurns]

RE:

"If the original post is not talking about a plan amendment, then they are talking about operating the plan outside of the document provisions. "

The poster asked "Has anyone out there heard of this technique and, if so, have you got something specific I can hang my hat on?" The poster did not know how it could be done but knew that the employer "could offer that specific person accelerated eligibility for the retirement plan" as part of a "recruiting package". The poster never mentioned or suggested a plan amendment.

If a plan amendment is the only way to do it then that would be a suggestion for a responder to make. Instead what we got was a monologue expounding the problems of a plan amendment etc etc etc. No one had suggetsed that a plan amendment could or should be used.

Why make assumptions rather than just asking the poster? Or is it that some people know it all and things can only be as they think it to be? That was my point.

[Mike Preston]

I'm still waiting for you to describe any method that can be used to accomplish the stated objective without an amendment. If there is no other way, why is it presumptuous to assume that an amendment is being contemplated? Look, you were just trying to start trouble with your post. You know that there is no way to accomplish it without an amendment. The OP knows it, too. Either make a credible argument as to how to implement the intended "additional benefit" or drop the issue, already.

[Harwood]

From Rev Proc 2003-44, Appendix B

(3) Inclusion of Ineligible Employee Failure. (a) Plan Amendment Correction Method. The Operational Failure of including an ineligible employee in the plan who either (i) has not completed the plan's minimum age or service requirements, or (ii) has completed the plan's minimum age or service requirements but became a participant in the plan on a date earlier than the applicable plan entry date, may be corrected under VCP and SCP by using the plan amendment correction method set forth in this paragraph. The plan is amended retroactively to change the eligibility or entry date provisions to provide for the inclusion of the ineligible employee to reflect the plan's actual operations. The amendment may change the eligibility or entry date provisions with respect to only those ineligible employees that were wrongly included, and only to those ineligible employees, provided (i) the amendment satisfies § 401(a) at the time it is adopted, (ii) the amendment would have satisfied § 401(a) had the amendment been adopted at the earlier time when it is effective, and (iii) the employees affected by the amendment are predominantly nonhighly compensated employees.

[WDIK]

It was known (as per the post) at the time of employment that this employee was going to be a HCE very shortly.

The original post never stated that the "recruit" would later become an HCE.

Why make assumptions rather than just asking the poster? Or is it that some people know it all and things can only be as they think it to be? That was my point.

[Mike Preston]

Good point, WDIK. However, just like the OP never stated that the mechanism for accomplishing the early entry was an amendment to the plan, there is a presumption here that the individual in question is likely to be an HCE in the second year. pmacduff's message was the first to suppose that HCE status was likely, and I agree it is likely, because in the absence of said individual becoming an HCE, there is no discrimination issue at all, notwithstanding GBurns' irrational comment to the contrary.

[GBurns]

The original post includes "since a new employee (unless he/she owned more than 5%) could never be an HCE in the first year so there is no discrimination" IMHO implying that after the first year that new employee would then be an HCE. As a result others posted " I wouldn't want to see what happens when the early entry is discovered and by then the participant IS an HCE!!!! " and "particular BRF means the NHCE-who-becomes-an-HCE has greater benefits earlier. " and "I guess I thought from the tone of the first post that this person was going to be HCE in future years ....a new employee who was going to definately be HCE in future years." and "those NHCEs who joined the employer that year and whom the employer believes will be a HCE in a later year".

The general concensus seems to be that it was known and implied by the poster etc.

Mike,

Look up the definition and meaning of "irrational comment " then try and see how it applies to my comments which were mainly geared at questioning your comments. How does it become irrational to ask a poster questions such as "How and Where did this idea of an amendment come from?" etc? Or is it really that no one should question your comments and if they do they must be irrational??

[Mike Preston]

Oh, definitely the latter. Except for my wife, of course. BTW, would it be too much trouble for you to actually read what I wrote? You seem to be oblivious to what I was referring to as your irrational comment. If you try real, real hard I think you can suss it out. Then again, maybe not. But I stick to my guns as it being "not endowed with reason or understanding"; or, if you prefer: "lacking usual or normal mental clarity"; or, if you prefer: "not governed by or according to reason." They all fit. But only if you can find the specific comment I was referring to.

And, oh, BTW, you have yet to provide any mechanism for accomplishing the original goal, legitimately, without an amendment. Coincidence?

Unless you can provide some mechanism for accomplishing the original poster's objective without an amendment it is completely irrational to challenge somebody else's supposition of there being an amendment! But do NOT be confused by this last statement. It has nothing to do with the first paragraph. See, there were actually multiple irrational statements, but I only pointed out one before. I know, I know. I'm making it too easy for you. All these clues and everything. I'm so kindhearted.

Gotta love this guy.

[GBurns]

You seem to believe in the old saw.. If you cannot dazzle them with brilliance, just baffle them with ....

[Blinky the 3-eyed Fish]

I hear the black pot talking.

[Mike Preston]

Still waiting for that mechanism, GBurns. None forthcoming?

[GBurns]

As implied by the original post, the employer just does, no mechanism, no plan amendment, they just give it and allow it. The posted seemed to wondering if this could be done.

As I posted:

"How do they accomplish it? Simple! Do exactly as the original post stated... you offer it as part of the benefits package. That is what the question pertained to. That is all the post stated. Why assume that something else must be done and why must it be only the way that you assume? If the poster had something else in mind, they would have posted so."

[GBurns]

Blinky

Although we are both doing the same thing, as you see it, I am curious.

Which is which or Who is which?

[Mike Preston]

Well, if you think that it can be done via the description you just gave, you have proven yourself more dangerous than I thought. To even assume, for a moment, that such a course of action is rational is beyond the pale. It is horrible advice. If you don't see that, you should be ashamed. It would clearly disqualify the plan and I'm hopeful (but not very) that you can recognize that.

I'm waiting for Kevin to come back and inject some rationality to this thread by continuing the discussion on discrimination.

[GBurns]

Read it again and read the original post. It is not and never has been my advice. I have rendered no advice.

[Mike Preston]

Yes, you did. By implying strongly that it was inappropriate to assume an amendment was required, you made it clear that an amendment might not be required. That is, that there was some other legitimate method of implementing what was desired. That is very, very bad advice.