Testing Sevice for the General Test

[flosfur]

A non-safe harbor plan's projected and accrued benefits are based on Years of Participation (YOP). The plan is tested using the Accrued-to-Date method using all Years of Service (YOS) to date with the employer.

The plan was submitted to the IRS for a determination letter and the reviewer does not agree with the use of YOS for testing citing the general rule of 1.401(a)(4)-3(d)(1)(iv), namely, Testing service means an employee's years of service as defined in the plan for purposes of applying the benefit formula under the plan .....

However, 1.401(a)(4)-3(d)(1)(iv) continues with "Alternatively, testing service means service determined for all employees in a reasonable manner... " and goes on to refer to 1.401(a)(4)-11(d)(3) for additional rules.

1.401(a)(4)-11(d)(3)(i)(B) & © clearly permits taking into account Past & Pre-participation service.

In view of the above, am I OK in using all service as testing service? Are there any other cites/references for using all service that I can give the reviewer?

If this is not true then the formulas of the type "250% for the owner and $100 for others with the fractional accrued based on YOP" I have seen presented at conferences, have no chance of passing the general test!

As an aside, I can easily get the same end result by using non-safe formulas using all service but that can (& does) create past service liability, Unfunded accrued & vested benefits, PBGC's variable premiums and so on! So I rather not do that.

[Blinky the 3-eyed Fish]

While I agree that the testing service can use service that differs from that taken into account for the benefit formula, that service still cannot discriminate in favor of HCE's. (I didn't research a cite.) You didn't address whether that is an issue in your case.

As for your last paragraph, can you recreate it without using more than 5-years of past service? If not, have you determined whether or not this consideration of service is discriminatory?

Your example you quote as seeing in seminars was interesting. I wonder what the circumstances were to allow for such a formula to pass testing.

[flosfur]

Using all service as the testing service, the plan passes the general test - the each rate group test and the average benefit % test.

The plan is non-safe harbor and as such is designed to provide higher benefit accruals to (discriminates in favor of) HCEs. The question is whether the discrimination is permitted discrimination - as is the case with the integrated plans as well as the DC cross tested (new Comparability) plans.

[Blinky the 3-eyed Fish]

Using all service as the testing service, the plan passes the general test - the each rate group test and the average benefit % test.

This does not answer the question as to whether or not the use of service is discriminatory. That is a facts and circumstances test.

For example, you have an owner of the company that has been been employed for 30 years, and all the while the company has had nonhighly compensated employees. But all his current employees have only been there for 1 year. In this case you certainly cannot use all 30 years of the owner as his testing service.

Again, I am giving you a quick answer devoid of cites, but perhaps someone (Mike Preston) can spend the time to look them up in 1.401(a)(4) somewhere or provide some specifics of how the IRS looks at the facts and circumstances issue.

Quick find is 1.401(a)(4)-11(d)(2)(i).

[flosfur]

This does not answer the question as to whether or not the use of service is discriminatory.  That is a facts and circumstances test.

Facts and circumstances is a subjective test. Whereas the each rate group and the average ben % tests are objective tests and are supposed to get us past the subjective facts and circumstances test?

If that was not so then we are stuck with using the safe harbor designs only since a non-safe harbor plan design will always be vulnerbale and would be at the mercy of a reviewer's whims and his/her subjective opinion, at the time, of the fact and circumstances!? What happens when the facts & circumstances change or the reviwer change?

For example, you have an owner of the company that has been been employed for 30 years, and all the while the company has had nonhighly compensated employees.  But all his current employees have only been there for 1 year.  In this case you certainly cannot use all 30 years of the owner as his testing service.

That's generally the rule than the exception in small plans. Where does it say that one cannot use all 30 years for the owner - that's what I am trying to find out. Remember, we are not talking about a "safe harbor" plan design.

Using that logic one could argue that one cannot use the permitted disparity plan design in circumstances where only the owner is likely to have compensation above the integration level e.g. when all employees are at the minimum wage level.

Quick find is 1.401(a)(4)-11(d)(2)(i).

That refers to how a Year of Sevice is defined (actual hours or lapsed time method) and using comparable definition for all classes of employees.

[AndyH]

My two cents on this. Once again I agree with Blinky.

When I started in this business, the typical DB plan based benefits on service but accrued on participation, exactly for the 30 year versus 1 year reason that Blinky mentioned. Then this design was prohibited as a safe harbor design under the a(4) regulations.

To suggest that this is now allowed by simply general testing is not correct. The testing service must relate to the benefits being provided.

ok, I just found the IRS audit guidelines Document 9240 4/2000 page 11:

"Testing service, for purposes of determining accrual rates, generally means the employee's years of service as defined in the plan for purposes of the plan's benefit formula. Alternatively, testing service can be determined for all employees in a reasonable manner. An example of a reasonable alternative definition of testing service is the number of years of service the employee has benefited under the plan."

I don't think that basing benefits on participation but testing on service meets the reasonable criteria in most cases.

[Blinky the 3-eyed Fish]

Flosfur, I don't think you are getting my point. It is not the general test or the use of permitted disparity that is a facts and circumstances test. Rather I am specifically discussing the ability to use testing service other than what is used by the benefit formula. It is almost like a gateway situation. First you must determine that the testing service being used is not discriminatory. If it is not, then you can proceed to the general test using that testing service. If it is discriminatory, then you are not allowed to use that definition of testing service in the general test.

I found some discussion on this in the ERISA Outline Book 2003 Edition Ch 9 Section XI Part E.

[flosfur]

An update on this issue....

I checked with my other sources (including a fee based legal search service) about using (a) All Service with the Employer Or (b) Service from the date an employee met the participation eligibility requirement as the Testing Service when a plan's benefits are based on Participation Service and the answer was: (a) was doubtful but (b) would be OK. The reference given was the same as I cited in my initial posting, namely regs 1.401(a)(4)-11(d)(3)(i)(B) & ©.

I responded to the IRS reviewer with this cite and have not heard back from him since, almost 7 weeks, but on the other hand I have not received the DL yet either. Either he accepted the response and the case is working its way through the process or the case was sent to the National Office for review and is sitting there.

I will report back the outcome.

[flosfur]

FWIW.

Well the IRS came back sooner after my last post and they are sticking to their postion (but they have not given any cite).

So I have been busy researching on the subject.

The people who had previously assured me that my approach was OK are now changing their opinion.

During my research, I came across someone who has been designing the non-safe harbor DBs using "all service" for the projected benefits but participation service for the accrual fraction and using all service as the testing service.

He told me he was receiving favorable determination letters in the past but recently, the IRS has started objecting to his approach. He is still debating with the IRS on this issue.

Well, I have decided to change my approach and will be using the same service for both the projected and the accrued benefits and if some plans are not do-able, they are not do-able.

[AndyH]

flosfur, we had one of these a few years ago, benefits reduced based on service but accrued on participation. We submitted the general test using testing service as all service and it was accepted, but we never felt comfortable with this and considered ourselves lucky that it was approved.

I think you are reading it correctly. Even the IRS is learning.