Component plan testing

[Richard Anderson]

For 401(a)(4) testing, the plan will be restructured into component plans A and B. The plan has 3 HCEs and 5 NHCEs. One of the HCEs is excluded from participation by the plan document. Component plan A will have 1 HCE and 2 NHCEs. Component plan B will have 1 HCE and 2 NHCEs. I assume that the excluded HCE may be assigned to either of the component plans. Is this correct?

Both component plans must pass 410(B) coverage on their own. In testing component plan A for coverage I assume that I include participants in both component plans in the test, but with only the participants in component plan A as benefiting. Is this correct? Also, in testing the component plan for coverage, are all options available (70% and ABT)? In performing the ABT for a component plan, is the ABT test preformed as if the component plan was the only plan, or are all component plans aggregated for the ABT.

When performing rate group testing on a component plan, are there any special rules that I should be aware of? When testing component plans, each employee is cherry-picked for one component plan or the other. Does this make the classification not "reasonable", therefore the rate group must pass 70% and not the mid-point %?

Also, in performing rate group testing for component plan A, I assume that I include all participants (including component plan (B) in the rate group test, but with all participants in component plan B as a 0% benefit. Is this correct?

Thanks.

[AndyH]

Richard, lots of questions!

I've had to focus on all of this stuff due to a takeover DB/DC combo, so I'll tell you what I've learned:

1. You can put any of the people in the test in either component plan. This can be done randomly or selectively and can be changed year to year. So, yes, you can put the excluded HCE in either plan.

2. With respect to 410(B), if your component selection is arbitrary, the NCT conditions (objective business reason/reasonable classification) standard is not met. Therefore you must use the ratio percentage test and each component plan must have a r/p of 70%, counting all (non excludable) NHCEs and HCEs in the denominator and only those benefitting in that component in the numerator.

Hope this helps. If I missed a question, please advise. Sounds like you suspected these answers yourself.

[Guest merlin]

My understanding of restructuring is that once your component plans satify 410(B) separately you test their rate groups separately. See 1.401(a)(4)-9©(1).

[AndyH]

Well, now I'm not sure. Merlin's way is what I used to think, then I was told otherwise, and I'm pretty sure I've seen textbook examples using both components in the ratio calculations. Perhaps the key to Merlin's cite is "may"? Maybe it can be done either way?

Let's see how others interpret this.

[Guest merlin]

My reasoning is as follows:

Assume two plans of the same employer, one for salaried ees,the other for hourly. Neither one is a safe harbor plan. If each plan satifies coverage separately I can test each one separately for (a)(4). If I have to aggregate them to pass coverage I have to aggrgate them for (a)(4).

In restructuring,since each component plan must pass 410(B) in order to be a component plan,this permits each cp to be tested without regard to the other cp's.

As for the "may" in the cite, to me that's what allows you to break the plan up into components in the first place. Otherwise you're back at square one with a single plan that doesn't pass.

BTW, Richard how come the plan as doesn't pass as a whole.You've got one HCE with a 0 EBAR, are the other HCEs very young?

[Richard Anderson]

Thanks AndyH and merlin.

Andy, you stated:

"2. With respect to 410(B), if your component selection is arbitrary, the NCT conditions (objective business reason/reasonable classification) standard is not met. Therefore you must use the ratio percentage test and each component plan must have a r/p of 70%, counting all (non excludable) NHCEs and HCEs in the denominator and only those benefitting in that component in the numerator. "

When you say "counting all" do you you mean all from both component plans A and B? Also, when doing the rate group test, do you also count all (both A & b)?

Also. if the component plans pass coverage at 70%, then when testing rate groups of the component plans, I can use the mid-point %. The rate groups do not have to pass at 70%. Is this correct? Also, in calculating the NHCE concentration % (in order to get mid-point %), is this calculated on a component plan basis, or on the plan as a whole.

BTW, the 2 HCEs that are benefiting are father and son. The son's component plan includes older, lower paid NHCEs. That component plan will be tested on a contributions basis. The father's component plan includes younger higher paid NHCEs, and that component plan will be tested on a benefits basis.

merlin,

Are saying that the component plans must each pass coverage by including all eligibles (both A & b)? But, once coverage passes, then the rate groups of the component plans are tested using only the eligibles for that component plan?

[AndyH]

Yes, Richard, you seem to have it right. Each component plan must pass r/p by 70%, i.e. just a normal coverage test-all nonexcludables are in the test.

Then, each rate group needs to pass the midpoint. But, in determining each rate group, I understand that the other component plan is treated as non excludable and non-benefitting, but Merlin is saying you may ignore the other component group as if it did not exist. On that point, I am uncertain. That is not my understanding, but I could be wrong.

I have been told that Merlin's approach is incorrect. After reading his cite, however, I am now unsure.

I have in the past done it both ways and have not found a large difference in the result because each component plan has to be 70% + to begin with, and if they are both near 70%, the results will be nearly identical under either approach.

[Mike Preston]

Would anybody mind if I weighed in on this?

The inclusion of the 3rd HCE in either of the plans is a red-herring, I think. The HCE isn't getting any benefit, so he isn't counted for 410(B), whether he's technically included or excluded. That is my interpretation of what Richard meant when he said "assigned." The ratio percentage of each plan is (2/4)/(1/3) = 50%/33.3% = 150%. This pretty obviously passes the ratio percentage test, without having to move to the average benefits test.

So, both restructured "plans" satisfy 410(B).

We then move on to 401(a)(4).

When testing plan one, there is one and only one, rate group. That rate group has 1 out of 3 HCE's, so the HCE percentage in that rate group is 33.3%. The question is how many NHCE's are also in that rate group? The only people eligible to be in that rate group are the two NHCE's in this plan. You have one of three scenarios. Either 0, 1 or 2 are in the rate group. Zero will obviously fail. Going to the other end, the ratio percentage if two are in the rate group would be identical to the 410(B) testing percentage, so that must pass. The question is whether having one in the rate group would pass. The percentage calculation would be (1/4) / (1/3) = 25% / 33% = 75%. That will also pass.

Let's review. By having separate plans, we essentially are able to assign a single NHCE as support for each HCE. If we chose not to restructure, there would be 2 HCE's in the single plan being tested. Hence there would be one rate group with both HCE's in it. That rate group would need at least 2 NHCE's in it for support. Restructuring serves to reduce the number needed for each HCE to one.

So, let's see what can be done with this. Since the restructured plans can be tested on different bases, you can test one on a cross-tested basis, and the other on contributions. Or one on annual and the other on accrued to date. My favorite subject in college was Linear Algebra and this is stuff that is tailor made for techniques that are useful in Linear Algebra - of which "trial and error" is perhaps the best known.

Note that in this particular case, each plan's ratio percentage exceeds 70%. Hence, one never needs to cross the threshold as to whether or not the average benefits test is passed. So therefore one never needs to determine whether the component plans satisfy the reasonable business classification rule.

But let's go there anyway. Let's assume that, while the average benefits test is passed, the reasonable business classification test is not. That is, we cherry picked who is in each plan. Now, the 410(B) testing isn't impacted, because each restructured plan passes the ratio percentage test of 70%. But, if we were to increase the numbers of each, such that, let's say there were 30, rather than 3 HCE's. And 40, rather than 4 NHCE's, and we exclude 10 HCE's (rather than 1) while including 10 HCE's in each of the two restructured plans, where each restructured plan has 20 NHCE's, we get the same result as far as 410(B) goes.

But looking at 401(a)(4) and the rate groups under each plan, we need to know how many NHCE's are needed to support each HCE. Again, let's assume that all 10 HCE's in each plan are identical in age, compensation and testing benefit. So, we have 1 rate group. How many NHCE's are needed to be in that rate group so that the plan will pass 401(a)(4)? If one takes the position that the reasonable classification test has meaning such that if it isn't passed, the ratio percentage must be 70%, then we must find X such that (X/40) / (10/30) = 70%. I think you will find that the number is 9.333, which means 10. Which is exactly where we were before. If one takes the position that the reasonable classification test has no meaning in this context (that is, even if it isn't passed, one can still use the midpoint of the safe and unsafe harbor (or, if lower, the ratio percentage of the plan) - which, by the way is what I believe), then, instead of 70%, the rate group would only need 33.75% of the NHCE's. Thus, our formula changes to finding X such that (X/40) / (10/30) = 33.75% and I think you will find that X is 4.5, which means you need only 5.

Clear as mud, huh?

[AndyH]

[this was written before I saw Mike Preston's comments]

On the point in question, I have in front of me a detailed example of rate group determination with two component plans. The rate group percentages clearly include all NHCEs and all HCEs in each component plan.

It's written by Maria Sarli and Dennis Coleman of Kwasha Lipton, and it is a reprint of an article from Tax Management Compensation Planning Journal 8/5/94. It's part of the required reading for ASPA's C-4 exam, included in an ASPA publication "Current Topics for the Retirement Plan Consultant".

So, right or wrong, it seems clear that there are different interpretations to this particular issue.

[Mike Preston]

I'm with Andy on this one.

I would love to see the cite or source for saying that the denominators for the rate groups in any of the restructured plans should be based solely on the HCE's and NHCE's in the restructured plan being tested.

That is not the way one tests if one has two separate plans (say, one for salaried and one for hourly) and I don't believe that is the way one tests a restructured plan.

[Guest merlin]

Andy, I think you're right. I've found a similar example from the 98 or 99 ASPA Conference using two component plans. Thanks for the discussion.

[Richard Anderson]

Andy,

I have been doing my own analysis of the regs and I agree with you.

1.401(a)(4)-9© says that "If each of the component plans of a plan satisfies all of the requirements of section 401(a)(4) and 410(B) as if it were a separate plan, then the plan is treated as satisfying section 410(a)(4)."

If component plan A is treated as separate plan, I don't think that would mean that you could exclude from testing (either 410(B) or rate group) all the employees that are not eligible for component plan A. All non-excludible eligibles (both A & b) are included in the testing in the denominator, but only those benefiting in the component plan are included in the numerator for that component plan.

I have the 1998 version of "Current Topics for the Retirement Plan Consultant" at home somewhere. I'll see if I can find the article.

After looking closely at this I see, as Mike points out, that the excluded HCE is a non-issue. In both the 410(B) and rate group testing this person will be in all denominators and will not be in any numerator. This is true whether he is assigned to component plan A or B.

Thanks everyone for your help.

[AndyH]

Richard, my version is the 5th edition, copyright 1999. The article starts on page 579. It's tough to find materials that address these issues as in as much depth. It's titled "Planning Opportunities to Maximize Benefits for Key Employees Under Qualified Defined Benefit Plans", but it covers cross tested DC plan testing as well.

Well worth locating.

And, let's thank Mike Preston for lending his expertise to the discussion as well. Kind of like the old EF Hutton Commercials, "when EF Hutton speaks, people listen".

[Mike Preston]

Thank you, Andy, that is very kind.

[AndyH]

Mike, I just re-read your long thread. Are you saying that you don't believe that each component plan must have a ratio/percentage of 70% even if the members are cherry picked, or did I misunderstand you?

If so, could you elaborate? I haven't read or heard this opinion, although I have seen some dance around the question.

[Mike Preston]

Andy, no, I didn't mean to imply that at all. Here is what I said on that issue:

"Note that in this particular case, each plan's ratio percentage exceeds 70%. Hence, one never needs to cross the threshold as to whether or not the average benefits test is passed. So therefore one never needs to determine whether the component plans satisfy the reasonable business classification rule.

But let's go there anyway. Let's assume that, while the average benefits test is passed, the reasonable business classification test is not. That is, we cherry picked who is in each plan. Now, the 410(B) testing isn't impacted, because each restructured plan passes the ratio percentage test of 70%. "

The corresponding statement, which I didn't make, is that if one of the restructured plans failed the 70% test, then the fact that the reasonable business classification test is not satisfied would definitely cause the plan to fail 410(B).

If this isn't clear, let me know.