Tough Question (at least for me)

[Dougsbpc]

We have a client who has a 20 employees. The company has done very well so they wish to adopt a floor-offset DB. They already have a salary deferral only 401(k) that has been active for all of 2002. Since the owner (only key employee) will have high benefits in the DB, all plans will be top heavy for 2002.

Under their current salary deferral only 401(k) employees are eligible after 3 months. Therefore they have 10 eligible participants.

Suppose they terminate the current 401(k) prior to year end and adopt a new 401(k) profit sharing plan effective for all of 2002. Furthermore, suppose only 5 of the 10 current participants will be eligible for the new plan (this because the new plan has a 1-yr elig requirement). Also, only 5 of the 10 will be eligible for the DB. A 5% top heavy minimum will be provided in the new 401(k) Profit Sharing Plan. Are we required to provide the top heavy minimum to just the 5 that are eligible for the new plans or all 10?

Thanks

[KJohnson]

"Suppose they terminate the current 401(k) prior to year end and adopt a new 401(k) profit sharing plan effective for all of 2002."

You really could only "freeze" you cannot terminate and start another 401(k) without running afoul of the successor plan rule. Frozen plans are still in the required aggregation group.

Also, plan amendments and terminations are subject to the "smell test" under 1.401(a)(4)-5...and this one kind of stinks.

[david rigby]

"Since the owner (only key employee) will have high benefits in the DB, all plans will be top heavy for 2002."

If the plans have common Key EEs, they must be aggregated to determine top-heav status. It does not matter whether one plan is top-heavy by itself.

A couple of miscellaneous questions:

1. Why terminate any plan?

2. Why have a floor-offset plan?

These are summarized by the generic question: what is the goal of the plan sponsor?

P.S. it might help to have some demographics:

The owner is the only Key EE. Is he also the only HCE?

Approximate age of the owner?

Approximate age the owner wishes to retire?

Any NHCE's older than the owner?

[Guest Keith N]

Also, be careful with the "floor offset" approach. The IRS is taking a dim view to this type of arrangement and fighting them using the meaningful benefit rules under 410(a)(26). Even though the regs state that the test is done prior to the offset, they are looking at some creative ways to fight you.

You may have an easier time getting it approved using a cash balance with a minimum benefit.

[Everett Moreland]

Keith: Please expand on "they are looking at some creative ways to fight you."

[Guest Keith N]

Paul Shultz, Director Employee Plans, Rulings and Agreements released a Memorandum during the summer addressing "meaningful benefits" for employees.

In the memorandum he states that "where a defined benefit plan that is tested on a benefits basis is found to provide much larger benefit accruals to shareholders (or other principals) and benefit accrual rates of less than one-half of one percent (.50%) of compensation (per year of participation or service) for non-shareholder employees, the questions of whether the plan provides meaningful benefits and whether the plan exits primarily to benefit shareholders should be raised when reviewing determination letter applications."

The memo goes on to say that this memorandum should be followed with any defined benefit plan that "provide much larger benefits accruals for shareholder (or other principals)"

This is interesting because the term "meaningful benefits" is not defined in the code or regulations.

I think the memo is available on the ASPA web site, but I'm not sure. There also may be links on this site to it if you seach the boards.

[Everett Moreland]

Keith: Thank you. I've not found the Shultz memo. I would appreciated it if you or someone would post the memo.

[MGB]

This was sent internally in the IRS to agents reviewing determination letter requests.

[Dougsbpc]

Here is some additional background:

The owner (and only key employee) is 57. There is one other HCE age 58, and most NHCE's are young (late 20's, early 30's).

The goal of the employer is to be able to put away about $100K per year for him and approx 10% of pay for all other eligible participants. The problem is that he has 4 hourly participants who work > 1,000 hrs per year who would normally be independent contractors. However, because some of their jobs are government jobs, the otherwise independent contractors must be employees. The company does not anticipate having any more of these hourly employees going forward. Basically, they want to benefit salaried participants and not these hourly employees.

The problem is that they already have a salary deferral only 401(k) that all 4 of these hourly employees are eligible for. If the employer had thought about the DB last January, we would have had them adopt a 401(k) Profit Sharing Plan with a one yr eligibility. Then 6 salaried NHCE's would have been eligible and all 4 hourly employees would not have been eligible.

The Floor-Offset DB seems to work fine and will pass 401(a)(4) with the 10% profit sharing portion of the 401(k). We are aware of the meaningful benefit issue and will provide 1% of pay per year of participation for all non owner participants. This amount would be offset by the 10% profit sharing contribution. The owner has not or will not participate in the profit sharing portion of the 401(k) (although he has made Salary Deferrals).

In a nutshell, the plans are top heavy, and the owner would like to benefit salaried employees and not provide the top heavy minimum to hourly employees for 2002.

This most likely cannot be done, but we were thinking that if there were some way to make hourly employees an ineligible class of employees prior to year end, they would not need to be given the 5% top heavy minimum on December 31. Even if this could be done, we would fail 401(a)(4) (just barely) by having to consider the 4 hourly employees in the test.

Thanks for the responses.

DK

[Everett Moreland]

MGB: Thank you.