FORFEITURE ALLOCATION BY RATE GROUP

[Guest DIB]

I have a question regarding forfeiture allocations in a cross tested plan.

If forfeitures are being added to an employer contribution-

Is the overall total (employer contribution plus forfeiture) allocated (as a percentage of

compensation in this case) by rate group

Or

Is the total allocated (as a percent of comp by rate group) strictly the new employer

contribution amount...and, the forfeitures would be allocated by rate group in proportion to

the employer contribution to that rate group?

[Mike Preston]

Why are you shouting?

[Blinky the 3-eyed Fish]

What does the document say?

[Guest DIB]

The document states that forf's are to be added to the employer contribution & allocated in the same manner as the employer contribution.

There is a difference of opinion in my office in terms of how to approach this.

I'm in the belief the total (contrib + forf's) is allocated based on the %'s of comp. specified by the employer per rate group.

[Blinky the 3-eyed Fish]

If the document says the forfeiture is added to the contribution and allocated in the same manner (a common provision), then you would be correct.

I am curious why someone would think otherwise. Do they have a basis for their opinion or as my daughter would say, "because, that's why".

[AndyH]

The question arises about what to do if there are forfeitures but no employer contribution in a particular year for a discretionary class plan.

In effect, the employer would direct the forfeiture reallocation at it's discretion. How is this definitely determinable? I believe that most XTested documents allocate forfeitures pro rata for this reason.

In addition, what happens if there is no employer contribution and forfeitures are miniscule? You could end up general testing $1 in forfeitures.

These are a couple of arguments for having the document call for pro rata allocations. DIB's internal debate may have arisen from questions about the definitely determinable requirement, but if the document has a FDL, it would appear to be ok to do that; if not, I'd have some concern.

We have a volume discretionary class document which was written in the manner that DIB describes, and it has an FDL. That is the only reason that my concerns have been muted. But I still don't like this provision.

[Blinky the 3-eyed Fish]

Andy, I am not understanding why there is a problem with classifying the forfeitures as an additional contribution even in years where there is no contribution and the allocation is only forfeitures. Why is it any less determinable than if there were employer contributions added? If the forfeiture ended up being very small, the employer could simply work the allocation so everyone gets the same percentage and no general testing would be required.

If you don't like this provision, then you don't like everyone of my DC documents.

[Guest DIB]

Part of the internal debate was how different people were approaching it from a system processing stand-point.

It is easier to calculate the total %'s by rate group (as specified by the employer) to come up to the total allocation (contrib's + forf's) and see if your passing the test.

Having the totals by rate group and backing out those transactions....you could then do a pro-rata forf allocation to see what the forf's would break out by rate group...then you would come to a net amount as your base contribution per rate group to process on the system. In the end you come up to the original % totals (contrib + forfs) needed per group.

The problem occurs is if coming up to the total % via a pro rata forf alloc is acceptable. Technically, forfs aren't allocated in the same manner as the employer contribution, even though, in the end you come up to the intended target %.

Contrary, doing it proportional to contributions by rate group gives you different forf's amounts and different totals. In addition, is this arguable that forfs are allocated in the same manner as the employer contribution. Also, from a system standpoint, you then testing the base allocation (to see if it passes), and then testing again on the overall ending totals (to see if it passes). Much more cumbersome process then the above.

The ERISA outline books states that forf's added to employer contributions should be treated as "additional employer contributions". So, I believe whether there is a "0 employer contribution" + forfs or "$0.01 employer contribution" + forfs, forfs should be treated the same as new employer contributions would for allocation/testing purposes.

[AndyH]

Blinky, I think the word "problem" is too strong.

The IRS Field Directive (3/13/98) confirming that discretionary allocation groups were ok for ER contributions did not say anything about forfeitures.

I just happen to think it is borderline abusive when the employer has the right to direct the reallocation of forfeitures in an arbitrary manner not pursuant to written plan terms. If there is an employer contribution to a discretionary class plan, the forfeiture provision is irrelevant because the ER contribution could be adjusted to achieve the same desired objective.

Every takeover discretionary group cross tested document that I have seen allocates forfeitures pro rata, with one exception. And the exception may have been an oversight on the part of the drafter.

If I am not mistaken, Corbel's volume submitter does as well.

I'm probably in the minority, but I just don't think this is right. Am I the only one?

[Blinky the 3-eyed Fish]

Andy, yes, you are the only one.

Here is Accudraft's language from one of my cross-tested plans:

"Forfeitures Of Non-Elective Contributions: Forfeitures attributable to Non-Elective Contributions will be used to reduce, at the discretion of the Administrator, either the Matching Contribution, the Qualified Matching Contribution, the Non-Elective Contribution, the Qualified Non-Elective Contribution, or any combination thereof, for the current Plan Year or for a future Plan Year."

Very flexible indeed.

I still am having trouble seeing why allocating forfeitures in the same manner as the employer contribution could be considered abusive or is not pursuant to plan terms. In my mind, there is a total allocation, so whether a portion comes from employer contributions and another portion comes from forfeitures is irrelevant.

I think you would agree that the IRS has become more lenient since 1998 on the various cross-testing guidlines.

[AndyH]

ok, now I feel better that I did not make this up.

The following is an excerpt from Sal Tripodi's publication called "Cross Tested Profit Sharing Plans. Summary of 2001 Regulations, Sample plan formulas, SPD language, and commentary" , which we purchased. Granted it is somewhere between 1 and 2 years old, but on the subject of forfeitures it says the following (page 37):

"Allocation of forfeitures: The sample language assumes that forfeitures will be allocated pro rata to all participants. The document preparer might modify this rule to provide a different result.......Could the plan simply give the employer the discretion to divide the forfeitures among the designated allocation group? We would be concerned that the IRS could view this as violating the definite allocation formula requirement under Treas. Reg. 1.401-1(b)1. A determination letter requrest would be advisable, so IRS could have the opportunity to object to the language."

[Blinky the 3-eyed Fish]

I didn't doubt something concrete existed, but I just can't get it through my thick head why there is an issue.

[AndyH]

Clearly you are right about them relaxing their objections, but the conspiracy theorist in me doesn't accept that as benign. Payback's a bitch; somehow they must have teamed up with Pamela Olsen to write that ourageous Bush administration proposal that would have outlawed just about everything!

And oh, yeah, everything but DBs. Sure. First divide, then conquer.

[Guest DIB]

AndyH & Blinky

Thanks for your feed back. I've come to my answer based on both of your comments. Most important is satisfying the definite allocation formula requirement (which would be a communication in the trustee letter or ie "written designation by employer" outlining in writing the amount of the contribution to be allocated to each group). Ultimately, that letter has to express the ending total allocation (sum of both er cont. + forf) by rate group. Also, the definite allocation formula would be met if the allocations are based pro rata on comp.

So,

whether you add the forf's to the er contrib and then express as a % among the rate groups based on comp

or

whether you take the employer contrib....express it as a % among the rate groups based on comp and then add/pro rate the forfs based on the contrib to each rate group (remember the contributions to each rate group is expressed in terms of a % based on comp)

you would be fine as long as the tests pass, the allocation method is within the definite allocation formula (consistently applied to all eligible participants - as in this case pro rata against comp) and the ending total allocations are expressed in the "written designation" trustee letter".

I appreciate your feed back and debate.....

[Blinky the 3-eyed Fish]

I recall at the LA Benefits Conference that Dick Wickersham said the IRS is not requiring anymore the written designation of the contribution within each rate group in order for the benefit to be definitely determinable. Obviously, there is no harm in doing it, but this goes along the lines of their relaxation of the some of the earlier cross-testing guidelines.

[AndyH]

Blinky, that is useful to know, but we should remind anyone reading this that the field directive stated that

"...the plan must require that the employer notify the trustee, in writing, of the amount of contributions for each group."

So, my point is that even if the IRS does not currently require plans to have this language, most do, so their terms must be followed to avoid an operational defect. I don't think Wickersham would say that you can ignore such an existing provision in an existing document.

[Blinky the 3-eyed Fish]

Yes, the document must be followed. Now with most of my plans the owner of the employer and the trustee are the same person. We provide them with written materials showing what each person received. As soon as he picks it up, he has effectively satisfied the document language.

[Mike Preston]

AndyH, I don't think you are the only one. However,most plans that I've seen take the position that forfeitures reduce contributions. I think that language solves all problems as long as the contribution itself is well enough defined.

Blinky, can you be more precise as to what session and what year you heard Wick indicate that the written requirement as to designation of contribution was eliminated?

DIB, I know I'm coming late to the party here, but if I had noticed earlier I would have suggested that every time you had used the phrase "rate group" you replace that language with "allocation group". This stuff is confusing enough for those that are reliatively inexperienced with these issues without mixing the technical terms. A plan's rate groups are defined only by the testing under 401(a)(4), not by the plan's terms.

[Blinky the 3-eyed Fish]

Mike, it was in one of the general sessions in which Wickersham was there. How's that for narrowing it down? Sorry, but it was 3 months ago, so I am not sure which.

[Mike Preston]

That might be enough. Thanks.