415 Year of Participation

[Guest Scott McHenry]

Suppose a corporation adopts a Defined Benefit Plan in 2003 with an initial PY 1/1 - 12/31/2003. Assume the initial formula is 0% of AMC per year of service.

Assume benefits are accrued on a unit basis based upon years of service. All participants meeting 21 and 1 are eligible for the plan. All participants with at least 1000 hours in a year receive a year of service for accrual purposes. Service before the effective date is counted for the benefit formula and accrual.

Effective 1/1/2004, the formula is increased from 0% to 10% of AMC per year of service.

As of 12/31/2004, does a full time employee-participant have:

(a) 1 year of service for 415 $ limit phase in purposes or

(b) 2 years of service for 415 $ limit phase in purposes?

I think most would argue for (a) since no benefits accrue for 2003. However, an argument for (b) could be made as follows:

Paraphrased from Notice 87-25 Q and A - 7: a participant is credited with a year of participation for each accrual computation period for which the following conditions are met: (1) the participant is credited with at least the number of hours of service for benefit accrual purposes required under the terms of the plan in order to accrue a benefit for the accrual computation period and (2) the participant is included as a plan participant under the eligibility provisions of the plan for at least one day of the accrual computation period.

Since the participant has greater than 1000 hours, condition (1) is satisfied and since the participant is an ongoing participant for 2003 and 2004, condition (2) is also satisfied.

Considering 401(a)(26) for the first year, since no participant will have an accrual for 2003, the plan does not benefit an HCE and seemingly would get the free pass under 1.401(a)(26)-1(b).

Any thoughts?

[mwyatt]

I'm assuming that we're talking a small to one-man plan here, and your intent is to preemptively add in additional years of participation for when you actually make the move to a "funded" DB plan (assuming that your 0% of pay benefit will probably generate no contribution, and that TH issues, if any, are null due to EGTRRA changes - although you may run into a counterargument that you are "accruing" benefits for 415 but not for 416 so TH accruals aren't called for - another direction that this thread can proceed).

In practical terms, haven't run into too many clients with this much foresight (and or willingness to pay for a valuation that provides for no current deduction), but this could be one way to potentially boost contributions. The repeal of IRC 415(e) has modified the timing for switching from a maxed out DC plan to a DB plan; assume your client is obviously older than 52 with this type of planning going on.

[Guest Scott McHenry]

It will be a two person owner only plan (current ages 65 and 63). 2004 will be a huge income year. Income will then continue through 2008. Goal is to justify as large a contribution as possible for 2004 and then level contributions from 2005 - 2008.

There are other employees in 2003 with over 500 hours. There will not be any other employees after 8/2003. Client may consider benefitting these employees for 2003, but wants to consider other options as well.

[Blinky the 3-eyed Fish]

Two things:

You mention the plan passes 401(a)(26) on the basis of 1.401(a)(26)-1(b), but this also requires the plan not to be considered frozen under 1.401(a)(26)-2(b). How do you satisfy that?

Second, you have to consider the timing of amendments and whether or not they are discriminatory. If the NHCE's in 2003 would be eligible for the plan, I would be extremely wary of providing them with a 0% benefit, then increasing the formula right after they terminate.

[Guest Scott McHenry]

Thanks for the messages.

After looking again at the 1.401(a)(26) regs, it does seem like the plan would be subject to the prior benefit structure trap since frozen plans do not qualify under the no HCEs benefitting exemption.

So at this point, I see two options

(1) Benefit all non excludables (both HCEs and NHCEs) for 2003 at some minimal formula (0.50% accrual or $5/year or whatever passes as meaningful benefits these days). Then increase the formula for 2004. IThe timing of amendments will have to be considered for non discrimination, but this does seem to be better for the NHCE than the following option.

(2) No plan for 2003. Start Plan in 2004. One less year of participation for owners. No benefits for NHCE.

[Guest Keith N]

Does the employer have any other qualified plans? If not, you could consider using a vesting schedule that starts at the effective date of the Plan. If all of your other EE's term in August, they would all term Non-vested. Although, they may be able to argue that you had a partial termination and that they should be 100% vested.

How about a short PY in year 1 (8/2003 - 12/2003)?

I don't like the 0% of pay formula idea. I think it just raises a lot of red flags.