Beneficiary under 404(a)(7)

[Guest pension222]

404(a)(7)©(i) mentions that 404(a)(7) does not apply "if no employee is a beneficiary under more than 1 trust or under a trust and an annuity plan." 404(a)(7)©(ii) contains the exemption for 402(g) deferrals.

PLR 8743096 toward the end says: "..section 404(a)(7) would apply even though no contributions are currently being credited to the employee's profit-sharing account. An employee does not cease to be a beneficiary under the profit-sharing plan because contributions are not currently credited to his/her account."

Here is the situation, Plan A is a defined benefit plan, Plan B is a profit sharing plan. A participant of Plan B who has an account balance ceases participation (i.e. no more contributions) and moves to Plan A (both plan documents allow this).

I think that 404(a)(7) will apply and now limit the deductioin to both Plans A and B.

However, I have been told my an attorney that he heard Jim Holland say at a 1997 ASPA convention (and this may be pure unsubstantiated gossip) that 404(a)(7) only applies if the common participant(s) in question are currently benefiting, i.e., receiving an allocation and/or an increase in accruals.

Can anyone shed some informed light on this?

[Belgarath]

I can't shed any informed light on it, because I wasn't there. But I agree with your conclusion that 404(a)(7) would apply, and I don't believe I'd rely on a statement from the podium, on this particular issue, even if Mr. Holland did in fact state this. Any chance that the PS account balance could be transferred to the DB? Probably not a viable option - but it's all I can think of.

[Blinky the 3-eyed Fish]

This is one situation where I would feel more comfortable with the aggressive stance that the 404(a)(7) limits do not apply. The PLR mentioned is a bit antiquated with the EGTRRA changes to 404(a)(7)©(ii). I would like clear guidance though. That always helps.

[Guest pension222]

Regarding the rumor of the statement from Jim Holland, he actually wrote the PLR in question.

I asked this question because I know that there are a lot of folks out there selling 412(i) plans to supplement the existing profit sharing plan and my position is that because of the enormous required contribution to the 412(i) plan, there will not be any room left for a contribution to the profit sharing plan.

Of course I am not well liked for taking this position.

[Belgarath]

Then at least you're better off than I am - I'm not well liked period! Just curious - do you find the question generally has any "real life" application in a 412(i) situation? In other words, a 412(i) is nearly always sold in a small business. I would think that in order to pass nondiscrimination testing, you'd generally have at least one person who participates in both plans, and would therefore "benefit" under the PS as soon as any contribution is made, so that the question is moot - you are stuck with 25% or the DB cost if greater. But undoubtedly there are some aplications I haven't considered.

[Guest pension222]

Belgarath, the question has a very real life application and here it is.

The employer has ten non-excludable employees. Four are in the 412(i) plan and the other six are in the profit sharing plan. The plans are aggregated to pass nondiscrimination and coverage.

One of the employees in the 412(i) plan quits and we now have 1/3 of the non-excludables covered in the 412(i) plan and we run afoul of 401(a)(26).

The solution I have heard is to take one of the participants in the profit sharing plan and move her to the 412(i) plan so we now have 44% coverage in the 412(i) plan. I have been told that this will not invoke the deduction limit of 404(a)(7) because even though the transferred employee does have an employer derived account in the profit sharing plan, she will not get any more employer contribution allocations.

If the PLR is valid then this "solution" to minimum coverage under 401(a)(26) is invalid because if the 412(i) plan soaks up the entire deduction, there will not be any room for a contribution to the profit sharing plan and then there will be a problem with passing the 401(a)(4) general test (all those profit sharing participants with zero contribution).

[mwyatt]

I think your example points out the dangers of pushing to the wall with a small group. Let's face it: in a situation where the termination/addition of a single participant causes massive swings in ratio test percentages, are you really doing the client a favor by establishing aggressive coverage designs when the termination of one employee can blow up your whole scenario the following year? I just reviewed a DB design where the kitchen sink was invoked to exclude participants to the bare minimum allowed to pass 401(a)(26). As you pointed out, one person leaving sinks the plan. How much do you really save to beat out nurse nancy from her 2k contribution when you run the risk of DQing the plan in toto?

[Belgarath]

Interesting case. Call me overly conservative, but I don't buy this as a viable solution without something "official" from the IRS. If we had such a case, we would cancel our service contract if the client insisted on using this approach. It certainly is a creative solution, however, so I give whoever thought of it credit for being able to think outside the box. And maybe it IS ok - I'm just not a risk taker when it comes to plan administration.

[Guest pension222]

I agree completely with all the comments about pushing too hard. I simply will not do it. Not all clients are worth having. It's nice to hear that I'm not alone out there.

The problem is that there are firms out there marketing 412(i) plans with just this plan design and the leverage of contribution toward the owner is not trivial. Greed is a powerful motivator.

Whenever a someone approaches my clients with this type of "carve out" as the 412(i) salesfolks like to call it I always ask "how will they fix it when someone in the 412(i) plan quits?" One of my favorite answers is that the person who designed the plan asked the business owner if he or she plans on any turnover in the next year or two and they said "no" so there really is not cause for alarm. Wow. The other answer is that they will just move someone from the profit sharing plan to the 412(i) plan and of course this is where the validity of the PLR comes in.