410(b) and 5500 Schedule T - Does this Plan fail?

[Effen]

Let’s say I have a DB plan with 4 HCE's and one NHCE. The DB Plan uses the 1000 hour rule for benefit accruals.

The NHCE previously satisfied eligibility and has an accrued benefit. The NHCE goes to “part time” and is working less than 1000 hours per year.

Do I fail 410(b) because the NHCE is not "excludable" and therefore my coverage percentage is 0%? Does the Plan need to provide the NHCE with some benefit?

What if the denominator in my accrual fraction is the sum of 1) the numerator and 2) expected future years of service, so that technically, the NHCE's accrued benefit IS increasing each year because I am reducing my denominator by one.

[AndyH]

I think you have a coverage failure, unless the person's average comp increases, resulting in an increase in the person's accrued benefit.

The accrued benefit definition you describe does not in my view satisfy the accrual rules.

What about top heavy minimum benefits? Isn't a plan with 4 HCEs and 1 NHCE likely to be top heavy? Just a thought.

[Effen]

The Plan is TH, but it also requires 1000 hours for the TH accrual so it doesn't help.

[david rigby]

What do you want the answer to be? For example, if you want to cover the NHCE, perhaps reducing the hours requirement for a TH benefit will solve the problem.

[Blinky the 3-eyed Fish]

Of course there is the chance that your document already spells out the correction method for 410(b) failure. The toucan is supposed to follow its nose. You must follow your document. If there is no fail-safe language, then 1.401(a)(4)-11(g) is your guide.

[Mike Preston]

Why would the fractional rule violate the accrual rules?

Why would application of the fractional rule, which results in an increased accrued benefit, not establish the participant as benefitting under 410(b)?

[Effen]

That was really my original question. Does the fact that NHCE's accrual fraction goes from 3/36 to 3/35 constitute "benefiting"?

Also, the plan is TH, but the TH minimum is less than the formula’s benefit. The formula is 100% of comp and this NHCE's current fraction is 3/35 (8.57%) which is greater than 2% per year (6%). Even if I let her have the TH min for a year when she worked less than 1000 hours, it would only be 8%, which is still lower than 8.57%.

[Tom Poje]

another possible thought for the future. you did not indicate why the people are HCEs. If it is not due to ownership, I would consider amending to use top-paid group.

[AndyH]

Effen, I'd be interested in knowing how the document defines the numerator and denominator in the fraction. This is an interesting question.

[Effen]

Tom,

all HCE's are owners

Andy,

... multiplied by a fraction whose numerator is the Participant's number of Year of Service as of the date of determination, and whose denominator is the number of Years of Service he will have at his NRD assuming that he continues in the Employer's service until such date and completes at least 1,000 hours of service during each future Plan Year.

[david rigby]

I'm not sure that definition will require a decreasing denominator. However, that is probably an administrative determination. (Probably too optimistic to hope for a precedent.)

That said, it looks like a fraction of 3/36 one year and 3/35 next year will result in an increased accrued benefit. Sounds like "benefiting" to me.

Prior discussion: http://www.benefitslink.com/boards/index.php?showtopic=5211

[AndyH]

I'd argue that treating this person as benefiting may be arguable but is excessively aggressive since it can't be an intended consequence of cross referencing DOL regulations the purpose of which is to establish reasonable minimum service crediting rules.

[Blinky the 3-eyed Fish]

I too think that by the definition of 1.410(b)-3(a)(1) he is benefiting. But wouldn't you then have a situation where different participants receive different accrual rates and the plan must be general tested. What I am not sure of is if you are able to consider the person as not benefiting akin to someone only receiving a TH minimum to keep the formula a safe harbor.

[Mike Preston]

Andy, we gotta talk at ASPA. ;-)

"arguable"? "excessively aggressive"? "intended consequence"?

410(b) is a simple section of the Code. (g) The regulations in this area are quite clear. If a participant would have received a lesser benefit had they terminated in a prior year then they are considered benefitting. The fact that the way the fractional rule works causes this participant to get a bigger benefit means the person is benefitting under 410(b).

[Mike Preston]

Blinky, the fractional rule and the safe-harbor rule are from different areas of the Code and don't impact one another.

[AndyH]

Mike, this presupposes that the shrinking denominator interpretation is correct. Why is it correct?

And to consider such a person benefiting defies common sense, does it not?

Yeah, I know it's coming. I'm ducking.

But what makes this the correct interpretation?

[Blinky the 3-eyed Fish]

Yes Mike, but you have a case where different formulas apply to different people. Those with over 1,000 hours get an increase in their numerator, those with less than 1,000 hours get a decrease in their denominator. Don't you think this would require general testing?

Consider an egregious situation where everyone begins full-time and are switched to part-time except for an owner. He reaps the huge benefits while his staff gets miniscule accruals. This certainly wouldn't fly, so the same should be said with only one person affected.

Andy, congrats on the Red Sox, BTW.

[Mike Preston]

Benefitting when someone gets an allocation in a DC plan of $1 is a given. Benefitting when someone has an increase in their accrued benefit in a DB plan is a given.

The question is whether the denominator decreases. This has come up over the years in various forums, IIRC. Some believe that it decreases, some don't. I happen to believe that in most cases it does.

Certainly there are some gray areas here. That isn't anything new to what we do. Take the case of a participant with an accrual fraction of 10/25, so they are 40% accrued in their projected normal retirement benefit at the end of the year. In the next year they work 10 hours through December 31 and then quit on January 1 thereafter. Let's assume that such a person has a fractional accrual of 10/24 at that time.

Now, start backing up the termination date. At some point, maybe around July 15th, projecting hours for this person on the basis of full time employment will start to credit that person with more than 1000 hours during the year.

Does anybody really do this sort of calculation? That is, take actual hours + projected hours for the year of termination into account when determining whether a year should be counted in the denominator? No, I don't think it is done typically.

This is perhaps the strongest argument for the denominator not decreasing.

But how does one satisfy the rule of 411 that the Normal Retirement Benefit must be fully accrued at Normal Retirement without decreasing the denominator? Take a formula where the projected benefit is not reduced for service less than a specific number. Say, 30% of pay at age 65, accrued fractionally. Note that this is not 30% of pay reduced for years of participation less than, say, 15. How does one satisfy 411 if the denominator does not reduce? I'm not saying this is a common design, I'm saying it is an allowable design.

Luckily, this issue does not come up very often, so it is not critical to day-to-day plan operation in most cases.

But it is an interesting discussion.

I agree that if the denominator does not decrease, the individual is not benefitting, as the accrued benefit would not be increasing.

[AndyH]

Blinky, Thanks. And from Mike's comments it feels like our team just hit a two run triple when we were down three runs in the bottom of the ninth. At least we avoided the shutout this time against Mike's team.

[Mike Preston]

But your team already beat my team, 3 games to 2!

Around here, I'm beginning to think this is the Windy City. Everybody is saying: "Wait 'till next year!". :-(

[Mike Preston]

Let's see if this helps (see the last post)

http://www.benefitslink.com/boards/index.p...wtopic=5211&hl=

[Mike Preston]

It looks like RR 81-11 explicitly authorizes the method whereby the denominator decreases. It certainly allows for a lesser benefit (Method 1). However, I wonder what current plan documents say about the issue?

I just checked my volume submitter. Deafening silence.

Hence, if the Plan Administrator decides to interpret it such that Medhod 2 of RR 81-11 applies, and hence the denominator decreases, I stand by my assertion that such a participant *IS* considered benefitting under 410(b).

I think the RR 81-11 introduces another issue that has a major impact on the determination of accrued benefits in this circumstance. The way I read the RR, it seems to be saying that unless or until a participant works enough to generate some increase in credited service (or participation) the accrued benefit does not need to change. Does anybody else see that in the RR?

Hence, a Plan Administrator might interpret a plan that is silent on the issue as not providing a reduction to the denominator unless or until a participant works enough hours to be credited with at least a partial year of service or participation under the fractional accrual rule in effect.

This would solve the seemingly silly situation where somebody terminated July 15 and was treated differently from somebody who terminated July 16, each of which terminated with 10 hours (total) in the year.

Good to revisit these things every once in a while.

[AndyH]

But in Effen's extreme situation, the Plan Administrator, by choosing a particular interpretation, causes the NHCE to accrue $.01 (or whatever meaningless result it produces) whereas a different interpretation might require that the NHCE be provided with an accrual that has "substance" within the meaning of 11-(g). Hence my view that determining that the participant is benefiting is aggressive in this situation, in that it does not resolve the doubt in favor of the employee.

But in other cases this interpretation could be quite useful.

[Mike Preston]

I don't think that going from 3/35 to 3/34 is meaningless. It is nearly a 3% increase in accrual. Subtance is indeed necessary for an -11g amendment. It is specifically not needed in the case of an increase in accrual under 410(b) without an -11g amendment.

[Blinky the 3-eyed Fish]

Mike, you haven't addressed my thoughts on the differing formulas that apply if you do choose to reduce the denominator and consider the person benefiting. Don't you think it's a concern or am I way off here?

[Mike Preston]

I don't think it is a concern. The formula is the same. The fact that somebody doesn't work in a given time period shouldn't cause the formula to be considered "tiered", IMO.

People have to get a "Wow" first, before they can be "way off base". You aren't even close!

[Blinky the 3-eyed Fish]

I should let this die, but I can't. I guess I am going for the "wow".

In the situation where the numerator is reduced and the participant is considered benefiting, I personally don't see how it cannot be a factor when you are getting the best of both worlds. The NHCE is considered benefiting, is getting a much reduced accrual that if he/she worked 1,000 hours, and no general testing is required.

If true, this is definitely a situation looking for a client.

[Mike Preston]

Do I risk over-exciting you by saying that such a person would also satisfy 401(a)(26)?

I think the likelihood of decreasing fractions being used to a client's advantage is so low that the IRS would not think there is significant potential for abuse.

But, does it work to potentially help a 410(b) test to have a Plan Sponsor fail to terminate the employment relationship in certain cases? Yes, it very well could.