Cash Balance Floor Offset Plans - Fantastic Results?

[Guest merlin]

An RIA who works with our firm just passed me some marketing material from a local actuary that illustrates db/cb floor-offset plans with > 90% of the contribution attributable to the owners. The offset is provided by the prospective client's already existing 401k plan. The floor-offset arrangement is not a safe harbor. The material targets plan sponsors with 20-500 employees.

One illustration shows a firm with 2 owners and 18 employees. Over $20000 goes for the owners and < $400 goes for the employees. The 401k/ps piece is in addition. Has anyone seen this stuff, or gotten similar results with your own clients? I know that the general test can do wonderful things, but this seems too good to be true. Or is it just lucky demographics?

[SRM]

There definitely are a number of situations where adding a db plan can greatly increase the owner contribution/benefits without significantly increasing the employee cost. I have seen some impressive results. Are there a lot of lower paid employees?

I think a lot of the push towards floor offset plans in the past few years is the great cross testing results derived from the difference in converting a dc allocation at the 7.50% to 8.50% testing rate versus the growth of a cash balance allocation at the recent 417(e) interest rates (around 5%).

However, after working with a number of these, I have come to believe that since the cross testing gateway allocations for db/dc plans generally require at least 7.50% of compensation contribution to nhce (between the db and dc), there is usually not that much additional benefit that a floor offset provides than does a regular cross testing db/dc arrangment. Additionally the floor offset has a significant amount of additional complications, such as:

1. IRS scrutiny of 401(a)(26) issues

2. Additional asset and contribution fluctuation concerns - Are the 401(k) Profit Sharing Plan assets trustee or individually directed? If individually directed, what is the db contribution going to be if the 401(k) Profit Sharing assets tank. It's a lot bigger issue if the db is offset than if it isn't.

3. Communication issues...telling a nhce participant that they have a db benefit but that it is really worth nothing (or very little) after the offset.

Floor offsets can work great, but make sure that a regular add on db or cash balance doesn't work as well before taking on the headaches of a floor offset.

[mbozek]

This question is probably best answered by the actuaries but I thought that a floor /offset between DB and DC plans would have pass cross testing under Reg. 1.401(a)(4)-8 which does not permit employee contributions to be used to fund the stated benefit (in other words can't use employee contributions to pass cross testing).

Also a top heavy plan must provide a minimum benefit of 3% of comp in the dc plan or 2% to the DB plan. If a 401(k) plan is top heavy then the employer must make a 3% contribution to all non key employees in any year in which a key employee makes a 3% contribution to the plan.

[Mike Preston]

Just ">90%"? Not ">95%"? Why so generous?

[Guest merlin]

Sorry, Mike, I left a 0 out of my example. It should have read 200000, not 20000. That makes 99.8% for the owners. Is that sufficiently "ungenerous" for you?

mbozek's comment about employee contributions ( which I think applies only to safe harbor target benefit plans) brings another question to mind. In a safe habor floor-offset the dc plan cannot be a 401k/m plan. But if the f-o is not a safe harbor, does that mean that you can use deferrals/match as part of the offset?

Did anyone attend Ed Burrows/Larry Deutsch's seminar in August. This stuff was probably on the program.

[Mike Preston]

Well, it might not be ungenerous enough, but then again it might be. I think it is likely that the analysis is using accrued-to-date methodologies in a non-top-heavy plan. That allows employers to catch up for past allocations which were bottom heavy. Looked at in that vein, the overall percentage is not likely to be 99.8% or anywhere near.

I don't think that using k/m as offsets is ever allowed under a4.

[Blinky the 3-eyed Fish]

Merlin, are the numbers you show only in the DB? The NHCE's would have to get a least the minimum gateway amount of 7.5% between both plans.

I agree with Mike on the last point. To use the deferrals or match in the offset would violate the rule (cite not handy) where only matching contributions can be based on deferrals

[mbozek]

In the interest of helping the rest of us understand what the proposal is, why not post the f/o illustration used by the actuary to determine whether it would pass muster under IRS regs.

[Guest merlin]

Yes, Blinky, they are only the db #s, so as Mike suggests, the overall #s are probably not nearly as favorable. Maybe this guy is only telling the good half of the story.

Mike, thank you for the comment about the accrued-to date method.

Thanks also ot mbozek and SRM for their thoughts. Who knows, maybe this guy really has found the Philosopher's Stone.

[Guest merlin]

mbozek, there is nothing in the proposal that will tell anyone what he's doing. He only gives the results: verbiage, bar graphs,etc. That's the problem I'm having. There's nothing to analyze, just his references to his use of the nondiscrimination rules, and some unique features in his plans that borrow from the multiple plan regulations "generally used by the Fortune 500".

Andy, as a lifelong Yankee fan, I can only say that I agree wholeheartedly with the decision to leave him in. Actually, it probably wasn't Little's decision at all. He was channeling The Babe, who whispered, "Leave him in, Grady, he's doing fine".

[Mike Preston]

I told you the reinsurers would be cautious. I just didn't know it would be because Grady wouldn't pull Pedro when he obviously should have done so.

This appears to be a common theme. Except for Joe Torre. We've seen the Giants (Dusty Baker) in game 6 of the 2002 World Series do it. Dusty does it again this year. Grady does it, too. While it seems obvious to those watching on TV or, in hindsight, maybe the view is entirely different on the field (or, from the dugout). In each case it appeared clear that the pitcher had lost a significant amount of "stuff" and that the bullpen had to be the better option. But in each case the manager says, with an apparently straight face, "That is the guy we _wanted_ to go with at the time.....".

Maybe that is why the Yankees are going to the WS again. Maybe Torre has somebody watching on TV so he can actually tell when a pitcher has hit the wall. Then again, it could just be that he has Mariano.

[david rigby]

Enough already! Please see earlier discussion in which I pointed out that the baseball season ended on October 5.

[mbozek]

Maybe the difference is between good managers and great managers such as Torre who showed no hesitation in pulling Roger Clements in what could have been his last game in the 4th with the Yanks behind 4-0 and putting in Mussina who had never relieved in 400 previous pitching appearences. Maybe I dont know enough baseball to know why a manager would not use two fresh relief pitchers to protect a 3 run lead in the last two innings of the most important game of his career instead of keeping in a starter who had already thrown over 100 pitches. Maybe some managers rely too much on their instincts of when a pitcher should come out.

[AndyH]

Pax, nothing else matters to Red Sox Nation today. Nothing.

I appear to be the only non-Yankee fan in the nation to somewhat support THE DECISION (or to not totally oppose it at the time-in hindsight it was WRONG) . But THE DECISION may have had something to do with the fact that Pedro is scheduled to earn $17.5 million next year ($90,000+ per inning!), while Grady was scheduled to earn $0. And I don't think Grady could have moved Manny down to #7 in the batting order, either, if he wanted to. Something about power and authority.

[AndyH]

Merlin, I snuck these comments on this thread because I though there'd be no darn Yankee fans on it. And you of all people. But I guess there are Yankees everywhere. Nothing personal, but we have to route for your team to get squished by Blinky's distant cousins.

[Guest guppy]

Andy, I'm a Sox fan and I supported the decision at the time. But I think we're probably the only 2. It was obviously the wrong decision because they lost, but would it have been wrong if Pedro struck out the next 2. Either way, I do think people are giving the pen a little too much credit. They've pitched well recently, but I don't know that I can say there's a guy in there (yes even Timlin or Williamson) that I'd rather have on the mound instead of a tired Pedro at crunch time.

I know one thing. Even before that, it got awfully cold in my house and I felt a very strange presence. One I've not felt in many years....about 17 in fact.

[mwyatt]

Hey Andy:

Just had to chime in (although this obviously has nothing to do with this "get rich quick" scheme that originated this thread). Was listening to WEEI on the way home and Ordway had Steve Buckley from the Herald in house and Sean McAdam from the Projo and Tony Mazarotti from the Herald on the line from NYC. Glenn and Tony almost reached the "f*** you" stage on the decision, as Maz was defending the decision to leave Petey in for the 8th. Maz did bring up the valid point that what would have happened if you lifted Petey and threw Timlin/Embree into the mix in the 8th, given the amazing pressure of the situation. I guess Petey is human after all, but after this season's experience with the bullpen, Grady would have been equally bashed if he had lifted Petey and went to the bullpen and the same result happened. Given Timlin (who had been great BTW in the playoffs) immediately throwing balls, who is to say that the game would have ended any differently (except the rant would go that Forrest Little took out a 3-time Cy Young winner and let the bullpen implode). They got out of the 8th (and the 9th) only by two amazing plays by the much defensively maligned Todd Walker (please - resign this guy for next year, Theo).

Our best hope for us long suffering Red Sox fans: Clemens and Wells are gone (a certainty), Don "the ghost of Woody Hayes" Zimmer leaves as he said today, and Joe Torre finally says "Take This Job and Shove It".

Go Marlins!!!

[Guest merlin]

That's OK, Andy. I don't take it personally. Besides, I have an idea of what it must be like for the citizens of RSN. I root for the Giants in the NFL.

[mwyatt]

Hey now Merlin...

I must be getting up in years, but memory serves of a Super Bowl win (if that's what they call it, my mind is getting hazy) in 1991.

2003-1991 = 12

2003-1918 = 85 (and counting)

The RSN's only hope: McKeon pulls it off, Georgie pulls his best Captain Queeg, and fires everybody...

Go marlins...

[Guest merlin]

Alright, enough of this seriousness. Back to fooling around. Lo and behold, a real example just walked in the door. It's not from the firm in my initial post, but it will do for discussion purposes. The two plans are a 401k and a cash balance. The 401k eligibility is 1 year for deferrals, 1 hour for er nec. That's right, just the opposite from what you normally see. The 401k nec is allocted by employee classification.

The cb eligibilty is 1 hour for employees in the following categories:

Category I = Executive Officers, in this case the owners.

Category II =Each employee in the "Lowest Paid Group". The LPG means for, each plan year, that group comprised of nhce who have completed 1 HOS and received the lowest compensation for the plan year. The LPG shall include the lesser of (2) 40% of all employees , or (2) 50 employees; less all Category I employes who are active particpants for the year. For purposes of the LPG, employees described in 410b3 are excluded.

The cb plan gives accrual credits at various levels to the employees in Categories I and II above. A third category is established for prior participant swho previously were in Category I or II in the current year. These Category III employees get no credit. The vested cash balance benefit for Category II and III employees is offset by the present value of their vested nec balance in the k plan. There is no offset applied to the Category I employees. Minimum accrual after offset is 0.5% of compensation for Category II employees.

Demographics:

40 employees, of which 7 are HCEs (4 in Cat I and 3 are excluded from cb plan and the nec portion of the k plan), and 33 NHCEs, of which 12 are Category II employees in the cb plan.

Testing:

The plans are aggregated for testing. Since all NHCEs are getting something somewhere, 410b is OK.The cb eligibility is pre-rigged to pass 401a26. The minimum nec allocation in the k plan is 5%. The highest aggregate HCE allocation rate is > 40% so it looks like the gateway should be 7-1/2%. Looks OK for those who are benefitting in both plans, i.e., the Category IIs in the cb plan, but 5% + 0 = 5% for those only in the k. Maybe they're restructuring with the excluded HCEs? No, because you can't avoid the gateway by restructuring,right? Maybe that's the flaw? Other than that ,the testing is routine and passes with without even imputing disparity. I know, other than World War II the 40's were a great decade.

Thoughts? Questions? Comments? Anyone? Anyone? Bueller? Bueller?

[Blinky the 3-eyed Fish]

I agree that the 7.5% gateway needs to be provided. Perhaps you can inquire to their reasoning for not providing it.

Other than that, I don't necessarily see a problem with the idea. However, it is overly complex where it doesn't need to be. They go out of their way to specifically have it so at least 40% of the nonexcludables get a meaningful net benefit (.5% or higher) in the CB plan so that it passes 401(a)(26).

It would be much easier to just have a floor offset plan where everybody is in both plans having their CB benefits offset by DC nonelective allocations. The nonhighlies could have their CB accruals completely offset by their DC nonelective allocations and that would avoid having so many of them with pittance benefits. They are still benefiting for 401(a)(26) purposes. It's just extra work to have to eventually pay them out and it cost more in PBGC premiums and adminstration to value all those benefits.

[SRM]

I agree with Blinky.

Additionally, if a minimum 0.5% accrual is going to be provided after the offset, then what does the offset really accomplish? Wouldn't you get to the same place with a tiered DB or Cash Balance maximizing the executives and providing a 0.5% accrual to the others without any offset?

[Guest merlin]

They're now saying that they meet the exception for Broadly Available Separate Plans.

[Blinky the 3-eyed Fish]

Do you have details as to the contribution credit formula in the CB plan and the allocation formula in the DC plan? If so, would the amounts given in each plan pass nondiscrimination requirements on their own, without regard to the average benefits test? If you don't know the answer to the second question, but do to the first, post the formulas for both plans.

[Guest merlin]

The CB credit for the Category I employee (= the 4 owners) = 10 x some compensation called the "Special Bonus". For 2 of the drs. this translates into an annual accrual of $16000 = an accrual rate of 8% of pay. No NHCE has a rate greater than 6.97%, so even with permitted disparity there are two rate groups with 0 coverage. I don't have access to any more of the underlying work papers, so I can't tell if they're doing anything else to make it pass, but based on what I do have it looks like it doesn't, so they don't get the exemption.

[Blinky the 3-eyed Fish]

Maybe the CB plan passes on a benefits basis?

[Guest merlin]

Those are the benefits. It surely doesn't pass on an allocation basis.

[Guest merlin]

Additional information. The accrual rates shown above are net of the offset. If you're trying to show that the combination meets the BASP exception for the gateway are you permitted to test the db plan on a gross basis,i.e., before the offset?

[Blinky the 3-eyed Fish]

To meet the broadly available separate plans option each plan must be nondiscriminatory on its own without regard to the average benefits test. So, for the cash balance plan you are performing a general test on the plan which would require you to test net benefits.

BTW, the $16,000 = 8% accrual rate is not on a contributions basis? $16,000/$200,000 = 8%, is that a coincidence?

[Guest merlin]

Blinky, I came to the same conclusion after my last post. Thanks for the confirmation. As for the accrual , yeah, it's just a coincidence. The year in question was the initial plan year, so the maximum accrual is 1/10 of the 415 $ max, which is 16000.

[Guest merlin]

This plan has been submitted for a DL, including a request for a determination on the general test. Assuming that the IRS reviewer comes to the same conclusion that we all have, i.e., the minimum gateway is required and has not been provided, therefore the plan cannot use crosstesting to satisfy a4, where does that leave the plan? Submitting for a DL give the sponsor additional time to amend plan language if necessary. Does it also extend the time available correct a testing problem? The year in question is 12/31/02, so the normal time frame for an a4 corrective amendment has come and gone.

[could be me maybe not]

merlin, isn't there a moratorium on FDLs for cash balance plans? If so, you will have an indefinite 11-(g) correction period. I believe that you have 90 days from the issuance of the FDL to do a corrective amendment to fix a failed test.

[Blinky the 3-eyed Fish]

There is not a moratorium any longer on all cash balance plan determination letters. I have received some recently.