404 Fun

[Blinky the 3-eyed Fish]

404(a)(1)(A)(ii)

(ii) the amount necessary to provide with respect to all of the employees under the trust the remaining unfunded cost of their past and current service credits distributed as a level amount, or a level percentage of compensation, over the remaining future service of each such employee, as determined under regulations prescribed by the Secretary, but if such remaining unfunded cost with respect to any 3 individuals is more than 50 percent of such remaining unfunded cost, the amount of such unfunded cost attributable to such individuals shall be distributed over a period of at least 5 taxable years,

This wonderful paragraph has puzzled me for a bit and I wanted the madness to stop. Can anyone give me an example of a situation where this comes into play? I have an idea, but I am not at all sure.

[david rigby]

You must not have much to do today. This paragraph is similar to (but not exactly like) pre-ERISA language in IRC 404(a)(1)(B). Also see pre-ERISA reg. 1.404(a)-5 (last amended 1/19/61).

I have no idea why it exists, other than to assume it was a response to some specific situation/abuse, but what do you think?

You can submit it for the GrayBook, but don't expect a response.

[FAPInJax]

Sure. I have seen it come into play when running an individual aggregate valuation and the owner is 3 years from retirement. The plan has accumulated a large credit balance (effectively eliminating the deduction under 404 for the minimum). IF his contribution is more than 50% (duh in a small plan!!) the 404 contribution is calculated with 5 years to retirement and not 3.

Hope this help!

[Blinky the 3-eyed Fish]

Frank, that is my understanding of the rule, but some additional questions exist. One, I would presume this rule would apply to a 1-person plan and that there wouldn't have to be at least 3 people in the plan for it to work. Two, for an individual aggregate valuation, would the following would take place?

Participant A - 15 yrs to retirement

Participant B - 10 yrs to retirement

Participant C - 3 yrs to retirement

Participants D-??

So, say A-C have unfunded cost that exceed 50% of the total. In this case, the rule would require that Participant C be effectively "deemed" to spread funding for 404 NC to 5 years. In other words, it's not the average in any way of the timespan for A-C (9.33 yrs), but for each individual.

My software program, albeit designed mostly for large plans, does not take this rule into account.

[Mike Preston]

In the case of a small plan using the Individual Aggregate funding method, wouldn't you use 404(a)(1)(A)(iii) and not 404(a)(1)(A)(ii)?

[Blinky the 3-eyed Fish]

I would ask then when you would use 404(a)(1)(A)(ii)? You certainly aren't going to amortize the unfunded costs over 10 years using IA as described in 404(a)(1)(A)(iii).

[Mike Preston]

I don't know when (ii) makes sense to use, as I have never used it.

I have always thought that the funding method defines the past service credits, if any and a spread gain method without any base to amortize seems to me to fit into (iii).

[Blinky the 3-eyed Fish]

Here's the comment from the DB Answer Book for what it's worth.

"Rules for limit 2. This amount is the level amount or level percentage of compensation needed to fund the benefits under the aggregate, individual aggregate, or individual level-premium funding method. [Examination Guidelines for IRC § 404, IRM 1.2.1.2(1)(a)] If 50 percent of the unfunded cost is attributable to any three employees, the unfunded cost for those employees must be distributed over at least five years. This limit does not otherwise reduce the amount deductible under limit 1, that is, fewer than five future years can be used in determining the cost for purposes of Code Section 412 and it will still be deductible under limit 1."

[Mike Preston]

I understand that and I think that was previously mentioned when somebody spoke about having a big credit balance in the FSA account rendering (i) someone ineffective.

[Ron Snyder]

That Code language predates ERISA. Prior to ERISA there was an actuarial cost method employed called the "Minimum Individual Funding Period" Cost Method, under which costs were spread over the greater of all future years or 5 years (if that was the minimum individual funding period). This paragraph was mooted by permitting the entire amount to be deducted over years of participation through ERISA-approved funding methods and other parts of 404 described above.