Is this definition of "accrued benefit" legal?

[Guest Dave Peckham]

A plan sponsor wants to almost freeze benefit accruals, except that the plan had a compensation limit in place for the final year of benefit accrual.

Is there any law to prevent us from drafting plan language to allow the benefit accrual fraction to be frozen as of a certain date, say 12/31/04, but allow the average compensation used in detemining the final accrued benefit to include one more year, say, through 12/31/05? We would also remove the plan's compensation limit so that statutory limits could be used instead for years prior to 12/31/05.

We would be open to not using the word "frozen" if the end result would be the same.

Thanks in advance for any comments or alternative suggestions.

Dave Peckham

[david rigby]

I don't think you ever have to use the word "frozen".

Your goal probably can be accomplished in 2 amendments, the first by 12/31/04, and the second by 12/31/05 (others may point out that those dates are not absolute, but are used to illustrate the sequence). However, you may also have other problems, with respect to 1.401(a)(4)-5. Difficult to answer that question here.

Other commenters may have different solutions.

[Guest Dave Peckham]

Thanks, pax.

I am aware of the 1.401(a)(4)-5 issue of whether each amendment itself is nondiscriminatory. We have 2 HCEs total. 1 HCE's benefit will not increase at all due to the amendments. More than 50% of the NHCEs' benefits will increase due to the amendments. Therefore, assuming that we can provide evidence that each amendment is nondiscriminatory, do you see any inherent problem in having an accrual fraction calculated through 12/31/04, and average compensation calculated through 12/31/05?

[Guest Harry O]

Can you pass nondiscrimination "amounts" testing in 2005? That is, will the increase in the NHCEs' benefits "support" the increase in the one HCE's benefit ?

[AndyH]

Just an unrelated tangent to Harry O. I couldn't pass up the chance.

I'm working on one of your spinnoffs (very very very slowly for 3 years now). Now let's talk about accrued benefit definitions that I wish were illegal! The most complicated thing I've ever seen, times 12.

[Guest Dave Peckham]

So, Andy H., can I assume that what I have proposed is not even close to the most complicated definition of "accrued benefit" you have ever seen, and therefore might actually be legal, in your opinion, if the amendments are properly drafted and nondiscrimination issues are properly addressed?

[david rigby]

Whether it is "complicated" is not the issue. Whether it is "legal" may not be the issue. The key, as suggested by HarryO, is the relationship between the benefit of NHCEs and the benefit of HCEs.

It may be possible to simulate the non-discrimination testing of your intended result, to determine in advance if it will pass the testing. Simulate, because that includes estimating a future compensation, where the actual compensation will be used in the final testing. But there may be other issues as well, such as the timing of the amendment(s), and notice to participants. Discuss with your actuary and ERISA counsel.

[Guest Harry O]

AndyH -

"One of my spinoffs"????

Not sure what you are referring to . . .

[AndyH]

Dave, what do you mean by:

We would also remove the plan's compensation limit so that statutory limits could be used instead for years prior to 12/31/05.

?

Under the a(4) testing regs, you are permitted to have a "fresh start" amendment and effectively freeze benefits at a certain point, and index those for comp changes, so except for the question I am raising, it appears that you have an A + B formula, except that A is frozen but indexed for comp 1 year and B is zero. If formula A is in compliance, then it looks ok to me, except for the part that I am questioning.

[Guest Dave Peckham]

Andy H,

The plan is using a $170,000 comp limit for the current and all prior years for the 1/1/04 valuation. (Originally adopted as an elective option in the EGTRRA good faith amendment.) We want to allow the comp limit to go up to the statutory $205,000 for 2004 and $200,000 for all prior years, starting with the 1/1/05 valuation.

Does this change your answer?

[AndyH]

Yes, you are describing a benefit increase that would be subject to testing. And it would not by itself pass.