"Special" PS contribution to specific people

[Guest TrustMe401k]

Company A maintains a 401k profit sharing plan. The PS is discretionary. There is a group of 8 employees (managers) that the company would like to give an additional 3% ps contribution on top of the 2% it will give to all employees. All 8 of the "special" group are NHCE's although it is possbile that one or more may become HCE in the future. There is no way to know at the moment as compensation includes commissions.

Someone confirm for me that this is ok to do. I guess we need to name those specific people in the resolution stating this year's ps contribution.

Any comments?

[Guest Pensions in Paradise]

If the plan contains a traditional pro-rata allocation formula, then you cannot do what you mention. Look at the plan's allocation formula. If it says that the PS contribution is allocated to all eligible participants in proporation to pay, then you will have to amend the formula. If the plan requires participants to be employed on the last day of the plan year, then you have until the 30th to amend the plan.

[chris]

PIP is correct. The allocation formula in the plan document will control. The allocation formula may be based on a participant's compensation as it relates to the total of all participants' compensation. Additionally, it may be integrated with Social Security, etc..... The only way to get where you want to get is to amend the allocation formula to allow for specific groups of employees to receive a contribution as determined by the E/er, i.e., cross-testing. HOWEVER, the allocation formula may prevent such an amendment. For example, if there is NO requirement that a participant be employed on the last day in order to receive an allocation of a contribution and if the plan requires a participant to have at least 1,000 hours of service, then the allocation formula could not be amended because those participants with at least 1,000 hours have already met all of the conditions for receiving an allocation, i.e., >= 1,000 hours. The employment on the last day of the plan year requirement is probably the only out...

[david rigby]

... if there is NO requirement that a participant be employed on the last day in order to receive an allocation of a contribution and if the plan requires a participant to have at least 1,000 hours of service, then the allocation formula could not be amended ...

Disagree. Just because some or all participants have earned the right to an allocation, does not mean you cannot still amend the plan to provide another level (or class) of benefit.

[could be me maybe not]

pax, I think that is a (small) minority opinion, and not one shared by the IRS' talking heads.

[chris]

How would you go about doing that? My understanding was that if all conditions have been met in order to receive a contribution under the allocation formula in the plan document, then you can't just go change the allocation formula as the participant is entitled to an allocatin under that formula. I believe I had TAM 9735001 in mind from prior research. But I see at 3.303 of the ERISA Outline Book that the general argument is that since the PSP is "discretionary", the formula can be changed regardless of whether or not participants have met the conditions....... Is that where you're coming from...???

[david rigby]

Well "discretionary" certainly is an important word. But look at the original post: "...an additional 3% PS contribution..." If that is the goal, then why would the 1000-hour rule (or anything else) prohibit such amendment?

The original Q seems to be asking if such amendment would be discriminatory, which is usually a question related to 401(a)(4), but most of the above answers seem to be focusing on 411(d)(6).

Accordingly, if the affected individuals are all NHCEs, as described in original post, then the proposed amendment will not fail 401(a)(4).

[chris]

Wouldn't you still have to amend the allocation formula in the document? And how would you amend it other than to provide for different classes of e/ee's, i.e., cross-testing? It would seem that you still have a 411(d)(6) issue to deal with.....as the plan document would need to be amended regardless of what the resolution said. Just because it may be OK under 401(a)(4) doesn't necessarily mean it's OK under 411(d)(6). Working out all the applicable issues.......

[Blinky the 3-eyed Fish]

Pax, I have to disagree with you as well if the right to the allocation is already earned UNLESS the profit sharing document says something like "a discretionary contribution up to 2% of compensation". Otherwise, while the employer is seeing it as an additional 3% for some, the IRS is seeing it as a cutback for others who aren't receiving their proper share of the total contribution.

[KJohnson]

I agree with Pax that is should pass 401(a)(4) but I am not sure whether it would still be a safe harbor uner the multiple formula provisions of the regs.

As to the 411(d)(6) issues the employer could simply start another plan with a 1/1/04 effective date on 12/31/04 which provided for the contribution and merge the plans on 1/1/05. Kind of silly right? I have had instances where I have kept the old allocation formula "intact" added a new allocation formula and stated that the contribuiton would be the sum of the two formulas and flagged what I was doing in the cover letter for the determ and have gotten a letter (but both formulas covered all participants). I agree, however, that this is an area where you could get differing views from the IRS. However, they seem to acknowledge that the new plan/merger method would work (as long as your new allocation forumal passes 401(a)(4 on its own) so it all seems to be form over substance.

You also get into some semantic issues on what is "adding" a formula and what is "amending" an exising formula --for example is adding a class to a crosstested plan adding a new formula or amending the exisitng formula?

As to why the additional 3% would make a diference, the IRS reasoining would be if you put the additional $ in under the old formula, different people would get the money than if you put the additional $ under the combination of the new formual and old formula and that the person had accrued a benefit for any $ put into the plan for that year.

On the other hand, the sponsor would argue that all they have accrued the right to is the "formula" and not the dollars put in under the "formula" (which are discretionary) and that the old formula is still in the plan.

[Guest merlin]

Q&A 28 from the 2002 ASP(P)A Conference supports KJohnson's comments about the 411d6 issue, and even goes a little farther.

Q:A calendar year profit sharing plan allocates its contribution between two classes of employees: HCEs and NHCEs. The plan requires that an employee be credited with 100Hours of Service to qualify for a share of the allocation. The contribution is allocated pro rata on compensation within the class. A preliminary allocation is prepared for the 2002 year. It is determined that a contribution of 5% will be sufficient to support a mximum allocation to the HCEs. Before the end of the year, but after all participants have met the allocation requirements, the sponsor decides to create a third allocation class: NHCEs who have at least 6 years of service. He wants to contribute 10% of compensation to these NHCEs, but still maintain the original 5% contribution to the other NHCEs who have less than 6 years of service. Is this permissible?

A: The Service would probably consider this a 411(d)(6) protection issue. They could set up a separate plan to accomplish their objective. They might also find that a -11(g) amendment would meet their requirements.

[could be me maybe not]

merlin, I think you are reading the Q&A's conclusion incorrectly. They are saying that it would be a violation to amend the formula. They are saying that instead you could ADD a plan or ADD contributions pursuant to 11-(g). They are cautioning against tinkering with the existing plan except as under 11-(g).

kjohnson's comments are perfectly valid; but somebody needs to be there to defend against a potential challenge - years later. Not the safest course unless legal counsel is engaged long term. It is form versus substance but you need to be careful to maintain the proper form. This is something that you also need to be careful about with 11-(g) amendments.

[Guest merlin]

We're reading it the same way. All I was trying to show was that even if no one is harmed by the proposed change, the Service still has a problem with it, and you have to go the long way around, i.e., a new plan or a corrective amendment. This application of TAM 9735001 has never made sense to me, but there it is.

[mbozek]

I dont see a problem with adding an additonal contribution for nhces because additional contribuions are only prohibited if they favor HCEs not NHCEs. The TAM is inapplicable because it pertains to a situation where an amendment reduced the allocations of some participants under the plan formula after the close of the year. Providing an addional contribution to some nhces does not reduce the allocations to other NHCEs. Finally IRC 411d6 prevents a reduction of a participant's account balance not a change in the benefit formula.

[Blinky the 3-eyed Fish]

Mbozek, you may see it that way, but the IRS doesn't. Who is to say that it is an additional contribution and not the same contribution allocated differently and therefore a cutback for some?

[mbozek]

I dont know of any IRS authority which contradicts my position. The IRS is required to follow the law the same as taxpayers and I dont know of any IRS inrerpretation in which an additional contribution to nhces is construed as a cutback under the IRC if it does not reduce the participants's account balance. I would be interested in any citations to the contrary. Statements by IRS talking heads at conferences in response to questions are not authoritative since the speakers comments do not represent the views of the IRS.

[Bird]

I don't understand the concept of an "extra" contribution to a PS plan (unless, as noted earlier, there is a limit of 2% or whatever). PS contributions are, generally, optional, so it would be arbitrary to say "the basic contribution is 3%, and we're making an extra contribution of (whatever) to certain people." It is a cutback for participants if they would have received more had the total allocation been allocated under the existing formula. You are allowed discretion in the AMOUNT of the contribution. How that contribution is allocated is determined under the 4 corners of the document. I don't see how you can reach any other conclusion.

[david rigby]

Could it be because you can change the allocation formula in a PS plan?

[Guest merlin]

mbozek,

Your answer makes sense, but the IRS disagrees. The thrust of the TAM is that the basis for an allocation, rather than an allocation itself, is protected. This positon was taken by the Service with one of our clients about 12 years ago (prior to TAM 9735001). Client wanted to amend his ps plan (calendar year, 1000 hours, last day) from an integrated allocation to age-wtd after the year ended. Plan counsel prepared the amendment after 12/31/xx, but prior to 3/15/xx+1. Service would not approve the amendment, using the reasoning that ultimately appeared in the TAM. To the best of my knowledge they've never backed off from that position, even in an instance where it can be shown that no one is being harmed as a result of the change. Hence the respone to the question in my post above.

[mbozek]

I dont see how the TAM would prevent an employer from increasing allocations to particpants after the close of the year on the grounds that it would be a cutback. Under the TAM the allocations to some particpants would have been reduced by the formula change. In the question posted the employer will increases the allocations for nhces from X% to X=2% which is not a cutback to the participants account balance. There are many PS plans where ers increase allocations to participants after the end of the year because of a change in the financial statements which were not known at year end.

[Blinky the 3-eyed Fish]

Mbozek, as discussed previously, your point is valid IF the profit sharing document prescribed allocation amounts (say 2%) and then an increase in those allocation amounts was desired. But under the question posed that is not the case. Rather the contribution is DISCRETIONARY! Bird can't say it any clearer in his last post.

Employers do increase allocations after year-end, but they do so within the framework of the allocation formula in the document.

You ask for IRS authority to contradict your position. Well how about 411(d)(6) and their repeated interpretation of its application under these situations at conferences and anywhere else? What authoritity do you have to support your position? The bottom line is that a plan was audited, the IRS would have issues with the amendment. I doubt any client is looking to go to tax court over this.

[mbozek]

If the contributon is discretonary then the allocation is based on what the employer decides to contribute to the plan for the participants. Under Rev rule 76-28 an employer can contribute to a plan by claiming a deduction without any formal allocation or employer approval by making multiple contributons. A typical discretionary formula will allow the employer to "make descretionay contributions for eligible participants as determined by the employer" without defining how they are allocated. The er will contribute x% of comp for one group of ee and y% of comp for another group. The allocation for each employee is what is contributed to their account either X or y %, not what is allocated to their account in the proportion that their comp bears to the total comp. I fail to see how the IRS can interpret 411d6 with any authority that making additonal discretionary contributions for some employees is a cutback since the additional contribution does not reduce the account balance in any participant's account which is the conduct prohibited by 411d6.

In the original post the employer proposed to give some NHCEs 3% over the 2% contributed to all employees. If some employes get 2% and others get 5% in their acounts but the additional 3% is not coming out of the account balances of those who are getting 2% how is there is a violation of 411d6? Repeating what was said at conferences by IRS officials which cannot be attributed as an authorative position of the IRS doesnt make the allocation formula a violation of 411d6.

[Guest Pensions in Paradise]

Wow mbozek. By your logic, we could have been doing cross-tested allocations (i.e., different allocations to different groups) for the last 20 years using standardized prototype documents. And to think that the entire pension community wasted countless hours converting plans onto cross-tested documents. (For those who can't tell, I am being sarcastic. I agree with Bird and Blinky.)

[Blinky the 3-eyed Fish]

Mbozek, let's spin it a different way.

By year's end the company is going to contribute $20,000, which will provide for a 2% allocation for those eligible. After determining they are having a fabulous year in January, they decide to reward certain employees with an additional 3% of pay allocation via an amendment to the plan, for a total contribution of $40,000

Now compare that to the company who is just going to make a $40,000 contribution, but wants to change the allocation formula after year-end to target certain employees.

HOW IS THE IRS, OR ANYONE ELSE FOR THAT MATTER OUTSIDE THE COMPANY, GOING TO KNOW THE DIFFERENCE?

The answer is that they aren't going to know. And that is why the IRS is treating the first instance as a cutback and a true violation of 411(d)(6).

Company CEO, "Really Mr. IRS agent, this is what we intended to do."

IRS Agent, "You're a filthy liar! Prove it!"

[mbozek]

This discussion was premised on making additional contributons for NHCEs which is not subject to the nondiscrimination rules since 401(a)(4) only prohibits discrimination in benefits in favor of HCEs. The CT rules apply when testing benefits for HCEs.

[Bird]

It's not about non-discrimination, it's about prohibited cutbacks.

I believe that the original post was about a plan with a formula, not one with groups, which is a different matter, although similar logic ultimately prevails with regard to (not) being able to change groups.

If you have a pro-rata formula, and two NHCEs, each earned $50,000, and (after the end of the year to avoid other distractions) the employer says "let's make a 2% contribution"; then each will get $1,000. If the employer then says, "oh, and I want to give an extra $1,000 to #2" then that is a cutback to #1. Why? Because the plan has no provision for multiple contributions; the plan says the employer can make an optional contribution, and it is allocated under the terms of the document. In this case, the contribution is $3,000, and each should get $1,500. (Unless, as noted, the plan has a cap of 2%, but let's face it, it doesn't.)

If you disagree, you are effectively saying that the employer can make a $3,000 contribution, and allocate $2,000 according to the terms of the document and $1,000 according to its whim. You could take that to an extreme and say that the first $.02 are allocated according to the terms of the document ($.01 each) and the next $2,999.98 goes to #2. (Frankly, that does nothing to support my argument but I hope that the result defies common sense.)

Addressing your example:

In the original post the employer proposed to give some NHCEs 3% over the 2% contributed to all employees. If some employes get 2% and others get 5% in their acounts but the additional 3% is not coming out of the account balances of those who are getting 2% how is there is a violation of 411d6?

Because the contribution is somewhere between 2% and 5% of total compensation; let's say you add it up and it is 4% of total compensation. In this plan, everyone should get 4% of compensation. You have taken 2% from the accounts of some who would have gotten 4% had the total contribution been allocated according to the terms of the document (pro-rata) by arbitrarily amending the formula (to "2% for everyone and an extra 3% for certain participants").