DB Dual formula

[Guest Roman]

Can I design this formula for a DB client:

5% for ALL service for the owner max of 20 years; .5% of participation service for all others. Accrued benefit is accrued as earned. If owner has more than 20 years of service, his accrual is already zero. When I do the general test, it automatically passes using the accrual method since the owner's accrual is zero while the others is .5. Only need to provide 5% on the DC side to satisfy cross testing. Using the accrual method for the general test seems smelly to me but I cannot say for sure what is wrong with it.

[Effen]

Seems like you might have a problem under 1.401(a)(4)-5.

[Blinky the 3-eyed Fish]

And the accrual for testing is not zero. Your measurement period is the current and prior years, emphasis on the fact that the current year is part of it.

[Guest Roman]

Accrual is end of year AB minus beginning of year AB which means the accrual reflects only the change in pay, right?

[Blinky the 3-eyed Fish]

No. If your measurement period were the current year, well then your AB at the beginning of the year was $0, since you didn't have the plan. If you are attempting to pass under the accrued to date method, well then your increase is the AB/testing service. Either way you have a positive accrual for the year.

But of course this design has other more severe issues.

[Guest Roman]

Blinky,

I am granting past service to the owner, so my accrued benefit at year 0 is positive and at year 1 my accrued benefit is increased only by the increase in pay. So using the accrual method, my numerator is a minimal amount (not zero).

A corollary to this question is if I use the accrued to date method in the general test, will I satisfy the facts and circumstances issue?

Thanks.

Roman

[Blinky the 3-eyed Fish]

If you are testing on current year, no matter that the formula accrued a positive benefit at year 0, for testing purposes, you are at 0 at the BOY.

If you are using the accrued to date method, in this case your measurement period is the CURRENT year and all prior years. The accrual rate is the increase in the AB during the measurement period divided by testing service.

So you see that there is a positive benefit that is used for testing that is not just due to a compensation increase no matter which method you use?

As to your second question, I don't know the facts and circumstances, but I feel I can safely answer that it is definitely discriminatory.

[Guest Roman]

Blinky, I agree with you. Any comment on limiting past service to 5 years (safe harbor) and using either the accrual or accrued-to-date method for general testing?

[Blinky the 3-eyed Fish]

Well limiting past service to 5 years eliminates any discrimination issues for using that service for testing. The less past service the staff has, the better the accrued-to-date method will most likely be. You are definitely on a much better plan design path.

[AndyH]

Huh Wa? Mind splainin your second sentence Blinker? Is that a new heat based testing theory?

Roman, all Blinky's (other?) comments are right on as usual but to put it more compactly there is a year that your owner accrues his benefit and that benefit accrual must be in the test for AT LEAST one year and that is the year you will FAIL.

Any testing method must include the current year so unless that benefit was accrued in a prior year in which you had a safe harbor formula (which is of course not possible) or in a year prior to a fresh start date (which also required a test) then it had to be subject to a general test and that test could not pass.

Yeah, next year you can use the annual method and you may have a 0% for the owner but so what? It is the year of the accrual that'll get ya.

Does that help?

[Blinky the 3-eyed Fish]

If the staff has limited past service, then their accrued benefit will be less. If their accrued benefit is less, then the current year testing is worse because the owner will have 5 years. Hence, my line, "The less past service the staff has, the better the accrued-to-date method will most likely be." (in comparison with the current year method).

See, the heat hasn't got to me yet. (BTW, I realize that statement didn't make a lot of sense without explanation, but I really didn't feel like editing it.)

[AndyH]

Well, we don't disagree often but I think that if they have less past service then their testing service will normally be less so they would not have a lesser accrual rate. In fact, the opposite may be true depending upon their salary history and what you use for testing comp.

Now this all comes back to how you define testing service, and clearly there is some leeway but generally I think you would agree that it must relate to how benefits accrue or it must relate to what service is credited under the plan.

If benefits accrue on participation, for example, and there is preparticipation service then I don't think it is legitimate to use all service as testing service.

[Blinky the 3-eyed Fish]

I don't disagree with that. I suppose my point was not clear, but it's not important.

[Guest Roman]

I agree that the first year testing might not be good for the owner, but you can always make it up with a high DC contribution on the first year. Later years should be smooth sailing for the owner. I guess my issue here is that will using past service more than 5 years pass the facts and circumstances smell test.

[AndyH]

Yeah, the 5 year issue is a problem but aside from that you seem to think you can pass testing and I do not see how. Have you considered 415?

[Guest Roman]

You can pass 401(a)(4) on a DB/DC combo provided you have enough young employees to whom you can give enough DC contributions to pass cross-testing. I don't think 415 is an issue if the owner does not receive any DC contributions. The other employees get the .5 benefit on the DB plus enough DC to pass the test. The issue is the 25% max but with enough employees, this could be easily solved.

[AndyH]

Ok, I was trying to help but I give up. I have no idea what you are proposing. It makes zippo sense to me. What do DC allocations have to to with DB 415 limits?

Blinky again you were wiser than I. Roman, only trying to help. Towel now thrown in. Never mind. You seem to have found your answer.

[Guest Roman]

AndyH,

Thanks for the help. It's guys like you that make this site a joy to read.

[flosfur]

...........  Have you considered 415?

How could considering the S415 create a problem (if you meant it could)?

Since S415 would most likely limit the owner's benefit and reduce his accrual rates, doesn't S415 makes it easier to pass the test?

[AndyH]

The impression I was getting was that the Owner would get his total benefit in Year 1 because a large DC contribution would be made and the two would be tested together, and then years thereafter would be a snap.

For example, give the owner an accrual of 80% of pay in year one and try to test that over all years of service so the EBAR is low. Clearly 404 would be an issue, but clearly also 415 would be as well.

But I never got to the point where I understood exactly what was being proposed so that is merely a guess.

[flosfur]

......

For example, give the owner an accrual of 80% of pay in year one and try to test that over all years of service so the EBAR is low.  Clearly 404 would be an issue, but clearly also 415 would be as well.

.....

Since the maximum accrual after 1 YOP can only be the lesser of [1/10th of the $Max or YOS/10*Hi 3], S415 should not be an issue? And S404 issue (I presume you meant S404 issue related to exceeding S415 benefits and not the 25% DC/DB combo deduction issue) should not be an issue.

[Guest Roman]

I am sorry but I am not aware of the 1/10 accrual limit on the YOS percent limit nor the 404 issue on exceeding the 415 limit. Can you expand on these? Thanks.