Reasonable classification and compensation bands

[Guest Glen Archinal]

We are seeing plan designs that cover 100% of HCE's and as few as 25% of NHCE's with the NHCE's chosen simply as those in a particular compensation band. For example, only NHCE's making less than $5,000 receive a contribution.

There are no other plans being aggregated with the plans in question, so clearly it is represented that "employees earning less than $5,000" is a reasonable classification under 1.410(b)-4(b). Otherwise, the plan would not pass the nondiscriminatory classification test of 1.410(b)-4 and thus cannot pass the average benefit test of 1.410(b)-2(b)(3). We of course cannot have a qualified plan if we do not pass either the ratio percentage test or the average benefit test.

Does anyone have any evidence one way or the other as to whether "those earning less than $5,000 this year" is a "reasonable classification"? I say it clearly is not, but ERISA attorneys in the Cleveland area allegedly say it is. Am I wrong or are they just lucky to be finding reviewers who are not familiar with one of the oldest and most fundamental rules of qualified plans?

Thank you.

[AndyH]

Evidence, no. An opinion, yes, that your comments sound right on.

What you describe does not jive with what I have heard described as reasonable, and it also smells of the abuse that resulted in warnings issued about "short term employees" and such about a year or so ago.

[Tom Poje]

while the ERISA attorneys may say it is a 'reasonable' classification, I would agree with Andy in regards to 'short term employees' being used to pass testing. It smells bad, very bad in regards to that issue. I would wave the short term emplyee documentation in front of them so they can read for themselves that 'while possibly reasonable, it fails the short term ee test'

[Guest Mike Spickard]

I know it may not change any of your opinions, but we have a situation where the client regularly employs folks who work 500-700 hours per year, and generally speaking the same people work year after year. The plan benefits these employees at a much higher rate (due to compensation banding for allocations as Glen A describes). So strictly speaking it is not so much the "short service" employees helping to pass testing as it is the lowest paid used to help pass testing.

While we are on the topic, is there a "short term ee test"? I am not familiar with that.

[Tom Poje]

Mike:

Besides the scratch 'n' sniff smell test I don't know of any particular test. you did not indicate in your example if there was a block of nhces being excluded from contributions. I think that is the IRS' biggest gripe. If you are not excluding any NHCEs you have more of a leg to stand on.

Along the same lines, an example that was used (as a possible no-no) in one of the talks at the ASPPA conference was to include short time HCEs (the kids) and give them nothing.

I believe the example had a 5 yr old, 9 yr old and a 16 year old. The argument being that the 5 and 9 year old probably didn't do any 'legitimate work'. Ha. I almost asked about the 16 year old. must be a real special kid if they got any work out him as well.

[Guest Mike Spickard]

Thanks Tom. A plan I am thinking of excludes all EE's making over $80,000 except the President, so there are only about 4 non-HCE's who fall into this classification. However, there are only about 7 non-HCE's who make less than $80,000 and are thus eligible. 2 of them earned about $5,000 this year. There are also about 7 HCE's excluded from the Plan.

No family members in this one, though.

This Cash Balance plan received the fastest DL I have ever seen (about 5-6 months).