Discrimination Testing

[wsp]

Client has an integrated plan with the base contribution approximates 8% of pay. Plan is also Top Heavy and intially failed 410(b) due to large number of retirements during the year. As a means of passing 410(b) I am able to include the top heavy group for average benefits testing under 401(a)(4). Do I then simply start at the 3% top heavy contribution and increase that number until I pass the 401(a)(4) test? Or do I have to start at the oldest employees (in terms of service, not age) and bring them in at the regular contribution rate in order to pass (in other words separate out the top heavy from 401(a)(4))?

ErisaNut...you and I had talked about this before and this was the reason that I was increasing the top heavy to pass 401(a)(4), just had lost my train of thought back then.

[ERISAnut]

Okay, I am beginning to see it but am still a little unclear on all that has transpired.

I'll try to break your question down into the following facts:

1) Plan has a permitted disparity formula of 8% of base compensation plus 5.7% of excess compensation (with base compensation defined as the entire 401(a)(17) and not TWB).

2) This formula, even though provides higher percentages to higher paid, is deemed uniform by 401(l) and is subject to only the coverage ratio test.

3) Plan has a last day and 1000 hours requirement in order to receive an allocation under this formula.

4) There were some participants who were employed on the last day who worked less than 1000 hours that were excluded from this allocation. However, because of the top-heavy requirements received a top heavy minimum allocation of 3%.

5) You performed the general test (i.e. avg. benefits test, cross-testing, or other) by taking into account all contributions to be tested under whatever test was used; and continued to fail.

If this is correct, the one option would be to determine the impact of an additional discretionary based allocation (since the 5.7% maximum excess has been reached) to determine the impact that would have on the test. For instance, how would the general test come out of the discretionary formula was 8.5% of base compensation plus 5.7% of excess compensation.

Another option would be a corrective amendment to bring more participants into the allocation. If this is used, the class of participants brought into the allocation by the corrective amendment must remain throughout the end of 2006 (assuming that this is 2005 being tested). Also, such corrective amendment must by done by 9 1/2 months after year end (October 15th). Since this is an amendment, there is flexibility in determining how it will be done.

This gets difficult without seeing the actual test, but this should provide a general guide; assuming I have the facts straight.

[wsp]

4) There were some participants who were employed on the last day who worked less than 1000 hours that were excluded from this allocation. However, because of the top-heavy requirements received a top heavy minimum allocation of 3%.

You've got it pretty much nailed down.

One part that I realized I left out after reading your summary is that the entrance requirements for the 401k are much more lenient than the profit sharing and thus the number of people brought in for the top heavy minimum is fairly large. Additionally their ages in relation to everyone else makes that 3% more valuable and increasing it makes more of a difference when using accrual factors.

So, it's my hope to piggyback off the ability to simply increase the TH minimum contribution rather than amend plan to bring in people for 2 years when it shouldn't be necessary to go through this next year or even raising the base percentage which actually doesn't help me based upon the company census.

So that's my question...can I influence the 401(a)(4) testing by increasing the TH percentage rather than amending the plan. And, if so, is it capped? Could I theoretically go higher than that 8% base allocation figure?

[Mike Preston]

I am so confused.... I guess that is to be expected at times.

You can not increase "the top-heavy contribution" above 3%. "The top-heavy contribution" is defined in the plan. End of story.

As indicated, without amending the plan, about the only thing you can do is put more money in. More money going in will be allocated in accordance with the allocation rules defined in the plan. End of story.

But I'm having trouble with this whole thing. I am finding it difficult to believe that you are failing 410(b). Have you run the average benefits test? Have you run the average benefits test on a cross-tested basis?

We need numbers here (probably lots of them - at least start with body counts), or there really isn't any way to help.

[Mike Preston]

Another option would be a corrective amendment to bring more participants into the allocation. If this is used, the class of participants brought into the allocation by the corrective amendment must remain throughout the end of 2006 (assuming that this is 2005 being tested).

Well, that's a new one on me.

Care to share with us a citation for your assertion that "the class of participants brought into the allocation by the corrective amendment must remain thoughout the end of 2006.."?

[ERISAnut]

Another option would be a corrective amendment to bring more participants into the allocation. If this is used, the class of participants brought into the allocation by the corrective amendment must remain throughout the end of 2006 (assuming that this is 2005 being tested).

Well, that's a new one on me.

Care to share with us a citation for your assertion that "the class of participants brought into the allocation by the corrective amendment must remain thoughout the end of 2006.."?

I'm sorry. I was actually typing without thinking on that one. The rule I was quoting here applies to a corrective amendment to cure discriminatory availability of a benefit, right, or feature. I appologize for that. What I should've said was to be sure the corrective amendment to bring additional classes of employees in applies only to the year being corrected.

[ERISAnut]

4) There were some participants who were employed on the last day who worked less than 1000 hours that were excluded from this allocation. However, because of the top-heavy requirements received a top heavy minimum allocation of 3%.

You've got it pretty much nailed down.

One part that I realized I left out after reading your summary is that the entrance requirements for the 401k are much more lenient than the profit sharing and thus the number of people brought in for the top heavy minimum is fairly large. Additionally their ages in relation to everyone else makes that 3% more valuable and increasing it makes more of a difference when using accrual factors.

So, it's my hope to piggyback off the ability to simply increase the TH minimum contribution rather than amend plan to bring in people for 2 years when it shouldn't be necessary to go through this next year or even raising the base percentage which actually doesn't help me based upon the company census.

So that's my question...can I influence the 401(a)(4) testing by increasing the TH percentage rather than amending the plan. And, if so, is it capped? Could I theoretically go higher than that 8% base allocation figure?

I see where you are going and will try to answer the questions listed below.

Going higher on the 8% base allocation figure? This is an option provided the formula is discretionary. If increasing the base percentage to only those who meet the last day-1000 hours requirement will help pass, the you certainly have the ability to do that without violating the "definitely determinable formula rule).

As for increasing the TH percentage for those employees who receive only the TH minimum. Won't work for a couple of reasons. 1) It is no longer a top heavy requirement and would itself become an additional allocation formula to a unique group of people; who happen to be lower compensated due to the fact that they haven't even worked 1000 hours during the year. This is majorly aggressive and would to more harm that good. This amendment, instead, may be written to require only last day of employment as a requirement to receive the allocation. As stated in my last post, make sure the amendment is written to apply only to the year being corrected. Didn't mean to confuse the issue (due to a temporary brain-cramp).

If you are mapped to a prototype plan, you should make sure the plan hadn't elected the fail safe provisions which automatically brings in additional employees in order to pass 410(b) by use of the Coverage Ratio Test. I feel bad that I actually misquoted the BRF corrective amendment for this scenario.

[Mike Preston]

ERISAnut, thanks for the clarification. We all cramp from time to time.

But I've got another one.....

As for increasing the TH percentage for those employees who receive only the TH minimum. Won't work for a couple of reasons. 1) It is no longer a top heavy requirement and would itself become an additional allocation formula to a unique group of people; who happen to be lower compensated due to the fact that they haven't even worked 1000 hours during the year. This is majorly aggressive and would to more harm that good.

Emphasis added by me.

I completely disagree with the bolded statement. Making an amendment which benefits a group of NHCE's is fundamentally impossible to ring the discrimination bell, except in the rarest and most abusive situations. The Gold "short service" memo is my citation. There is absolutely no evidence in this case that providing the individuals that worked less than 1000 hours with a "top-up" benefit of any kind (through an amendment) would be "majorly aggressive". And there certainly is no evidence that it would do more harm than good.

It could very well be just what is required to make the average benefits test pass, which, in turn, then allows the plan to satisfy 410(b) without breaking a sweat.

[Tom Poje]

based on what was said:

more than 30% of the people received top heavy (or terminated with more than 500 hours and received no contribution)- otherwise I don't see how you can say you fail 410(b). that sounds like an awful high %.

if that is true then lets take a look at an individual making 110,000 (using 90,000 as my integration level) they would receive

8800 + 1140 or 9940, which is 9.94% of pay.

1/3 of that is 3.31%.

that means if (and I stress 'if') you were to go the cross tested route you would be 'required' to increase the contribution of all top heavy people to satisfy the gateway.

[Guest lskin]

I've got a question? Why if the plan is top heavy do you have to give a 3% contribution to employees who left before the last day of the year ? I thought if you used a nonstandardized plan that they did not have to get any employer contributions.

[ERISAnut]

I've got a question? Why if the plan is top heavy do you have to give a 3% contribution to employees who left before the last day of the year ? I thought if you used a nonstandardized plan that they did not have to get any employer contributions.

You're not. Your only providing the TH minimum to those participants who were employed on the last day of the plan year. This issue is that the plan formula is providing contribution to only those employees who worked at least 1000 hours AND were employed on the last day. The plan formula fails 410(b). When performing the general test, you are now bringing in the TH minimums that were given to only those participants who were employed on the last day, but failed to work 1000 hour (since they didn't otherwise receive the TH minimum).

[ERISAnut]

ERISAnut, thanks for the clarification. We all cramp from time to time.

I completely disagree with the bolded statement. Making an amendment which benefits a group of NHCE's is fundamentally impossible to ring the discrimination bell, except in the rarest and most abusive situations. The Gold "short service" memo is my citation. There is absolutely no evidence in this case that providing the individuals that worked less than 1000 hours with a "top-up" benefit of any kind (through an amendment) would be "majorly aggressive". And there certainly is no evidence that it would do more harm than good.

It could very well be just what is required to make the average benefits test pass, which, in turn, then allows the plan to satisfy 410(b) without breaking a sweat.

We would have to disagree on this one. I would normally take the approach of maintaining prototype status. I think the amendment that you are proposing would take the plan out of prototype status by creating separate class allocations. Also, I do stand by the my comment (but would admit that it would depend on the level of contributions being provided to these lower paid employees). I would not agree with any notion of directing large contributions to the a few lower paid people to get the test to pass.

Also, the point that Tom Poje pointed out that they are likely failing the gateway into cross-testing. There may be an amendment to increase this group to pass the gateway. Realize that nothing I say is absolute. They are all things to consider with a set of "facts and circumstances". We've all performed corrective amendments and have even written such amendments (unauthorized practice in law). These are thought process which must be considered when determining how to be correct. For the reasons mentioned, I think it is better to amend to bring employees into the formula already in place than to create an entirely different formula.

[Mike Preston]

that means if (and I stress 'if') you were to go the cross tested route you would be 'required' to increase the contribution of all top heavy people to satisfy the gateway.

Tom, I was suggesting using cross-testing to confirm that the average benefits test is satisfied. I was not suggesting the use of cross-testing for satisfaction of rate group testing under 401(a)(4). Hence, there would be no gateway requirement.

[Mike Preston]

The plan formula fails 410(b).

I remain supremely unconvinced that the above is a true statement.

[ERISAnut]

that means if (and I stress 'if') you were to go the cross tested route you would be 'required' to increase the contribution of all top heavy people to satisfy the gateway.

Tom, I was suggesting using cross-testing to confirm that the average benefits test is satisfied. I was not suggesting the use of cross-testing for satisfaction of rate group testing under 401(a)(4). Hence, there would be no gateway requirement.

Not exactly correct. You can apply the average benefits testing without cross-testing. But when you cross-test, the gateway automatically applies (unless a broadly available exception or primarily DB in Nature exceptions applies). No exceptions to this would seem to be applicable here.

[ERISAnut]

The plan formula fails 410(b).

I remain supremely unconvinced that the above is a true statement.

There is a difference between "benefiting" under the plan and having the plan formula satisfy the safe-harbor requirements of a uniform allocation formula. For instance, if you have a formula that provides a benefit in excess of the TH minimum, then that formula must be tested under 410(b) while treating the participants who received only the TH minimum as not benefiting under that formula. If not, then you have to perform more testing to prove nondiscrimination.

[Mike Preston]

ERISAnut, thanks for the clarification. We all cramp from time to time.

I completely disagree with the bolded statement. Making an amendment which benefits a group of NHCE's is fundamentally impossible to ring the discrimination bell, except in the rarest and most abusive situations. The Gold "short service" memo is my citation. There is absolutely no evidence in this case that providing the individuals that worked less than 1000 hours with a "top-up" benefit of any kind (through an amendment) would be "majorly aggressive". And there certainly is no evidence that it would do more harm than good.

It could very well be just what is required to make the average benefits test pass, which, in turn, then allows the plan to satisfy 410(b) without breaking a sweat.

We would have to disagree on this one. I would normally take the approach of maintaining prototype status. I think the amendment that you are proposing would take the plan out of prototype status by creating separate class allocations. Also, I do stand by the my comment (but would admit that it would depend on the level of contributions being provided to these lower paid employees). I would not agree with any notion of directing large contributions to the a few lower paid people to get the test to pass.

Also, the point that Tom Poje pointed out that they are likely failing the gateway into cross-testing. There may be an amendment to increase this group to pass the gateway. Realize that nothing I say is absolute. They are all things to consider with a set of "facts and circumstances". We've all performed corrective amendments and have even written such amendments (unauthorized practice in law). These are thought process which must be considered when determining how to be correct. For the reasons mentioned, I think it is better to amend to bring employees into the formula already in place than to create an entirely different formula.

I suppose agree to disagree is the correct phrase.

1) I searched for "prototype" in the prior messages and couldn't come up with that word except in your messages. Why are you attempting to retain a status that isn't evident from the discussion at hand? However, even if you are correct (from some prior knowledge not shared with the rest of us) I vehemently disagree with your approach. The "cost" of elimination of prototype status is a few thousand dollars, at most; and that is if you submit as an individually designed plan (wouldn't it be smarter just to arrange for a volume submitter plan that has the language you want?). If we are talking about just 1% of pay being allocated across the board, even with only 10 participants with average compensation of $25,000, we are talking about a $2,500 "cost". And from what I can gather we are talking about much, much, much larger numbers. And, even if we are talking about a prototype, there really isn't much to say, is there? Don't prototypes have fail-safe language in them which mandates what can/must be done to cure this type of problem? Basically, my responses were not based on prototype status either being initially in play or being something worth saving when dealing with this sort of situation. I note that you waffle by saying that you want to retain prototype status but then saying that it would depend on the numbers. So maybe we are actually in agreement and you just think the numbers are a lot smaller than I think they are. Fair enough. That is why I said we need, at the least, body counts.

2) "I would not agree with any notion of directing large contributions to the a few lower paid people to get the test to pass." Why not? If it makes the test pass, and it is otherwise not problematic to the company in terms of employee relations, why is this particular methodology something that you feel so strongly about? Are the thousands of plans that have used this approach over the last 10 years or so somehow in danger of being disqualified? Why? Citation, please. I am rather vehement about this because there are many in the industry who have gone to great lengths to see where it is appropriate to draw the lines and it is bad enough when rogue IRS agents begin to regulate from the hip by stating that their own regulations don't mean what they say. When I hear it from somebody within the industry, it rankles. Now, if you want to tell your client that you think the methodology is "unfair" and that you don't think it is appropriate, from an employee relations perspective, I have absolutely no problem with that. When you talk about it in a way that makes it seem like it is contrary to all that is good and right, I see red.

[Mike Preston]

that means if (and I stress 'if') you were to go the cross tested route you would be 'required' to increase the contribution of all top heavy people to satisfy the gateway.

Tom, I was suggesting using cross-testing to confirm that the average benefits test is satisfied. I was not suggesting the use of cross-testing for satisfaction of rate group testing under 401(a)(4). Hence, there would be no gateway requirement.

Not exactly correct. You can apply the average benefits testing without cross-testing. But when you cross-test, the gateway automatically applies (unless a broadly available exception or primarily DB in Nature exceptions applies). No exceptions to this would seem to be applicable here.

ERISAnut, please, please, please review prior threads on this issue. It is a settled issue and your understanding is incorrect. The use of crosstesting in the average benefits test does not, in any way, shape or form, cause the gateway requirements to come into play. The regs say it. The IRS has confirmed it at many, many conferences. If you think otherwise, please provide a citation.

[Mike Preston]

The plan formula fails 410(b).

I remain supremely unconvinced that the above is a true statement.

There is a difference between "benefiting" under the plan and having the plan formula satisfy the safe-harbor requirements of a uniform allocation formula. For instance, if you have a formula that provides a benefit in excess of the TH minimum, then that formula must be tested under 410(b) while treating the participants who received only the TH minimum as not benefiting under that formula. If not, then you have to perform more testing to prove nondiscrimination.

I don't disagree with anything you have said. Are you disagreeing with something I said? Perhaps a set of numbers will convince you? As I said earlier, we need body counts to give a better idea as to where things should really go from here. Assume there are 70 participants that "count" for 410(b) purposes and 23 of them are not benefitting because they either are not receiving an allocation at all because they terminated before the end of the year or they are getting only the top-heavy minimum. If I run the whole thing through the average benefits test (using any methodology allowed, including crosstesting) and find that the average benefits test is satisfied, then the plan's regular allocation formula (5.7% up to wage base + 13.7% above) satisfies 410(b) because it covers 47/70, which is 67%. 67% is greater than the safe-harbor percentage, since the safe-harbor percentage can't be greater than 50%.

What part of my calculations do you disagree with?

[ERISAnut]

I do not agree with two parts (one seemed to be a typo).

1) The formula would be 8% up to the wage base and 13.7% above. The excess amount cannot exceed the base amount. The additional excess is limited to 5.7%. I am assuming this was a typo.

2) You just performed a partial calculation of the nondiscriminatory classification test (which is only one of two requirements for the average benefits test).

The rule is you must pass the coverage ratio test or both the nondisc class and avg benefits test.

Regardless of which test you run, you are comparing the PERCENTAGE of the HCE's who benefit to the PERCENTAGE of the NHCE's who benefit. Just saying that 67% of the entire population benefited doesn't say anything. Now, if you had proven that 70% of all nonexcludable NHCE's benefited, then I would agree with you. For now, we disagree.

[ERISAnut]

that means if (and I stress 'if') you were to go the cross tested route you would be 'required' to increase the contribution of all top heavy people to satisfy the gateway.

Tom, I was suggesting using cross-testing to confirm that the average benefits test is satisfied. I was not suggesting the use of cross-testing for satisfaction of rate group testing under 401(a)(4). Hence, there would be no gateway requirement.

Not exactly correct. You can apply the average benefits testing without cross-testing. But when you cross-test, the gateway automatically applies (unless a broadly available exception or primarily DB in Nature exceptions applies). No exceptions to this would seem to be applicable here.

ERISAnut, please, please, please review prior threads on this issue. It is a settled issue and your understanding is incorrect. The use of crosstesting in the average benefits test does not, in any way, shape or form, cause the gateway requirements to come into play. The regs say it. The IRS has confirmed it at many, many conferences. If you think otherwise, please provide a citation.

Mike Preston, what do you propose the "gateway" is to. It's a gateway into "cross-testing" when benefits aren't made on a broadly available basis or the benefits aren't primarily DB in Nature. The term "gateway" means gateway into cross-testing. You and I will agree to disagree on this one.

[Mike Preston]

I do not agree with two parts (one seemed to be a typo).

1) The formula would be 8% up to the wage base and 13.7% above. The excess amount cannot exceed the base amount. The additional excess is limited to 5.7%. I am assuming this was a typo.

2) You just performed a partial calculation of the nondiscriminatory classification test (which is only one of two requirements for the average benefits test).

The rule is you must pass the coverage ratio test or both the nondisc class and avg benefits test.

Regardless of which test you run, you are comparing the PERCENTAGE of the HCE's who benefit to the PERCENTAGE of the NHCE's who benefit. Just saying that 67% of the entire population benefited doesn't say anything. Now, if you had proven that 70% of all nonexcludable NHCE's benefited, then I would agree with you. For now, we disagree.

Yes, it should have been 8% + 13.7%

I will stipulate that the coverage ratio test (the 70% test) is not satisfied. I am presuming that the plan covers 100% of the employee population - that is all the HCE's and all the NHCE's. I am presuming that 100% of the HCE's benefit at the highest rate. I am presuming that the only participants that do not benefit (either because they actually do not benefit or that they received only the top heavy minimum) are NHCE's. So, forget the body counts, and go with the percentages. I am saying that 67% of the NHCE's are receiving an allocation under the 8% + 13.7%. I am saying that the average benefits test is satisfied (pretend for now that it is passed using a methodology you approve of). I am saying that if the average benefits test is satisfied, then a plan that covers 67% of the entire NHCE population is guaranteed to satisfy 410(b).

All that is left is to convince you that use of crosstesting in the average benefits test does not give rise to a requirement to satisfy the gateway rules.

I'll go look up at least one quote from the IRS on this issue.

You are not alone in your misunderstanding of the rules in this area.

[Mike Preston]

Mike Preston, what do you propose the "gateway" is to. It's a gateway into "cross-testing" when benefits aren't made on a broadly available basis or the benefits aren't primarily DB in Nature. The term "gateway" means gateway into cross-testing. You and I will agree to disagree on this one.

Here's one:

QUESTION 20 (IRS Q&A's Grey Book 2003)

Nondiscrimination: New Comparability Regulations

Do the new comparability regulations apply for purposes of the average benefits percentage test? Assume an employer sponsors both a defined benefit and defined contribution plan, each of which is tested for coverage and nondiscrimination separately, but uses the average benefits test for demonstrating compliance with the coverage requirements for one or both plans. Do the new comparability regulations affect the employer’s ability to do the average benefits percentage test on a benefits basis?

RESPONSE

No. Although Treas. Reg. 1.410(b)-5(d)(5) may be interpreted to suggest that the new comparability regulations do apply for purposes of the average benefits percentage test, the preamble to the final new comparability regulations clearly states, "These rules do not apply ...to the situation in which plans are aggregated solely for purposes of satisfying the average benefit percentage test of section 1.410(b)-5."

[ERISAnut]

Mike Preston, what do you propose the "gateway" is to. It's a gateway into "cross-testing" when benefits aren't made on a broadly available basis or the benefits aren't primarily DB in Nature. The term "gateway" means gateway into cross-testing. You and I will agree to disagree on this one.

Here's one:

QUESTION 20 (IRS Q&A's Grey Book 2003)

Nondiscrimination: New Comparability Regulations

Do the new comparability regulations apply for purposes of the average benefits percentage test? Assume an employer sponsors both a defined benefit and defined contribution plan, each of which is tested for coverage and nondiscrimination separately, but uses the average benefits test for demonstrating compliance with the coverage requirements for one or both plans. Do the new comparability regulations affect the employer’s ability to do the average benefits percentage test on a benefits basis?

RESPONSE

No. Although Treas. Reg. 1.410(b)-5(d)(5) may be interpreted to suggest that the new comparability regulations do apply for purposes of the average benefits percentage test, the preamble to the final new comparability regulations clearly states, "These rules do not apply ...to the situation in which plans are aggregated solely for purposes of satisfying the average benefit percentage test of section 1.410(b)-5."

Let's compare apples to apples. This exception to the gateway would be because the benefits provided are primarily DB in nature. Your example here includes the existence of a DB plan which makes a world of difference. Are we learning yet?

[Mike Preston]

Mike Preston, what do you propose the "gateway" is to. It's a gateway into "cross-testing" when benefits aren't made on a broadly available basis or the benefits aren't primarily DB in Nature. The term "gateway" means gateway into cross-testing. You and I will agree to disagree on this one.

Here's another: (IRS Q&A's 2002 ASPA Annual Conference)

29. An employer maintains only a profit sharing plan. The contributions under the plan do not satisfy any of the gateways under the cross-testing regulations. The plan passes the average benefit percentage test on a benefits (cross-tested) basis, but not on a contributions basis. In applying the general test to the amount of contributions, may the rate groups be tested by comparing their ratio percentages to the mid-point of the safe and unsafe harbors?

Yes.

In other words, may the plan use cross testing in the average benefits percentage test, even though it may not use cross testing in the 401(a)(4) general test itself?

Yes.