401(a)(26) for DB with Benefit Offset

[John Feldt ERPA CPC QPA]

Here's an interesting potential takeover that is causing me to examine my interpretation of 1.401(a)(26)-5:

Two business owners (50% each) have differing investment philosophies, so they set up 2 DB plans, one for each owner (and each plan covers the employees too, uh sort of, - well, you'll see...)

They set up the formula for Plan A (for owner A and all non-owner employees) to provide the largest benefit (both plan's have the same retirement age provisions and actuarial equivalence).

For owner B and all non-owner employees, they set up Plan B which has a smaller formula where the benefit accruals are offset by the actuarial equivalent of the amounts accrued under Plan A. Thus, the benefits in Plan B are completely offset by the benefits accrued in Plan A, other than the benefit for owner B. You see, the document for Plan A excluded owner B from participation in Plan A. Likewise, Owner A was excluded from Plan B.

However, the requirement under 1.401(a)(26)-5(a)(2)(iii)(2) states,

"The employees who benefit under the formula being tested also benefit under the other plan on a reasonable and uniform basis."

Does that mean ALL employees under the formula MUST also benefit under the other plan?

If so, then doesn't this two-plan arrangement (described above) fall apart, since it does not get to disregard the offset when determining who 'benefits' -which is what 1.401(a)(26)-5(a)(2) would otherwise allow?

Is there a way such a 2 plan arrangement could be established to ultimately have only one owner with a net benefit in the plan?

[Blinky the 3-eyed Fish]

I think the design could be suspect for plan B. Do you have a determination letter ruling on 401(a)(26)?

This question mostly comes up in the context of a DB/DC arrangement. For what it's worth, I have seen determination letters issued on offset plans when the owner is getting a DB benefit and nothing in the PS plan, while the staff's DB benefits are offset by the DC. I have also seen a determination letter where the DB is offset by the DC contributions for everyone but the owner. The practical result is the same as your situation, but in any offset case I would certainly want my own ruling.

As to your last question, why the offset at all? Why not just provide the staff benefits in both plans that in total equal the benefits they are receiving now? Then aggregate the plans for coverage and nondiscrimination testing.

[John Feldt ERPA CPC QPA]

They did not obtain an IRS opinion regarding 401(a)(26).

When you cover everyone in both plans as you suggest, do you have two accrual classes in the first plan so the second owner is not accruing the higher benefit that the first owner is? If so, does this jeopardize the "uniform" requirement?

[JAY21]

Let me piggy-back on J4f's question and ask if anyone sees any problems with this DB-offset design which I think is fairly typical (but I'm new to DB-Offset arrangements):

DB plan has 2 accrual rates; one for Owner (high) and lower accrual rate for staff (e.g., 0.5%). PS plan has uniform allocation formula and assume it's 7.5% of pay for all employees including owners. Let's assume 7.5% is sufficient for (a)(4) testing (and gateway; plans combo tested), does this structure passs 401(a)(26) if some/all of the participants DB accruals is fully offset by their DC balance ? Also, I assume the "offset" can be done on a benefits basis and therefore can be converted to EBARs before being offset against the DB accruals, correct ?

[SoCalActuary]

Jay - your design appears to be fine. I would test it by taking the net db benefit plus the benefit derived from the PS plan allocation. In other words, the net db benefit is based on the document's actuarial assumptions for valuing the PS offset, but only to determine the actual db benefit. Then the PS contribution gets tested using "reasonable" 8.5% assumptions.

[Guest Dave Peckham]

Blinky, I had an audit recently where my IRS field auditor had Newell Kimlin review the offset arrangement, and Newell opined that the participants of the DC plan did NOT "benefit under the [DC] plan on a reasonable and uniform basis" unless the owners got the same 7.5% contribution that everyone else got. In this case all participants of the DB plan, including owners, had benefits offset by the AE of their DC plan balance.

Now, I have a different situation. My client has an existing DB/DC offset arrangement, and now wants to provide higher DC benefits to M, a minority owner HCE. Eligibility is not a protected benefit, so the principal owner P wants to prospectively exclude M from participation in the DB plan.

Now M will no longer "benefit under the [DB] formula being tested," right?

So can M now have a DC benefit which is much higher than the 7.5% uniform benefit provided to everyone else who IS subject to a DB offset?

I'm certain this would work if the client adopted a third plan in which only M participates, but we want to avoid the expense of a third plan.

[SoCalActuary]

My concern is that you need to keep track of the offset benefit applied on a uniform basis, and keep the

account values for the non-uniform added contribution in a separate account. Thus you could properly

compute the offset benefits that comply with the current IRS position.

[ak2ary]

The concern should be that the IRS is all over the map in terms of the concurrent offset rules, especially the reasonable and uniform requirement. They see this area as ripe with abuse. Certain areas of the country have issued determination letters that are flat rejected in other regions. It is rumored that Kimlin and Holland and Pippins all answer the same questions on this topic differently and, I believe, for the last couple of years National Office personnel do not answer these question at all.

I recommend caution and determination letters with full full full disclosure in the application

[Blinky the 3-eyed Fish]

ak2, you are dead on with your observations. Pippins promised in July the IRS would come out with some guidance in this area. Someday I guess...

Dave, get an FDL.

[AndyH]

Would someone kindly elaborate on exactly what is under scrutiny.

If a DB plan provides 8% to owners and .50% to everyone else and is offset by a DC plan that gives everyone 5% is this under scrutiny?

What if the owners do not get offset by the DC plan? Is that an area of controversy? I think not.

What if the owners get 7% in the DC instead of 5%? That seems to be the issue, right? The uniformity of the offsetting plan?

[SoCalActuary]

The issue raised in these plans is that you don't get 401a26 protection if you do not offset exactly the same

uniform PS formula. That does not prevent the IRS from allowing an exception if you can make a good case for it.

But the default is that the IRS is not approving tier-allocation DC plans as a uniform offset.

[John Feldt ERPA CPC QPA]

ok, the original question is looking at 1.401(a)(26)-5(a)(2)(iii)(2) which says,

- - "The employees who benefit under the formula being tested also benefit under the other plan on a reasonable and uniform basis."

My question is what is uniform and does it mean all employees must benefit under the other plan?

Good Example: 2 HCEs and 5 NHCEs. HCE 1 and all NHCEs accrue 2% of pay in Plan 1. In Plan 2, HCE 1 accrues 3.4% of pay and all NHCEs accrue 2% of pay - and all benefits in Plan 2 are offset by the accruals in plan 1 (retirement ages are the same as well as other features in this example). All employees benefit under the other plan and on a uniform basis - so not a problem.

Questionable Example: 2 HCEs and 5 NHCEs. HCE 1 and all NHCEs accrue 2% of pay in Plan 1, but HCE 1 has his benefit offset by his accruals in Plan 2. In plan 2 HCE 1 accrues 3.4% of pay and all NHCEs accrue 2% of pay - and the benefits of only the NHCEs are offset by the accruals in plan 1. The employees benefiting in plan 1 are not accruing on a uniform basis- so this is a potential problem, according to how I think this regulation reads.