New Small Plan and Non Discrimination

[Gary]

A small employer with say an owner and 5 employees wishes to implement a combination DB/DC plan and intends to pass non discrimination by using cross testing.

The owner sees he can get a lot of mileage out of a DB plan since he has many years of past service as compared to the employees (no other employees previously worked in company other than the current five), and is older than the 5 employees.

Say the employer implements a DB plan with a unit credit accrual of 2% per year for him and 1% per year for the employees and by implementing a DC plan and using cross testing and combining plans he intends to pass 401a4.

So what happens is the owner enters the DB plan with an AB of 20% of comp due to his past service, subject to 415.

The question is can the owner be deemed to have an accrual of 2% on the annual accrual method or do we need to base the accrual on the fact that it is a new plan and he had $0 at start of year and now has an AB of say $15,000 at end of year due to past service leverage.

So based on one method his accrual is 2% and say his compensation is $75,000 then his accrual would be 20% based on the change in AB from $0 to $15,000.

Any thoughts? Obviously a key technique re: ND testing.

Thanks.

[Effen]

Take a look at §1.401(a)(4)-5.

Generally, you can't grant more than 5 years of past service without having to demonstrate it is non-discriminatory.

Also, you can't accrue more than the 415 limit, so the most he could have at the end of year 1 is 10% of the 415 $ limit. The % pay limit is based on service, so it might be ok.

[Gary]

Yes Effen I agree with your points.

So for example if the company never had any other prior employees then it should be no problem to grant past service greater than 5 years.

And I agree that 10% of the 415 dollar limit is the maximum annual accrual.

Thanks.

[Effen]

I wouldn't go that far. I'm not saying you shouldn't do it, but I wouldn't want to be to one to tell the client "they have nothing to worry about." I usually realy on the ERISA attorney for they type of statement. Anything beyond 5 years has some risk to it. If the client understands this and decides to do it, then it is his choice. I generally stay out of legal opinions.

[ak2ary]

In order to get the 2% accrual rate you have to use the accrued to date method...the annual method will result in a 20% accrual rate. If you use accrued to date, you must also use accrued to date in the DC plan (must have consistency in the measurement period)..this will spread the DC contribution over past service for all of the NHCEs and the HCE as well