Floor offset - minimum participation

[tymesup]

Suppose a profit sharing plan contributes 5% to some participants and 8% to others. Since all participants are getting 5% or more, can the DB plan benefit be offset by a uniform 5% and be OK with respect to 401(a)(26)?

Thanks in advance for the help.

[Mike Preston]

I believe the answer is yes, but you really should submit a letter of determination application to ensure your client is protected should the IRS come out with yet another strange interpretation.

[Andy the Actuary]

Wouldn't it be cleaner to set up the profit sharing plan with everyone getting 5% in their "A" account and only some getting the additional 3% in their "B" account. Then, the DB Plan would be written to offset only by the "A" account? Otherwise, it could become messy, in particular if someday the 5% or 8% rates were modified.

[tymesup]

Agreed that a determination letter would be prudent.

Agreed that separate accounts would be easier to administer.

Thanks for the help.

[SoCalActuary]

My experience with this issue is that the DC administrator must work closely with the actuary for the allocation to be done correctly. Especially in daily-valued accounts, the default is that the contribution will be allocated to one account, defeating the intent to keep the accounts separate.

I have also faced the problem that only "new" money was to be used in an offset formula, but the DC plan did not set up the new account. In smaller plans, this is managable, but beyond 25 lives it is a serious administrative burden to compute the balance subject to offset.

[Mike Preston]

You are kidding, right? You really have an offset plan where the offset is invested in a daily valued environment? Unless it is a very small offset, the logic of having the participants able to invest monies used as an offset escapes me.

[Andy the Actuary]

Unless the PS plan money is invested by a trustee, you would be giving participants a "risk free" investment by the floor plan design. Is there some rationale to offering participant's investment discretion that is being overlooked?

[tymesup]

If the offset is large, participant direction could work. If there is no accrued benefit in the DB plan, then the participant is gambling with their own money.

I had a prospect that was making a 15% SEP contribution for everyone. They wanted a new design including a DB plan for the partners that wouldn't hurt the staff. A floor offset would have worked well; everyone was an investment genius so they weren't going to take away participant direction. Most folks would never get anything under the DB plan. I wish I had thought of this design back then.

[Mike Preston]

Amazing the rationalizations, if you ask me. This whole thing falls apart the first time the participant finds themself in a position to arbitrage your risk, and the plan loses. All I know is that I wouldn't want to be the one who designed it. I suppose there might be a circumstance where it would make sense. I haven't heard it, yet, though. And, no, getting lucky (even for a long period of time) or having participants who are not capable of understanding the issue (even for a long period of time) is just not enough.

[SoCalActuary]

Not kidding.

The 401k with daily trading was in place before the DB was designed.

The DB was designed before I started working on the plan.

The client needs the DC plan to carry the weight of contribution for gateway and 401a4 testing rates

and frankly does not worry about the risks because the employees really value

their 401k plan enough not to gamble on risky returns.

Our challenge is separating the DC account into the uniform and non-uniform portions (old vs new money).

[ak2ary]

Reissued 7/17/2007

MEMORANDUM FOR MANAGER, EMPLOYEE PLANS DETERMINATIONS AND MANAGER,

EMPLOYEE PLANS DETERMINATIONS QUALITY ASSURANCE

FROM: Director, Employee Plans Rulings & Agreements

SUBJECT: Section 401(a)(26) as applied to offset plans

...

(2) If the plan provides a meaningful gross benefit that is

offset by a benefit under another plan under which the employees

benefit on a reasonable and uniform basis we will treat the plan as

satisfying section 401(a)(26). Of course, in order to satisfy the

requirements of section 1.401(a)(26)-2 of the regulations, the

requirements under 1.401(a)(26)-5(a)(2)(ii) or (iii) must be

satisfied (relating to sequential or concurrent offset

arrangements). Note that these rules generally will not be satisfied

if the offset applies for some participants (usually non-highly

compensated employees) but not all participants. These rules

generally will be satisfied if the benefits under the offsetting plan

are either a level percentage of pay, or a flat dollar amount, or an

amount necessary to provide a uniform benefit (either flat dollar or

level percentage of pay) in the plan being offset.

It seems to me that this is saying that the uniform allocation cannot be a new comp allocation (other than an age-based). Prior to seeing this the other day, it was my understanding that the IRS had backed off this position and was allowing the underlying DC plan to be a cross tested plan as long as the allocation used for the offset was uniform. Now...I am not so sure

[Andy the Actuary]

These rules

generally will be satisfied if

appears to state a condition of satisfaction but not necessarily imply a condition of dissatisfaction.

[ak2ary]

While I agree with your analysis of the the language and sentence structure, this memo is directed to field agents and DL reviewers and I do not believe that any of them will read this as saying, this is not meant to imply that a plan that applies the offset by only taking into account a uniform portion of the underlying DC plan will fail the concurrent offset rules.

The Service has been grappling with different interpretations of the the concurrent offset rules for years and the IRS interpretations differed in different regions. This is the national office guidance to the field on this topic and it seems to me that, since this issue has been raised time and again, this was their opportunity to finalize their opinion on the "uniform portion" offset and they did not OK it

[Andy the Actuary]

They have more important issues to fret over than floor offset plans, such as whether or not to use generational mortality tables for one-person plans!

[Blinky the 3-eyed Fish]

All I know is I would be very hesitant to put in an offset plan unless the DC provided strictly uniform beneifts. I would think an integrated allocation would meet that requirement.

I do recall there are a number of these plans in technical review and that's been the case for 2-3 years now. Maybe someday we will know the rules.

[SRM]

ak2ary,

Could you post the entire memorandum or send via private email?

Thanks.

SRM

[Dougsbpc]

Does anyone think just having cross-tested language in the DC plan would prevent the DB from passing 401(a)(26)? The last sentence in the memo indicates "or an amount necessary to provide a uniform benefit". Suppose your DC had allocation groups 1 and 2, but in operation you always provided 10% of salary to both groups 1 and 2 (i.e. all participants receive the same percentage of salary). Would this fail 401(a)(26) just because you have different allocation groups in the DC document?

[Blinky the 3-eyed Fish]

Based on the 1.401(a)(26)-5 language:

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

I don't see that the document language is a factor in the determination and think having cross-tested language in the document is acceptable.

But again, I would be cautious.

[ak2ary]

Given that this issue has been in for tech advice, and that the national office is keenly aware of it; and given that it has been far easier, apparently, to get a DL on the west coast with respect to the "portion of the DC" offset than on the east, the timing of this memo seems to imply that the IRS isn't buying into this offset.

Otherwise why would they publish this memo now?

If it was just to say that the offset has to apply to both HCEs and NHCEs, they could have left the uniform allocation comment out.

So I agree with Blinky...I would also agree that an integrated allocation is uniform

[ak2ary]

Given that this issue has been in for tech advice, and that the national office is keenly aware of it; and given that it has been far easier, apparently, to get a DL on the west coast with respect to the "portion of the DC" offset than on the east, the timing of this memo seems to imply that the IRS isn't buying into this offset.

Otherwise why would they publish this memo now?

If it was just to say that the offset has to apply to both HCEs and NHCEs, they could have left the uniform allocation comment out.

So I agree with Blinky...I would also agree that an integrated allocation is uniform

Just read page 2...sorry

I agree that the determination is based on how the employees actually benefit...not on how the employees could potentially benefit. So if you have different allocation classes for different groups, but all the classes get a 5% allocation, they would, IMHO, be benefiting on a reasonable and uniform basis.

Attached is the full memo

FloorOffset_A_26.doc

[tymesup]

1.401(a)(4)-8(d)(1)(i) says "Under the floor-offset arrangement,... all or part of the employee's acount balance ..." - which anticipates partial offsets.

Compare that to 1.401(a)(26)-5(a)(2)(iii)(A)(3) - "The contributions or benefits under the plan that are used to offset". This doesn't seem to anticipate an offset by part of a plan.

The June 6, 2002 Memo refers to "the benefit provided under a profit sharing plan". This also doesn't seem to anticipate an offset by part of a plan.

The 7/17/2007 Memo refers to offset a number of times:

The first paragraph has "an offset by other plans".

The third paragraph has "the benefit provided under a profit-sharing plan" - again, no mention of part of a plan. However, it then has "if the offset applies for some participants" which must anticipate splitting a plan into parts.

The fourth paragraph then reverts to "the benefit provided under a profit-sharing plan" and "the benefit provided by another plan".

Therefore, one could argue either way whether it is permissible to offset by part of a PS plan.

***

If it is not permissible to offset by part of a PS plan, then (2)'s reference to "the benefits under the offsetting plan" means the same thing as the offset. However, if partial offsets are OK, then it appears that (2)'s reference ought to be interpreted to mean the offsetting benefits, rather than the benefits of the plan as a whole. This would be consistent with the earlier references to "the offset", "an offset" and "the benefit provided".

***

While it seems prudent to get a determination letter, is this even possible with the staggered system now in place?

[ak2ary]

The problem is that the only reference you give that allows a partial offset is 401(a)(4) {partial in terms of part of the participant's benefit as opposed to some participants and not others}. We are looking solely at whether to test 401(a)(26) by considering the gross benefit before offset or the net benefit after offset.

This looks at the definition of concurrent offset under 401(a)(26), which says (among other things) that unless the participants benfit under the offsetting plan on a reasonable and uniform basis, you must test the net benefit

There is no question that it is legal to offset by a portion of the account balance...it just looks like, in the IRS' eyes, you may be forced to test for 401(a)(26) AFTER the offset, Thus, anyone whose net benefit is zero or less than a meaningful amount, would not be benefiting for 401(a)(26) purposes

[Mike Preston]

I think this issue was directly addressed by Jim Holland at the COPA conference this last weekend. My understanding of what he said is that the IRS would not force one to set up two plans to accomplish a proper offset and satisfy 401(a)(26). That, to me, makes it clear that a partial offset is allowable. Have fun tracking everything, of course.

Hopefully, he'll be asked the same question at the ASPPA Annual conference and answer it the same way.

[Guest Judy S]

Could someone please post the June 2002 IRS memorandum?

[Everett Moreland]

http://www.irs.gov/pub/irs-tege/memo_060602.pdf

[ak2ary]

I think this issue was directly addressed by Jim Holland at the COPA conference this last weekend. My understanding of what he said is that the IRS would not force one to set up two plans to accomplish a proper offset and satisfy 401(a)(26). That, to me, makes it clear that a partial offset is allowable. Have fun tracking everything, of course.

Hopefully, he'll be asked the same question at the ASPPA Annual conference and answer it the same way.

This is why I was surprised by the memo. Both Jim and Marty have said at conferences over the past year or so, and in preconference meetings, that they believed that they were allowing the partial offset and seemed to give the go-ahead to the design. The question of course, then, is why does the memo bring up "uniform and reasonable" and imply that it is a somewhat limited definition.

[Blinky the 3-eyed Fish]

Maybe someday we will know the rules.

[Andy the Actuary]

There will be corrective lens for 3-eyed fish before that happens!!!!!!!!!!!

[tymesup]

Suppose a plan had a tiered allocation in past years, but was uniform this year. Could the entire account balance be used as an offset this year? Or is this arrangement tainted forever?

Thanks again for any help on the subject.

[ak2ary]

Unless the plan tracked or could track the uniform portion of the prior account balance and use only that portion for the offset, I think you've got problems. You could start to track future contributions in a different bucket...

I don't see how you could use the entire balance as an offset