Amendment to Eligibility/Vesting Provisions

[Medusa]

We are TPA for this plan and are being asked to amend the plan to change the eligibility/vesting from 2 year/100% to 1 year/6 year graded.

Of course, the two principals came in under the 2 year eligibility and are fully vested. No staff entered under the old provision.

Is there an issue relative to dscrimination in timing of this amendment? I haven't been able to find anything exactly on point.

Any and all help appreciated.

Med

[John Feldt ERPA CPC QPA]

The law, under Internal Revenue Code Section 401(a) states

REQUIREMENTS FOR QUALIFICATION. --A trust created or organized in the United States and forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of his employees or their beneficiaries shall constitute a qualified trust under this section --

(1), ... (2), ... (3), ...; and

401(a)(4) if

the contributions or benefits provided under the plan do not discriminate in favor of highly compensated employees

(within the meaning of section 414(q)). For purposes of this paragraph, there shall be excluded from consideration employees described in section 410(b)(3)(A) and (C ).

IRC 401(a)(4) is interpreted under the Treasury Regulations, one section of which is 1.401(a)(4)-5.

§1.401(a)(4)-5. Plan amendments and plan terminations

(a) Introduction

(1) Overview. --

This paragraph (a) provides rules for determining whether the timing of a plan amendment or series of amendments has the effect of discriminating significantly in favor of HCEs or former HCEs.

For purposes of this section, a plan amendment includes, for example, the establishment or termination of the plan, and any change in the benefits, rights, or features, benefit formulas, or allocation formulas under the plan. Paragraph (b) of this section sets forth additional requirements that must be satisfied in the case of a plan termination.

(2) Facts-and-circumstances determination. --

Whether the timing of a plan amendment or series of plan amendments has the effect of discriminating significantly in favor of HCEs or former HCEs is determined at the time the plan amendment first becomes effective for purposes of section 401(a), based on all of the relevant facts and circumstances.

These include, for example, the relative numbers of current and former HCEs and NHCEs affected by the plan amendment, the relative length of service of current and former HCEs and NHCEs, the length of time the plan or plan provision being amended has been in effect, and the turnover of employees prior to the plan amendment. In addition, the relevant facts and circumstances include the relative accrued benefits of current and former HCEs and NHCEs before and after the plan amendment and any additional benefits provided to current and former HCEs and NHCEs under other plans (including plans of other employers, if relevant). In the case of a plan amendment that provides additional benefits based on an employee's service prior to the amendment, the relevant facts and circumstances also include the benefits that employees and former employees who do not benefit under the amendment would have received had the plan, as amended, been in effect throughout the period on which the additional benefits are based.

(3) Safe harbor for certain grants of benefits for past periods. ...

(4) Examples. --The following examples illustrate the rules in this paragraph (a):

Example 1. Plan A is a defined benefit plan that covered both HCEs and NHCEs for most of its existence. The employer decides to wind up its business. In the process of ceasing operations, but at a time when the plan covers only HCEs, Plan A is amended to increase benefits and thereafter is terminated. The timing of this plan amendment has the effect of discriminating significantly in favor of HCEs.

Do you think the amendment has the effect of discriminating significantly in favor of HCEs or former HCEs? It's facts and circumstances, so the IRS has some leeway when they look at something like this. IMHO, I don't know if a foolproof correct answer is truly known until the IRS gets involved.

Looking at one side, just exactly how does this discriminate significantly in favor of HCEs? Would that mean the forfeitures of the NHCEs may get allocated to HCEs? Doesn't that happen in lots of plans anyway? Maybe this could be discriminatory only if one of the HCE leaves before they achieve their 6th year of vesting service. If that happened, then it does appear to be discriminatory. But if neither HCE left before their 6th year, again, how would this specific amendment have the effect of significantly discriminating?

If they want to be mostly conservative, and if the HCEs only have a couple years of service now, perhaps the plan could be a little safer by adopting a 6-year graded vesting schedule that applies to all new employer contributions, that would impact the vesting of the HCEs too. Still not foolproof though.

[Medusa]

Actually, I seem to remember that you can't do that last thing you recommended.

Your post is much appreciated. I think we will let them go ahead and do it, with the appropriate caveat.

Med

[QDROphile]

What business do you have allowing or disallowing amendments? If you are in a position to be responsible for such matters and you deal with liability on a case by case basis, you have some inherent problems that you need to address.

[Bird]

FWIW, I don't see any "inherent problems" with Medusa's question or approach. In the real world, tpas are expected to provide an answer when a client says "can we do...?" Sometimes we can give a very straight answer but a lot of times we we have to say something to the effect of "well, they're no specific prohibition on the language but if it turns out to be discriminatory in operation according to the IRS then you could have a problem" - which I'm assuming is what Medusa said or will say as a caveat. Where/what is the problem?

[masteff]

No staff entered under the old provision.

Do they have current staff who are about to enter or no staff and just being pro-active before they hire some?

[Medusa]

They do have current staff who would enter soon.

As for the rest, Bird is on the money. Not allowing or disallowing, just advising of potential issues that might come up.

[masteff]

There's small section on vesting schedule changes in the CCH US Master Pension Guide. Some references are: IRC 411(a)(10), ERISA 203©(1), IRS Reg 1.411(a)-8(a), Temp Reg 1.411(a)-8T(b). My edition is a few years out of date, so I can't promise those haven't changed at all.

The CCH Guide does specifically state you can change to a longer schedule as long as it's w/in the standards allowed. The cite on that is an IRS Alert Guideline. I looked and found the latest version of that here: http://www.irs.gov/pub/irs-pdf/p6389.pdf (see section IV page 6 and section VII page 9).

Oh, also you are correct that new forfeitable accruals must be vested at the same level as previously accrued forfeitable money. From the IRS Alert Guideline: "For example, if a plan is being amended to replace a 3 to 7 year vesting schedule with 5 year cliff vesting, a participant who has three years of service at the time of the amendment and elects to go under the new schedule must be 20% vested in the amount accrued in the fourth year (as well as in amounts accrued in the first three years). 1.411(a)-8(a)"

EDIT: with regard to a BRF test, I'm assuming, and someone can correct me if I'm wrong, that the non-participants don't have any BRF's so changing the vesting schedule doesn't impact them. Only the 2 current participants have BRF's and they're being treated equally.

[Medusa]

Masteff - it's my understanding that the two "new" people don't actually get to make any election, since they have not yet entered the plan and have no rights to protect. Agree?

[masteff]

Masteff - it's my understanding that the two "new" people don't actually get to make any election, since they have not yet entered the plan and have no rights to protect. Agree?

That's the way I see it. They're non-participants and have no rights. Provided the amendment is made and effective before they become eligible to enter the plan, they simply go into the new schedule and have no choice in the matter.

[John Feldt ERPA CPC QPA]

Agree.