Plan Design Issues

[Gary]

Say we have a privately held company that has 5 employees, including the owner.

They want to design the plan with basic eligibility provisions of 21&1.

They want to include an additional employee who works less than 1000 hours and is age 17 (i.e. their son).

Is there a problem with adding an additional provision to include the son?

Of course we can just have the plan provisions be immediate entry for all employees, but just wondered if there is an explicit problem with the specific provision. There are no other employees that are not 21 & 1. But what if there were? Could it still be an acceptable provision or does the group not 21 & 1 need to be tested separately for the coverage tests?

Thanks.

[david rigby]

Can you define initial eligibiltiy as "employed on the effective date of the plan", and subsequent eligibility using dual entry dates and 21&1?

[J Simmons]

David,

Would that then be an amendment from liberal to restrictive eligibility rules and subject to nondiscrimination analysis under Treas Reg § 1.401(a)(4)-5(a)?

[david rigby]

Well, maybe. But I assumed this is a new plan, so my comment had nothing to do with an amendment (at least, not in the formal sense).

However, if -5 is relevant, who is harmed?

[Guest Sieve]

John, I have never even considered such a provision as suggested by David--or any other amendment changing liberal eligibility standards to the Code's minimum--to be subject to 401(a)(4) scrutiny, I guess because 21/1 is still within minimum standards and an amendment cannot be discriminatory if it complies with the minimum eligibility standards of the Code & ERISA. I think it gets a free pass around 401(a)(4).

[mwyatt]

Just a comment that allowing all at the Effective Date to participate and then future hires subject to 21/1 is pretty common option in prototype and Volume Submitter plans, so don't think that the IRS views this as a big issue. Of course, going forward for eligibility for accrual/contribution, you're going to have to do something less than 1,000 hours as a requirement or this is all academic.

[J Simmons]

Treas Reg § 1.401(a)(4)-5(a)(1) includes the following--

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.

Emphasis added.

Whether an amendment (or series of them) is discriminatory--

is determined at the time the plan amendment first becomes effective ..., 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)

Treas Reg § 1.401(a)(4)-5(a)(2).

Maybe because the amendment in essence from no age or service conditions for those on payroll on date of plan establishment to imposing 21&1 immediately thenafter cannot be 401a4 discriminatory because such latitude is allowed under 410. (It would seem to me if an amendment exceeded such latitude, for example, 24&3, you'd have qualification problems without the IRS needing 401a4 anyway.) Would then under similar logic Laura's posted situation be exempt from 401a4 discrimination if ACP testing passes?

Since Treas Reg § 1.401(a)(4)-5 is a facts-and-circumstances test, IRS opinion, notification, and D-letters for plans would not provide any cover for such an issue anyway.

As Tom likes to say, just my 2¢.

[Guest Sieve]

John --

A plan does not require 401(a)(4) testing between those covered under the plan and those not covered under the plan--non-discrimination testing only deals with individuals who are covered by (benefiting under) the plan. Comparing those covered by the plan with those not covered by the plan is a function of IRC Section 410(b) testing, and that allows us to exclude those not meeting the plan's eligibility standards.

If a group of employees is excluded from plan coverage--e.g., Division A employees, or employees not meeting 21/1--then the plan's exclusion of Division A employees (or employees with less than 21/1) first must pass 410(b) muster. If it does, then only those participanting in the plan have to be tested under 401(a)(4) (and, as for those not reaching 21/1, all those employees can be excluded for 410(b) purposes anyway). That's the whole point of Section 410(b): it determines whether the plan's eligibility standards are discriminatory, and then 401(a)(4)--after 410(b) passes--determines if the benefits under the plan are discriminatory. "To be a qualified plan, a plan must satisfy both section 410(b) and 401(a)(4). Section 410(b) requries that a plan benefit a non-disriminatory group of employees, and section 401(a)(4) requires that the contributions or benefits provided to employees benefiting under the plan not discriminate in favor of HCEs." (Treas Reg. Section 1.401(a)(4)-1©(4) (emphasis added).) So, a change to 21/1 will pass 410(b) coverage (all other things being equal), and then those not reaching 21/1 will not be tested for 401(a)(4) compliance.

I think determining discrimination upon establishment of the plan just means that there cannot be discrimination among plan participants even if that discrimination is not the result of an amendment, but simply arose as a consequence of the plan's provisions at the time of establishment. It doesn't change the general 401(a)(4) rule of determining discrimination among plan participants. So, if a plan established only for Division A contains loan provisions only for those who are HCEs, the plan still must pass 410(b) muster, and then 401(a)(4) discrimination with regard to loan provisions is determined based on those who are particiapnts in the plan. If a plan with loan provisions all of a sudden is amended to cover only one division, there still would have to be a 410(b) test, and the discrimination under 401(a)(4) would be based on those remaining in the plan after the amendment (assuming 410(b) passed).

Besides, eligibility to participate is not a BRF or a contribution or a benefit, so I don't see how it can even be subject to 401(a)(4) testing at all.

[J Simmons]

Thanks, Larry.

My thinking is that if you earlier do not take full advantage of the 410 exclusions--imposing, for example, no age and service requirements for those employed as of a certain date--you create one pool of benefiting employees. Then when you change and tighten up the age and service requirements (imposing the 21&1), there is a second, smaller pool of benefiting employees. You then compare the two pools of benefiting employees, before and after, per Treas Reg § 1.401(a)(4)-5 to determine if that change discriminates significantly in favor of HCEs, taking into account all the facts and circumstances.

Looking at the reach and breadth of a loan provision (not the timing of its addition, change or discontinuance) is a BRF current availability/effective availability issue under Treas Reg § 1.401(a)(4)-4.

However, I think that when that loan provision was added or is changed or discontinued, Treas Reg § 1.401(a)(4)-5 calls for an examination of the timing and a before-and-after comparison to determine if that discriminated significantly in favor of HCEs, even if looking at matters as they stood before the change separately from those after the change, each standing alone might be sufficiently available to pass BRF muster.

[Guest Sieve]

Assuming a plan meets 410(a), is age/service eligibility subject to 401(a)(4) testing? If not, how can an amendment impacting age/service eligibility be subject to testing under -5?

[J Simmons]

If you relax below 21&1 and allow into the plan, do not the elective deferrals of those individuals have to be taken into account in the ADP testing (whether separately or with all) in being deemed to pass 401a4?

[Guest Sieve]

Not sure what you mean. ADP test does incude deferrals for those below age 21/1 if they are eligible for the plan. You really don't test for 401(a)(4) because the right to defer is unifrom throughout the plan--but, I guess you could say that deemed 401(a)(4) testing for elective deferrals also includes all those eligible for the deferral, since everyone has the same right to defer. But the 21/1 itself isn't tested independently under 401(a)(4)--and, if we use 21/1 for plan eligibility, we certainly don't test for discrimination for elective deferrals by including in the test those who have not reached 21/1.

I just know that when you establish a plan with eligibility of 21/1, you don't test for discrimination under -5. When you amend from something more liberal into 21/1, you don't test under -5, either. You may have a partial termination with such an amendment (another issue entirely), but you don't test under 401(a)(4). Are you suggesting that what we're all doing it wrong (because I would be extremely surprised in anyone tests 21/1 under 401(a)(4))?

[J Simmons]

I'm suggesting that -5 (which applies to plan establishment, amendments and terminations) might apply to a change of the pool of benefiting employees (all within the latitude of 410), not that -2 or -4 applies to a static situation of minimum age and service requirements within that 410 latitude.

[Guest Sieve]

And I'm suggesting that -5 testing does not apply to an amendment which changes those who benefit under the plan if that change is nothing more than simply revising eligibility standards to 21/1. That's my 2 cents.

[J Simmons]

Larry, suppose a plan has 21&1. Plan is sponsored by dental practice. Another dentist that's practiced for 5 years separately from the plan sponsor buys into the dental practice, effective November 1, 2008, when the dentist will become an employee of the plan sponsor. The dental practice amends the plan to make it 21&0 on November 1, 2008, and then amends again on November 2, 2008 to reinstate the 21&1. If I understand your position, this could be done with -5 impunity because it is all within the latitude of 410. Is that right?

[Guest Sieve]

I see no problem under your facts. After the amendment to 21/0, all employees of the dental practice will become participants and the only people hurt by amending back to 21/2 are those who aren't even hired yet. Just because you change to 21/0 for a newly-hired HCE doesn't mean that you've discriminated by using a less liberal eligibility standard in the past. So, this one-time amendment is fine.

Now, if only the dentist is hired on day 1 and is allowed in the plan immediately, and then the dentist's 3 hygenists from the prior 5-year practice are all hired on day 2 subject to the 2-year eligibility rule, and especially if this is repeated with every dentist buy-in over the years, then, yes, there may be discrimination in the manipulation of the amendments and the hiring process over time. But, that's a series of amendments. Immediate eligibility in a new plan to the sole-employee owner followed by 21/1 for subsequent hires is OK, as is immediate eligibility for current employees followed by 21/1 for subsequent hires.

Now I see that we've actually been thinking differently. I've been narrowly visualizing just a one-time amendment changing eligibility, with nothing more (see my last post)--based on your initial suggestion that a one-time change from 0/0 to 21/1 might be subject to -5 testing--while I guess you've been viewing the discussion more broadly as including a series of manipulative amendments. Even though -5 testing can include a series of amendments, I was discussing whether "an" amendment to eligibility standards could be discriminatory under -5, not a series of amendments.

I will concede, gladly and completely, that a series of eligibility amendments might be discriminatory under -5, and certainly is subject to careful 401(a)(4) scrutiny. But I think it's a different story for a one-time eligibility change applicable to everybody.

[J Simmons]

-5 is one of those fluffy requirements where all of the relevant facts and circumstances are considered in determining whether the timing of a plan amendment or series of plan amendments has the effect of discriminating significantly in favor of HCEs.

[Guest Sieve]

Fluffy, indeed. I once heard someone refer to portions of the -4 regs in the same manner.

[J Simmons]

Since you coined the term in 401a4 context, maybe I owe you a dime each time I use it.