defined benefit inequities

[Guest lip]

We took over a db plan with 4 attys (partners)and 10 staff.

partners assumed they would each get what they put into plan when they left.

we told them dbs dont work that way;especially after assets have been lowered by market "downturn"

Besides a cash balance plan;does anyone see "outside agreements" that partnership agreement puts in to "equalize" these inequities?

[Blinky the 3-eyed Fish]

Depending on when the partner leaves depends on what they get. If they leave and the plan remains ongoing, they must get their full benefit. If they leave and the plan terminates, then the partners waive benefits and get less. Barring a crappy document provision preventing this, the partners (assuming they are HCE's) can waive basically however they want to even out any inequities.

Back to a situation though where the plan is ongoing, yet it is underfunded. In that case the remaining participants are the ones feeling shorted. I have had groups agree to reduce the departing partner's receivables to adjust for this "windfall". But this can be tough to quantify and so it's much better if they are told up front to do whatever they can to keep the plan fully funded. Conservative investments and bringing it to full funding each year are two helpful ways. Keep in mind too that if there are NHCE's in the plan, top 25 HCE distributions are restricted.

Lastly, this is much easier if it's a cash balance plan. If it's a traditional DB plan where 417(e) variances creep up, you have yourself another wrinkle to contend with.

[Andy the Actuary]

Let say it's a new plan with partners age 48, 52, 55, and 57 -- each earning well over the 401(a)(17) threshold. They will all go out at age 62. Now being like all good partners, they are petty and go ape over the inequity of one partner getting an iota more benefit than the other. So, (1) set lump sum a.e. at say 4% and say 94GAR. Then, determine maximum benefit at 62 for 48 year old such that you are assured lump sum at 62 will not exceed 415(b) limit. I don't know how you would do this but do it anyway. Then, you will determine ILP or EAN or whatever you call it level cost=L. Then, annual theoretical cost for age 48 is L48. Annual theoretical cost for age 52 is then L52=L48 x 14/10, for 55 is then L55=l48 x 14/7, and for 57 is then l57= L48 x 14/5. Accumulate L52 at 6% to 62 back into benefit, L55 at 6% to 62 to back into benefit, and l57 at 6% to 62 to back into benefit. Staff would have to have a benefit formula that yielded greatest accrual rate and new partners would have to be based on L48 -- even if younger.

Assuming no gains and losses, PPA, famine, pestilence, or plague, Partners will all have contributed same amount.

Now, this exercise is not to say you can hit it on the button, but you can't get reasonably close by having different benefits for each partner.

Frankly, I'd invest in money markets to give this silly arrangement the best chance of working.

[tymesup]

We took over a db plan with 4 attys (partners)and 10 staff.

partners assumed they would each get what they put into plan when they left.

we told them dbs dont work that way;especially after assets have been lowered by market "downturn"

Besides a cash balance plan;does anyone see "outside agreements" that partnership agreement puts in to "equalize" these inequities?

The feds don't like "outside agreements". Their contention is the combined arrangement constitutes a giant cash or deferred arrangement, in violation of the 401k deferral limit.

[Andy the Actuary]

I'm aware of profit sharing plans covering large law firms where each partner elects his/her own contribution rate. The proviso is the rate remains in effect for 3 plan years irrespective of the amount of whining and begging the partner may undertake. I'm not involved with such cases nor am I a legal beagle so please don't take this news as any more than "I have heard."

[jpod]

As to the partnership "side agreements," a partnership can make special allocations of profits and losses and cash distributions; it's done all the time.

As to each partner "deciding" on how much he or she will contribute from one year to the next, or each owner in a non-partnership setting, and then everyone being made "whole" through adjustments in cash distributions/salary payments, there is a line of thinking that this is not a "giant CODA" as long as each partner/owner does not have unilateral authority over these decisions. If a partner/owner merely expresses his or her preference, but the board or committee (or the entire partnership or the shareholders) is vested with the ultimate responsibility to decide on annual contributions for the entire firm, the position advocated is that this is not a CODA. I, for one, believe this line of thinking has a lot of merit.

[tymesup]

We had an attorney look at this years ago. He reached the conclusion that a partner could make a one-time irrevocable election with respect to the partners' plan, now get this, when the partner was first hypothetically eligible for the partners plan. Specifically, if you were hired as an associate, you had to make this election when you satisfied the age and service for the partners plan, even though you were still an associate (and had no idea when you would make partner or what partnership would look like).

[tymesup]

Pasted from another board, probably from 401(a)(26) regs

(iii) Defined benefit plans with other arrangements.

(A) In general. A defined benefit plan is treated as comprising separate plans if, under the facts and circumstances, there is an arrangement (either under or outside the plan) that has the effect of providing any employee with a greater interest in a portion of the assets of a plan in a way that has the effect of creating separate accounts. Separate plans are not created, however, merely because a partnership agreement provides for allocation among partners, in proportion to their partnership interests, of either the cost of funding the plan or surplus assets upon plan termination.

(B) Examples. The following examples illustrate certain situations in which other arrangements relating to a defined benefit plan are or are not treated as creating separate plans:

Example (1). Employer A maintains a defined benefit plan under which each highly compensated employee can direct the investment of the portion of the plan's assets that represents the accumulated contributions with respect to that employee's plan benefits. In addition, by agreement outside the plan, if the product of the employee's investment direction exceeds the value needed to fund that employee's benefits, Employer A agrees to make a special payment to the participant. In this case, each separate portion of the pool of assets over which an employee has investment authority is a separate plan for the employee.

Example (2). Employer B is a partnership that maintains a defined benefit plan. The partnership agreement provides that, upon termination of the plan, a special allocation of any excess plan assets after reversion is made to the partnership on the basis of partnership share. This arrangement does not create separate plans with respect to the partners.