Discriminatory Investment Choices In 404(c) Plan?

[mming]

The owners of a company were the only employees eligible to participate in the first year of the plan. During this first year they invested their account balances in 100% of the company's qualifying employer securities (which the doc allows). Ancillary employees enter the plan during the second year and can choose to invest from a menu of mutual funds, but do not have the choice of QES since there are no shares available. Is there a way to construe the plan as not being disciminatory due to the literal unavailability of the company stock? Thanks in advance.

[Kevin C]

You will want to read the recent guidance on Rollovers as Business Startups. What you are describing sounds somewhat close to the situations discussed in the guidance.

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

From page 6:

Benefits. Rights & Features Discrimination

Because ROBS transactions generally benefit only the principal involved with setting up

a business, and do not enable rank-and-file employees to acquire employer stock, we

believe that some of these plans violate the anti-discrimination provisions of the Code

and Regulations, on a case-by-case basis.

[MSN]

The availability of an investment alternative is not a protected benefit. You can disallow additional contributions into a fund at any time, provided that such removal is pursuant to prudency standards for the applicable plan fiduciary. Even in a ROBS transaction, the mere fact that an investment alternative is no longer available for future contributions does not, in and of itself, create any problem for the plan. The investment was available to all plan participants when it was offered, it just happens that the only participants were HCEs.

[Bird]

Even in a ROBS transaction, the mere fact that an investment alternative is no longer available for future contributions does not, in and of itself, create any problem for the plan. The investment was available to all plan participants when it was offered, it just happens that the only participants were HCEs.

That might be true; I know there is a catchall in the 401(a)(4) regs that says a pattern of amendments can create discrimination, but it's probably a stretch to make it apply here - or maybe not. Personally, I think it smells, and some day it might generate another 3000 pages of regs because somebody was greedy.

[Kevin C]

The timing of the amendment can also cause it to be discriminatory. Under 1.401(a)(4)-5(a)(1) any change in the benefits, rights or features under the plan is considered to be a plan amendment. I don't think it is much of a reach to say that when the employer securities ceased being effectively available as a plan investment option, it was a change in B, R or F under the plan.

Here is a B,R or F timing discussion from Rev. Rul 2004-10:

Taxpayers are also reminded that the allocation of plan expenses must comply with the nondiscrimination rules of §401(a)(4). The method of allocating plan expenses is a plan right or feature described under §1.401(a)(4)-4(e)(3)(i). For example, if, in anticipation of the divorce of a plan participant who is a highly compensated employee, the plan's method of allocating expenses is changed so that the expense of a determination of whether an order constitutes a qualified domestic relations order under §414(p) ceases to be allocated solely to the account of the participant for whom the expense is incurred, but instead is allocated pro rata to all accounts, the timing of such change may cause the plan to fail to satisfy the requirements of §1.401(a)(4)-1(b)(3) and (4) with respect to the nondiscriminatory availability of benefits, rights and features and with respect to the timing of plan amendments.

[MSN]

I don't think it is much of a reach to say that when the employer securities ceased being effectively available as a plan investment option, it was a change in B, R or F under the plan.

I'm not a fan of ROBS transactions either, but find it difficult to believe that there would be a BRF issue if only HCEs were in the plan at the time the investment was no longer available. Just out of curiosity, if a plan froze contributios into a particular fund, would you do BRF testing? I wouldn't (I don't believe the availability of an investment is a BRF), but maybe I should be??

[Kevin C]

(I don't believe the availability of an investment is a BRF)

§1.401(a)(4)-4(a) Introduction. --This section provides rules for determining whether the benefits, rights, and features provided under a plan (i.e., all optional forms of benefit, ancillary benefits, and other rights and features available to any employee under the plan) are made available in a nondiscriminatory manner. Benefits, rights, and features provided under a plan are made available to employees in a nondiscriminatory manner only if each benefit, right, or feature satisfies the current availability requirement of paragraph (b) of this section and the effective availability requirement of paragraph © of this section. Paragraph (d) of this section provides special rules for applying these requirements. Paragraph (e) of this section defines optional form of benefit, ancillary benefit, and other right or feature.

§1.401(a)(4)-4(e)(3)(iii) Examples. --Other rights and features include, but are not limited to --

(A) Plan loan provisions (other than those relating to a distribution of an employee's accrued benefit upon default under a loan);

(B) The right to direct investments;

© The right to a particular form of investment, including, for example, a particular class or type of employer securities (taking into account, in determining whether different forms of investment exist, any differences in conversion, dividend, voting, liquidation preference, or other rights conferred under the security);

...

[Bird]

There's a big difference between freezing a particular fund and ceasing to offer a particular type of investment - Kevin has nailed this pretty well, I think.