Is a self-directed brokerage investment option that requires a minimum

[Guest ak]

Is a self-directed brokerage investment option that requires a minimum account balance for participation (imposed by the broker) considered discriminatory under 401(a)(4), both "current" and "effective" availability?

[Guest Ray Williams]

At the ASPA General Conference in October the IRS was asked this specific question. The answer is that is is not discriminatory as long as the broker is the one setting the minimum account balance. The plan document may not contain an account minimum.

[MWeddell]

I'd also be interested in hearing others' opinions on this one, because the issue is arising more often. I think that it potentially is discriminatory, but have heard more than one reputable service provider suggest it, which makes me wonder whether I'm missing something.

Having access to a self-directed option is subject to benefit, rights, or features (BRF) testing. Treas. Reg. 1.401(a)(4)-4(e)(3)(iii)(B) & ©. This testing applies to any BRFs provided under a plan, without a distinction of whether the employer or the broker imposed the restriction. Treas. Reg. 1.401(a)(4)-4(a).

The fact that the restriction might not appear in the plan document isn't relevant technically (although it'll affect whether the IRS notices a potentially discriminatory BRF). Investments aren't subject to the 411(d)(6) regulations, so discretion is allowed and the condition needn't be stated in the plan document itself, but if the restriction is enforced, it's subject to BRF testing. [Ray Williams - Although I disagree with the IRS verbal analysis, let us know if they issued anything in writing at the ASPA conference.]

Once one has determined that the BRF is subject to testing, take a look at Treas. Reg. 1.401(a)(4)-4(B)(2)(ii)(D). It's not the easiest provision to read and apply, but seems to say one ignores a dollar limit if the BRF is available only for those with account balances <= $x but doesn't give us permission to ignore a dollar limit if the BRF is available only for those with account balances >= $x. This will often (but not always) cause a minimum account balance requirement for a self-directed option to flunk BRF testing, creating a disqualification issue.

[mwyatt]

The following is from the 1999 "Gray Book" from the Enrolled Actuaries Meeting and consists of a question posed to James Holland, Harlan M. Weller, and Richard Wickersham. Here is Q&A #19:

Nondiscrimination: Nondiscriminatory Benefits, Rights and Features

An employer has a profit sharing plan with individually directed accounts at a major mutual fund house. The participants are all being given the option of electing to use an investment manager for their accounts if they so desire. The management fees would be paid directly from the participant's account.

Only the HCEs have account balances at the minimum amount necessary, as established by the investment manager, to be serviced by the manager. There is a concern that the use of investment managers by the HCEs would violate the benefits, rights and features requirements of the non-discrmination rules. Is this an issue?

RESPONSE

Yes, there is an issue. If the option of using individually directed accounts is only effectively available to HCEs, the plan is in violation of the nondiscriminatory benefits, rights and features requirement.

(end of Q&A)

As anyone familiar with the Gray books responses knows, there isn't a whole lot of evasiveness in this response by IRS and Treasury. I would do some more research before proceeding (just because it is the broker who is setting the limit does not get the plan off the hook).

What is the minimum amount for self-direction and the qualification percentages for HCEs and NHCEs? If the level is say $5000 and you have a mix of qualification levels then this is certainly a different situation where the level is $100,000 and only HCEs qualify. If effectively only your HCEs qualify in your situation then I would have to think you have a real problem (as you probably would know on a gut level).

[This message has been edited by mwyatt (edited 11-17-1999).]

[Jon Chambers]

At least one large West Coast plan sponsor that I know of runs a coverage test to check whether their brokerage account minimum ($1,000 in their case) is discriminatory. They find that it isn't. This may be conservative, but I believe it's an appropriate approach. I'd suggest that an account vendor with a high minimum (e.g. $5,000) could introduce fiduciary selection issues for the plan sponsor. Why was the high minimum vendor selected when a vendor with a lower minimum could have been chosen?

Hope these brief thoughts help,

Jon

[mwyatt]

I think Jon brings up a good point as to the minimum level. AK, what is the specific threshold you are talking about in your situation? There is a big difference between a $1-5k minimum and a level so high as to only effectively include HCEs. My original post showed that the IRS's position is that if the practical effect is to exclude all NHCEs then you have a problem, even if the limitation is set by the broker, not the plan itself.

As another example, let's say your sponsor is trying to decide on the investment options. Many mutual funds have a minimum initial purchase amount (say $1000). I don't think that the IRS or DOL would have a problem with this as a choice in your plan. However, if you wanted to add a "Hedge Fund" option with a minimum purchase of $100,000, what do you think the IRS would think of that (although the limit is set by the fund, not the sponsor).

In essence, the dollar threshold is the important criterion here in determing BRF.

[This message has been edited by mwyatt (edited 11-19-1999).]

[This message has been edited by mwyatt (edited 11-19-1999).]

[Guest ak]

Thanks for all the comments. The initial minimum that was being discussed was $5,000. My initial reaction, one that I think still holds true, is that it would boil down to an "effective availability" issue (i.e., facts and circumstances).

[Dowist]

I think this is an issue of "current" availability, not "effective availability," and as such is subject to the objective test applicable to current availability - it will be discriminatory or not based on the numbers of highly compensated and nonhighly compensated employees who have the minimum balance required for the brokerage option (not a facts and circumstances approach).

Current availability is "based on the current facts and circumstances with respect to the employee (e.g. current compensation, accrued benefit, position, or net worth)." Reg. 1.401(a)(4)-4(B)(2). In other words if you restrict a benefit right or feature to pts with a minimum account balance - that is their "accrued benefit" - you have a current availability issue.