Cash Balance Plan with young owner

[carrots]

If a business consists of a younger owner, say age 45, and several older employees, say ages 55-60, can they have a Cash Balance plan with a uniform contribution credit of, say 25% of pay, in addition to a profit sharing plan?

Does this pass discrimination testing?

A traditional DB plan, with similar funding requirements, would almost certainly be discriminatory.

[My 2 cents]

They can cross-test it based on contributions, can't they? Sounds non-discriminatory on that basis.

How else would a cash balance plan ever pass testing?

[AndyH]

Agree, and also I believe that it would qualify under the "modified general test" of 1.401(a)(4)-8©(3)(iii)© that nobody has ever heard of including the IRS agent who recently reviewed one that we submitted. In the end he agreed.

You won't find it on any road maps including the submission forms.

[SoCalActuary]

This is one of the safe-harbor designs approved in 1.401(a)(4), and can even be better by applying DC level excess-type integration.

So the CB addition would be 25% of pay plus 5.7% of pay above the TWB.

[My 2 cents]

Can "safe harbor" and "cash balance plan" be used in the same sentence?

[AndyH]

This is one of the safe-harbor designs approved in 1.401(a)(4), and can even be better by applying DC level excess-type integration.

So the CB addition would be 25% of pay plus 5.7% of pay above the TWB.

Agree. Tweak it a bit and it can be tested as I described.

[SoCalActuary]

Can "safe harbor" and "cash balance plan" be used in the same sentence?

You might want to read 1.401(a)(4)-8.

(3) Safe harbor testing method for cash balance plans—

(i) General rule. A cash balance plan is a defined benefit plan that defines benefits for each employee by reference to the employee's hypothetical account. An employee's hypothetical account is determined by reference to hypothetical allocations and interest adjustments that are analogous to actual allocations of contributions and earnings to an employee's account under a defined contribution plan. Because a cash balance plan is a defined benefit plan, whether it satisfies section 401(a)(4) with respect to the equivalent amount of contributions is generally determined under paragraphs ©(1) and ©(2) of this section. However, a cash balance plan that satisfies each of the requirements in paragraphs ©(3)(ii) through (xi) of this section is deemed to satisfy section 401(a)(4) with respect to an equivalent amount of contributions.

(ii) Plan requirements in general. The plan must be an accumulation plan. The benefit formula under the plan must provide for hypothetical allocations for each employee in the plan that satisfy paragraph ©(3)(iii) of this section, and interest adjustments to these hypothetical allocations that satisfy paragraph ©(3)(iv) of this section. The benefit formula under the plan must provide that these hypothetical allocations and interest adjustments are accumulated as a hypothetical account for each employee, determined in accordance with paragraph ©(3)(v) of this section. The plan must provide that an employee's accrued benefit under the plan as of any date is an annuity that is the actuarial equivalent of the employee's projected hypothetical account as of normal retirement age, determined in accordance with paragraph ©(3)(vi) of this section. In addition, the plan must satisfy paragraphs ©(3)(vii) through (xi) of this section (to the extent applicable) regarding optional forms of benefit, past service credits, post-normal retirement age benefits, certain uniformity requirements, and changes in the plan's benefit formula, respectively.

(iii) Hypothetical allocations—

(A) In general. The hypothetical allocations provided under the plan's benefit formula must satisfy either paragraph ©(3)(iii)(B) or © of this section. Paragraph ©(3)(iii)(B) of this section provides a design-based safe harbor that does not require the annual comparison of hypothetical allocations under the plan. Paragraph ©(3)(iii)© of this section requires the annual comparison of hypothetical allocations.

(B) Uniform hypothetical allocation formula. To satisfy this paragraph ©(3)(iii)(B), the plan's benefit formula must provide for hypothetical allocations for all employees in the plan for all plan years of amounts that would satisfy §1.401(a)(4)–2(b)(3) for each such plan year if the hypothetical allocations were the only allocations under a defined contribution plan for the employees for those plan years. Thus, the plan's benefit formula must provide for hypothetical allocations for all employees in the plan for all plan years that are the same percentage of plan year compensation or the same dollar amount. In determining whether the hypothetical allocations satisfy §1.401(a)(4)–2(b)(3), the only provisions of §1.401(a)(4)–2(b)(5) that apply are §1.401(a)(4)–2(b)(5)(ii) (section 401(l) permitted disparity, (iii) (entry dates), (vi) (certain limits on allocations), and (vii) (dollar allocation per uniform unit of service). Thus, for example, the plan's benefit formula may take permitted disparity into account in a manner allowed under §1.401(l)–2 for defined contribution plans.

© Modified general test. To satisfy this paragraph ©(3)(iii)©, the plan's benefit formula must provide for hypothetical allocations for all employees in the plan for the plan year that would satisfy the general test in §1.401(a)(4)–2© for the plan year, if the hypothetical allocations were the only allocations for the employees taken into account under §1.401(a)(4)–2©(2)(ii) under a defined contribution plan for the plan year. In determining whether the hypothetical allocations satisfy §1.401(a)(4)–2©, the provisions of §1.401(a)(4)–2©(2)(iii) through (v) apply. Thus, for example, permitted disparity may be imputed under §1.401(a)(4)–2©(2)(iv) in accordance with the rules of §1.401(a)(4)–7(b) applicable to defined contribution plans.

(iv) Interest adjustments to hypothetical allocations—

(A) General rule. The plan benefit formula must provide that the dollar amount of the hypothetical allocation for each employee for a plan year is automatically adjusted using an interest rate that satisfies paragraph ©(3)(iv)(B) of this section, compounded no less frequently than annually, for the period that begins with a date in the plan year and that ends at normal retirement age. This requirement is not satisfied if any portion of the interest adjustments to a hypothetical allocation are contingent on the employee's satisfaction of any requirement. Thus, for example, the interest adjustments to a hypothetical allocation must be provided through normal retirement age, even though the employee terminates employment or commences benefits before that age.

(B) Requirements with respect to interest rates. The interest rate must be a single interest rate specified in the plan that is the same for all employees in the plan for all plan years. The interest rate must be either a standard interest rate or a variable interest rate. If the interest rate is a variable interest rate, it must satisfy paragraph ©(3)(iv)© of this section.

© Variable interest rates—(1) General rule. The plan must specify the variable interest rate, the method for determining the current value of the variable interest rate, and the period (not to exceed 1 year) for which the current value of the variable interest rate applies. Permissible variable interest rates are listed in paragraph ©(3)(iv)©(2) of this section. Permissible methods for determining the current value of the variable interest rate are provided in paragraph ©(3)(iv)©(3) of this section.

(2) Permissible variable interest rates. The variable interest rate specified in the plan must be one of the following—

(i) The rate on 3-month Treasury Bills,

(ii) The rate on 6-month Treasury Bills,

(iii) The rate on 1-year Treasury Bills,

(iv) The yield on 1-year Treasury Constant Maturities,

(v) The yield on 2-year Treasury Constant Maturities,

(vi) The yield on 5-year Treasury Constant Maturities,

(vii) The yield on 10-year Treasury Constant Maturities,

(viii) The yield on 30-year Treasury Constant Maturities, or

(ix) The single interest rate such that, as of a single age specified in the plan, the actuarial present value of a deferred straight life annuity of an amount commencing at the normal retirement age under the plan, calculated using that interest rate and a standard mortality table but assuming no mortality before normal retirement age, is equal to the actuarial present value, as of the single age specified in the plan, of the same annuity calculated using the section 417(e) rates applicable to distributions in excess of $25,000 (determined under §1.417(e)–1(d)), and the same mortality assumptions.

(3) Current value of variable interest rate. The current value of the variable interest rate that applies for a period must be either the value of the variable interest rate determined as of a specified date in the period or the immediately preceding period, or the average of the values of the variable interest rate as of two or more specified dates during the current period or the immediately preceding period. The value as of a date of the rate on a Treasury Bill is the average auction rate for the week or month in which the date falls, as reported in the Federal Reserve Bulletin. The value as of a date of the yield on a Treasury Constant Maturity is the average yield for the week, month, or year in which the date falls, as reported in the Federal Reserve Bulletin. (The Federal Reserve Bulletin is published by the Board of Governors of the Federal Reserve System and is available from Publication Services, Mail Stop 138, Board of Governors of the Federal Reserve System, Washington DC 20551.) The plan may limit the current value of the variable interest rate to a maximum (not less than the highest standard interest rate), or a minimum (not more than the lowest standard interest rate), or both.

(v) Hypothetical account—

(A) Current value of hypothetical account. As of any date, the current value of an employee's hypothetical account must equal the sum of all hypothetical allocations and the respective interest adjustments to each such hypothetical allocation provided through that date for the employee under the plan's benefit formula (without regard to any interest adjustments provided under the plan's benefit formula for periods after that date).

(B) Value of hypothetical account as of normal retirement age. Under paragraph ©(3)(vi) of this section, the value of an employee's hypothetical account must be determined as of normal retirement age in order to determine the employee's accrued benefit as of any date at or before normal retirement age. As of any date at or before normal retirement age, the value of an employee's hypothetical account as of normal retirement age must equal the sum of each hypothetical allocation provided through that date for the employee under the plan's benefit formula, plus the interest adjustments provided through normal retirement age on each of those hypothetical allocations for the employee under the plan's benefit formula (without regard to any hypothetical allocations that might be provided after that date under the plan's benefit formula). If the interest rate specified in the plan is a variable interest rate, the plan must specify that the determination in the preceding sentence is made by assuming that the current value of the variable interest rate for all future periods is either the current value of the variable interest rate for the current period or the average of the current values of the variable interest rate for the current period and one or more periods immediately preceding the current period (not to exceed 5 years in the aggregate).

[My 2 cents]

Thanks for the citation, which certainly looks like a resounding "yes" for the opening question in this discussion thread. As this is solely applicable to non-discrimination testing, I would imagine that a uniform 30% of pay credit (which would certainly fail 415 testing if the plan were actually a defined contribution plan) would be considered acceptably within the safe harbor under a defined benefit cash balance plan.