401(a)(26) prior benefits structure

[Dennis Povloski]

Owner only DB is frozen. He is considering hiring an employee for 2012. I think this means he will fail minimum participation when you look at prior benefits structure.

How much does he need to give the employee if there is a 401(a)(26) failure based on prior benefit structure? Just the 1/2%? Based on the prior benefit structure?

Thanks!

[Guest Quagmire]

Owner only DB is frozen. He is considering hiring an employee for 2012. I think this means he will fail minimum participation when you look at prior benefits structure.

How much does he need to give the employee if there is a 401(a)(26) failure based on prior benefit structure? Just the 1/2%? Based on the prior benefit structure?

Thanks!

Admittedly I'm not a 401(a)(26) expert, but in general frozen plans have no employees who are benefiting and thereby meet this exemption?

[shERPA]

Amend the DB to a 24 month eligibility period and kick the problem down the road to 2014.

[david rigby]

... in general frozen plans have no employees who are benefiting and thereby meet this exemption?

Well....., that's almost what the reg states.

See 1.401(a)(26)-1(b). There are two conditions that must be met:

- plan does not benefit any HCE, and

- plan not aggregated with any other plan in order to satisfy 401(a)(4) or 410(b).

[JBones]

... in general frozen plans have no employees who are benefiting and thereby meet this exemption?

Well....., that's almost what the reg states.

See 1.401(a)(26)-1(b). There are two conditions that must be met:

- plan does not benefit any HCE, and

- plan not aggregated with any other plan in order to satisfy 401(a)(4) or 410(b).

In addition, that exemption states that it applies to plans "other than a frozen defined benefit plan defined in § 1.401(a)(26)-2(b),".

§ 1.401(a)(26)-2(b) goes on to say "a frozen defined benefit plan satisfies section 401(a)(26) for a plan year by satisfying the prior benefit structure requirements in § 1.401(a)(26)-3."

§ 1.401(a)(26)-3(2) has the language that says "A plan does not satisfy this paragraph © if it exists primarily to preserve accrued benefits for a small group of employees and thereby functions more as an individual plan for the small group of employees or for the employer."

Based on this, I would say that if the plan remained frozen, only the owner had a benefit and there were no accruals for the employee, then the plan is not passing 401(a)(26).

[Effen]

Based on this, I would say that if the plan remained frozen, only the owner had a benefit and there were no accruals for the employee, then the plan is not passing 401(a)(26).

Agreed!

Now back to the original question. In order to pass 401(a)(26), at least 40% must receive a benefit. The amount of the benefit is never defined in the Code or the Regulations, other than 1.410(b)-3 that states “in the case of a defined benefit plan, the employee has an increase in a benefit accrued or treated as an accrued benefit under section 411(d)(6)”.

Since very bad people were designing plans that provided benefits of $1 or less in order to pass a(26), the IRS wrote an internal memo that told the agents to challenge any plan that didn’t provide at least a .5% accrual. This was done because the IRS knew it wasn’t worth the taxpayers effort to go to court over such a small benefit and because of this, people started designing plan’s around the .5%.

So, if you provide a reasonable benefit and the IRS accepts it, you are good. If you want to be safe, you can use the .5%. I have seen many plans with approval letters that don’t provide a .5% accrual.

Either way, the IRS doesn't want non-PBGC covered frozen plans hanging around, so why is your plan still hanging around? Why not just terminate it and avoid this whole issue?

[Dennis Povloski]

Based on this, I would say that if the plan remained frozen, only the owner had a benefit and there were no accruals for the employee, then the plan is not passing 401(a)(26).

Agreed!

Now back to the original question. In order to pass 401(a)(26), at least 40% must receive a benefit. The amount of the benefit is never defined in the Code or the Regulations, other than 1.410(b)-3 that states “in the case of a defined benefit plan, the employee has an increase in a benefit accrued or treated as an accrued benefit under section 411(d)(6)”.

Since very bad people were designing plans that provided benefits of $1 or less in order to pass a(26), the IRS wrote an internal memo that told the agents to challenge any plan that didn’t provide at least a .5% accrual. This was done because the IRS knew it wasn’t worth the taxpayers effort to go to court over such a small benefit and because of this, people started designing plan’s around the .5%.

So, if you provide a reasonable benefit and the IRS accepts it, you are good. If you want to be safe, you can use the .5%. I have seen many plans with approval letters that don’t provide a .5% accrual.

Either way, the IRS doesn't want non-PBGC covered frozen plans hanging around, so why is your plan still hanging around? Why not just terminate it and avoid this whole issue?

The plan not that old, and the owner no longer wants to contribute. I generally recommend keeping the plan around for at least 5 years to help satisfy the permanency requirements unless they have a really good business reason for terminating. The client just needs to keep it for 1 more year.....

[Effen]

Then you have a choice. Keep the plan open and allow people to "benefit" so you can satisify 401(a)(26), or terminate the plan and take your shot with a permanincy issue.

Personally, I would terminate it. I assume there is some business reason he doesn't want to fund it and if you are not going to submit for a letter, chances are remote the IRS will ever bring it up.

Explain both options to the client, let him make the choice.