Brain Cramp - Cash Balance Plans and Gateway Testing

[mwyatt]

Have a situation and I'm not sure of the reasonableness of the results.

Client has existing profit sharing plan, integrated with Social Security.

Established Cash Balance plan for 2011; Group A gets 28% of Comp hypothetical allocation, Group B gets 7.5% hypothetical allocation. Plan actuarial equivalence is 5% pre-retirement interest only, post-retirement 2011 415/417 Mortality Table @ 5.50% per annum. Interest crediting rate is 5.00% per annum.

Accrued benefit for testing purposes is derived from actuarial equivalence; that number is what it is. If an employee say left at end of first year, they would get hypothetical balance of 7.5% of salary.

When I run the General Test however, I'm stuck with using standard mortality and interest (7.5-8.5) assumptions for testing. Our software is effectively saying that the gateway contribution is something less than 7.5% for the year (significantly less as get younger); from a common sense standpoint, the participant is being credited with a fixed percentage of salary and would be paid as such; not sure as to the logic of stating for gateway that this 7.5% is worth less. What am I missing?

[Tom Poje]

I'm probably oversimplifying things but

when testing the cash balance portion we would take the 28% or 7.5% cash balance contribution and project out at the int credit rate of 5%

for gateway determination the benefit would be converted to a dc equivalent alloaction % and added to the dc alloaction % to determine the required gateway

for the NHCEs we use the avg of the dc converted values and apply that toward the gateway.

[mwyatt]

OK, here's where my "common sense" analysis may be running afoul:

Say rank and file participant is age 40 with NRA of 65.

Compensation for year is $50,000

Gets 6% Profit Sharing contribution of $3,000

On Cash Balance side, gets 7.5% hypothetical allocation of $3,750

CB Actuarial Equivalence factor from 2011 417/415 Applicable Mortality Table @ 5.50% per annum is 138.6807

For 401(a)(4) testing, I use 1983 IAF (Individual Annuity Female) and 8.50% as my testing interest rate

401a4 Immediate Annuity Factor is 115.3872

To get benefit from CB plan:

CB AB = $3,750.00 * (1.05^(65-40))/138.6807 = $91.57 (this is how plan calls to convert, so that number isn't subject to 401a4 mortality and interest as that is what would be paid if chose annuity).

PS hypothetical AB = $3,000 * (1.085^(65-40))/115.3872 = $199.85

So total AB for general testing would be $91.57 + $199.85 = $291.42

However, for Gateway testing the whole deal is to ensure that a NHCE is getting at least a threshold. From what you're saying, looks like interpreting the CB side to be

$91.57 AB * 115.3872 * (1.085 ^(40-65)) = $1,374.57, which is considerably less than the ACTUAL amount being credited to their account for the year under the CB plan of $3,750.00. This doesn't make "common" sense to me.

Guess my observation is on the DC side, would use the 401a4 standard interest and mortality to convert DC; however, on DB/CB side of things, lump sums and benefit amounts are subject to actual rates specified in the Plan; applying standard rates are all well and good, but DB/CB is only going to pay out on the plan rates. Intuitively doesn't make sense that would use the DB/CB rates to convert to benefit but then the DC/401a4 to see what hypothetical Gateway amount is; fact of matter is that DB/CB will be "really" paying a higher amount of LS.

[Tom Poje]

without getting into 'numbers', because my desk is full enough of stuff without stopping to look at things (sorry)

you generally get a 'sizable difference' between the cash balance and the DC equivalent beacsue of the interest rate difference.

you are providing a contribution credit at 5% interest for 40 years.

so if you provided a contribution at 8.5% interest for 40 years just what would that contribution be for the two numbers to be equal.

that is a real rough way of looking at it (because the APRs factor in as well)

[John Feldt ERPA CPC QPA]

The math is what it is. A 7.5% of pay cash balance credit when projected at 5%, converted to an accrued benefit, and then converted to a testing value at 8.5% will result in a value that is less than 7.5% of pay.

It is not uncommon to place the large benefits for the HCEs in the DB plan with the gateway for the NHCEs in the DC plan because of how the math works.

The overall combined-plan gateway, if it's 7.50% as a percent of pay, can be a combination of DB and DC as you are aware, but the DB benefits for the NHCEs are usually only provided in order to satisfy 401(a)(26) and thus they are fairly small, and will only account for a small portion of the gateway. If offsetting, it can be offset by the average actuarial value of the NHCE accruals in the DB plan and I think the offset can only be applied to the NHCEs that are in both plans.

If you are testing the 2 plans together it is generally to your advantage to provide the majority of the gateway to the NHCEs in the DC plan as it helps much more (than a DB accrual would) with with the average benefits percentage test (if needed) and the rate group tests.

[mwyatt]

Understand "more bang for the buck" in DC from testing standpoint; problem is non PBGC plan so potential to run into the combined plan cap; reason why 6% on PS plan. Thanks for the input.

[John Feldt ERPA CPC QPA]

If, in the DB plan, the HCE accruals are maxed and the NHCEs are merely there to satisfy 401(a)(26), then the most efficient use of the employer dollars in the DC plan may be to provide allocations above 6% for the NHCEs and below 6% for the HCEs. Just enough each way to keep the overall allocation to 6% of all combined eligible compensation.

For example, increase the NHCEs to 7% of pay in the DC plan and reduce the HCEs to something below 6% - just make sure the DC plan is not allocating more than 6% of compensation overall (the 6% is plan limit, not a person-by-person limit). If the average of the actuarial equivalent allocation rates in the DB plan equals 0.50% of pay, then the 7.50% gateway is met.

It can also be helpful to bring in an ineligible employee or two by lowering any age or service conditions. This gets more eligible compensation into the equation to help with the 6% limitation. Or, if the active participant count is close to 25, a lower age or shorter service requirement could perhaps get the plan over the hump, so to speak, to now (and for as long as the plan exists) require PBGC coverage due to the plan's active participant count.