Frozen plans & 401a26

[Craig Schiller]

This relates to a frozen DB plan. Assume that for the first 3 years all 10 employees accrue .5% a year except for 1 owner accruing a higher benefit such as 5% of pay.

The plan is frozen at the end of year 3 (2010, in this example). It is now 2012. Assume the same 10 employees are in the plan all 5 years, and no one else has become eligible.

The plan must pass 401a26 on its prior benefit structure.

Does this test fail at 1/1/2012? For 10 employees, their average accrual per year of participation is .15% / 4 if 2011, the frozen plan year, counts as a year of participation. On the other hand, if it is reasonable from the regulations to interpret the test as not requiring one to count Years of Participation after the freeze date, then the 10 employees' accrual would all average .5% per year.

Another words, plans using new comparability with employees generally at .5% will not be able to be frozen for more than one year if there is a < 40% owner to eligible employee ratio.

Other possible interpretations:

a): At the time of the freeze, the population of current & former employees is also frozen for purpose of the 40% test.

b): Years of participation don't count years after the freeze, but you do factor in newly eligible employees as a < 40% person in the test.

c): Same as "a", except when plan is re-activiated, you have to make up missing years of participation unless plan is terminated and not reactivated.

Has the IRS made any statements about how they enforce this?

Thanks for any opinions.

Craig Schiller, CPC

[Belgarath]

With the huge caveat that I'm neither an EA nor a "DB person" I'd say that you are ok. You can test the pass/fail based upon accrued benefits rather than current accruals, as per 1.401(a)(26)-3. To me, it makes no sense to include post-freeze years as years of participation for determining the accrued benefit for these purposes. Someone who deals with this stuff regularly can undoubtedly provide you with a better answer.

I'd also observe that while the .5% accrual rate is a commonly used "benchmark" it isn't a regulatory safe-harbor, but as far as I know the IRS currently accepts it and hasn't challenged it.

[Craig Schiller]

Thank you for your opinion. IAMAA either. I thought of another justification for not counting years while the plan was frozen.

Those years have an automatic pass on the regular Minimum Participation test (the one based on the Current Year Accruals). Normally a DB plan must if I'm understanding the rule correctly pass on both the Minimum Participation Rate for the current year and the prior benefit structure. When a plan is frozen, it gets a "free pass" from the regular Minimum Participation Rate test. So since those years aren't counted as years that one needs to test, at least a strong argument can be made that they shouldn't count as years when testing the prior benefit structure. At least I hope.