Combined Gateway and DB Offset

[emmetttrudy]

Hypothetically you have a CB Plan and a cross-tested 401k PSP. The compbnied Gateway is 7.5%. The average DB Allocation rate for NHCEs is .5%. So an NHCE would need to receive 7% in the PSP to meet the GW requirements (7.5% - .5%). What about a participant who does not benefit in the DB Plan in that year? For example, an employee is a participant in both plans, receives a 3% safe harbor contribution in the 401k PSP, but does not meet the allocation conditions for a cash balance credit (1,000 hours). Would this participant need the full 7.5% in the PSP, or still only the 7%?

[Lou S.]

The DB allocation rate has to be converted to a hypothetical contribution rate for each person whihc can be used to satisfy some or all of the 7.5% gateway. 0.5% cash balance credit probably not equal to 0.5% contribution for gateway testing. And 0.5% accrual in DB is very unlikely to be exactly 0.5% contribution rate for gateway.

If you are using the gateway and your requirement is 7.5% then all NHCEs that get any employer allocation must get 7.5% to pass gateway.

[emmetttrudy]

I was making up numbers to make the math simple for the example. The CB credit is not .5%.

[AndyH]

The averaging of the DB accruals only applies to participants who benefit under the DB plan. 1.401(a)(4)-9(b)(2)(iv)(D)(3)

So anyone that does not get a DB benefit must get the 7.50% PS.

[Lou S.]

I was making up numbers to make the math simple for the example. The CB credit is not .5%.

Even if the CB credit is 5% it is unlikely the DC equivalent for gateway testing is exactly 5%. Or simply put CB credit of X% is generally not X% for gateway testing.

[ak2ary]

For purposes of the gateways, the average of the equivalent allocation rates for NHCEs as can be treated as the actual equivalent allocation rate for each NHCE who actualy benefits under the DB plan. So for those who are in both the DB and DC, if the average DB equivalent allocation rate is .5%, then they must get at least 7.0% in the DC. Those not participating in the DB must get 7.5%

[emmetttrudy]

thank you ak2ary.

[John Feldt ERPA CPC QPA]

Some examples and comments to clarify Lou and Tom's comments above, and to expand on this topic:

In a recent design proposal, a 2.20% of pay hypothetical cash balance credit resulted in an average of only 0.57% of pay for this offset - the offset varies based on the plan's NHCE demographics.

In another design, a 2.1% of pay cash balance credit to all the NHCEs except one, who was given a 40% of pay credit, resulted in an average offset of 3.2% of pay for the NHCEs (the one NHCE was the sibling of the 100% owner).

So, for example, suppose your cash balance plan provides a hypothetical credit equal to 2.2% of annual pay for each NHCE with 1,000 hours in the plan year. The gateway is a percentage of pay as an allocation. Thus, the 2.2% of pay benefit must be converted into its equivalent accrued benefit using the plan's definition of actuarial equivalence, then converted into a lump sum value at the testing rate (do not impute disparity on this, per 1.401(a)(4)-9(b)(2)(v)(E)). I think there may be some that disagree about whether you must convert to the lump sum at the testing rate, but that's not the point here. This lump sum is divided by pay in order to get an equivalence DC-like allocation for gateway purposes.

At this point you have each NHCE's individual equivalent value for their cash balance credit, let's say it ranges from 0.38% of pay to 0.73% of pay and the average is 0.57% of pay. You now have at least three options:

A) Directly offset each NHCE by their individual equivalent values for their cash balance credit. This is based on the literal reading of Treasury Regulation 1.401(a)(4)-9(b)(v)(D)(1). This can result in a non-uniform DC allocation from 6.77% to 7.12% of pay, because each NHCE age produced a different offsetting value. Under this option, those not in the cash balance plan have no offset and those eligible in the cash balance plan who are receiving no cash balance accrual also have no offset. Employer's tend to prefer uniformity, so this method is rarely applied.

B) Give each NHCE 7.50% in the DC plan. This is based on Treasury Regulation 1.401(a)(4)-9(b)(v)(D)(2). This may be easiest, and is probably fairly common.

C) Average the equivalent values from the cash balance plan and offset all of the NHCEs who benefit in the cash balance plan. In Treasury Regulation 1.401(a)(4)-9(b)(v)(D)(3), it says "a plan is permitted to treat each NHCE who benefits under the defined benefit plan as having an equivalent normal allocation rate equal to the equivalent normal allocation rates under the defined benefit plan for all NHCEs benefitting under the plan." Thus, only those benefitting in the cash balance plan are offset. In this example, the resulting DC plan allocation is 6.93% of pay and the DB plan's 0.57% takes care of the rest, albeit the 0.57% is actually a pay credit of 2.2% of pay!

Note: Suppose the DB plan did not have a 1000 hour accrual requirement, or suppose it only applied the 1000 hours as a requirement for HCEs (the largest benefit costs). If that was the case, then each NHCE can get the offset, resulting in a lower uniform allocation and perhaps 401(a)(26) will be a bit easier to pass, even if young NHCEs leave employment before working 1000 hours.

[Rball4]

Caution, don't set the CB% too low or else you will fail 401(a)(26). Those benefitting need to have accrual rates (not CB%) greater than or equal to 0.5%.

[John Feldt ERPA CPC QPA]

Yes, although not all of them must benefit at 0.50%. Under 401(a)(26), at least 40% must have "meaningful" benefits, that's where the 0.50% comes in. For larger plans it's just 50 employees instead of 40% of the population. For a small employer, if the only 2 employees meet the age and service rules, then at least 2 employees have to have meaningful benefits.

In contrast, under 401(a)(4), as discussed in the posts above, we just look for anyone who is merely "benefitting" - which is any accrual.

For 401(a)(26) we must count the number of NHCEs whose benefitting amounts are "meaningful". The IRS generally believes this means the participants need to get an accrual in the form of an annuity payable at the participant's normal retirement age of at least 0.50% of pay in order to be "meaningful". This is not a regulatory minimum, it is from internal IRS documents on what they think "meaningful" should be.

Again, as before, the 0.50% is an annuity (the accrued benefit) as converted from the cash balance credit, not the actual lump sum cash balance credit itself.

So, in the example given where a recent design provided a 2.20% pay credit in the cash balance plan, it turns out that this provided a meaningful benefit to 50% of the employees.

edit: typo

[emmetttrudy]

Assume the approach is © from your post above. Say, for example, a participant has a hypothetical account balance at the BOY (he had accrued benefits in previous year). However, for the current year he did not meet the 1,000 hour accrual requirement and so accrued no pay credit for 2012, only received interest credit. My understanding is this participant would not be eligible for the offset in 2012. Would you agree?

[John Feldt ERPA CPC QPA]

I would agree.

If something happens that subjects the participant to require a gateway (such as a 3% SH allocation, or a top heavy minimum allocation, or a forfeiture allocation), then the gateway minimum for this participant should not be offset by the cash balance accruals that are credited to the other NHCEs.