401(a)(26) - any exception?

[Lynn Campbell]

Is there any exception to the 401(a)(26) requirement that at least 2 EEs must participate, in a situation where there are only 2 EEs who are both owners of the business, but only 1 wants to participate? The 2 EEs are father and daughter and the father would like to waive participation.

[Lorraine Dorsa]

I know of no exception.

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[richard]

How about giving thre father a $1 benefit?

[Lynn Campbell]

Richard - thank you for input. Do you know of any way to add this $1 benefit to a prototype document without changing it to an individually designed plan? Have you used this technique yourself?

[Lynn Campbell]

Richard - The Father is 76 and not interested in funding his "retirement".

I am thinking of having him waive (permitted by Non Std. Proto) all but $1/month of benefit - just to meet 401(a)(26). I think the IRS would OK this? Any other ideas?

[richard]

I don't know of any easy way to add the $1 benefit to a prototype document without changing it to an individually designed plan.

However, while "technically" this would become an individually designed plan, I'm not sure if the IRS would really review it (in practice) as such. Especially if it were a non-standarized prototype and you get a determination letter, this might work.

I've used the technique of modifying prototypes and it has worked (maybe it's been luck so far); I haven't used the one-dollar technique, but that shouldn't be a problem.

(I prefer to use volume submitter documents, especially for DB and most DC plans, because of such issues. It takes an awful lot of extra changes for the IRS to view a volume submitter document as an individually designed plan.)

By the way, why does the father want to waive participation? That might give us some other ideas.

Richard

[Lorraine Dorsa]

I have a problem with the $1/month benefit.

IRC 1.401(a)(26)-3 states that all DB plans have a prior benefit structure, that the prior benefit structure is defined as all accrued benefits as of the beginning of a plan year and that the prior benefit structure satisfies 401(a)(26) if either 50/40%/2 employees are currently accruing "meaningful benefits" or if 50/40%/2 employees have "meaningful" accrued benefits. Unfortunately, the definition of "meaningful" is a facts and circumstances definition, but I find it hard to believe that $1/month would be meaningful.

Applying this concept to the proposed plan, in year 2 of the plan, the prior benefit structure will be an AB of whatever for the daughter and an AB of $1/month for the father. Unless you can figure out a way to show that $1/month is meaningful, 40/50%/2 employees are neither currently accruing meaningful benefit or have previously accrued meaningful benefits.

I do understand what the goal here and I think this is an unintended consequence of 401(a)(26), but I don't see a way to get around it under the current regulations.

[Maybe they should just hire one of the grandkids and let him/her benefit so grandpa can be excluded :-)]

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[richard]

Hmmm. I defer to Lorraine's good catch.

Now, let's see what other bright (?) ideas I can come up with.

I presume the father is working at least 1,000 hours, and isn't likely to "take it easy."

I presume that adding the father and reducing the daughter's benefit so that the total cost of the plan is unchanged isn't an acceptable solution.

How about chewing on the following idea (alright, maybe it's a bit tricky and circumvents the intent of 401a26, but so be it).

Allow the father participate. Set normal retirement equal to age 65 (not 65 and 5 years of participation). Allow for unlimited lump sums. Allow employees past normal retirement (or past age 70.5) to take their full accrued benefit ... as a lump sum.

Let's say the father's pension accrual for the year is $100 per month. The normal cost for his is, say $12,000. This amount (along with the amount for the daughter) is contributed during the year by the business into the plan. At the end of the year, the father exercises his right to take his full accrued pension in cash as a lump sum -- the accrued pension is $100 per month, the cashout is $12,000. Meanwhile, the father takes a salary from the business of $12,000 less than he otherwise would have.

If I've done the flows correctly, all of these hijinks put the father (and the business) in exactly the same cash position they would have been had 401(a)(26) not existed.

Yes, there are some timing issues. And, yes, the funding lump sum factors would have to be set equal to the plan's lump sum factors for the father. And, yes, this is complicated.

But, yes, maybe this avoids 401(a)(26).

I never said it would be simple.

Seriously, while this might not be the most practical solution, are there any issues that I've missed?

Richard

[Guest TaxLady]

I really like Richards alternative plan here, and it has an additional potential benefit. The amounts contributed to and subsequently distributed from the plan avoid FICA tax. Depending on the fathers existing compensation level, this could be a significant benefit, perhaps even paying for the cost of setting up the plan in the first year.

[Guest JoeFriberg]

I would like to ask about a different scenario, it happens to be a father & son who are the employees.

Suppose it is the father who wants the DB plan, and the son wants a DC plan since he would be able to make higher contributions under DC.

Other than Lorraine's suggestion of introducing a third (family) employee to the mix, are there any other potential solutions?

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[Guest Joshua Meltzer]

This cries out for an offset type arrangement. Have the company adopt a DC plan and a DB plan with the benefits of the DB plan offset by any contributions to the DC plan. Have the father elect out of the DC plan. The benefits in the DB plan should be completely offset by the DC contribution for the son. I believe (but am not completely sure) that the son's offset benefits would be included for 401(a)(26).

[Lorraine Dorsa]

I agree with Joshua--the floor offset is the way to go here.

One comment, if you are trying to translate this design to a slightly larger group--father, son and 1 employee--having the father waive out of the DC plan will cause the DB to fail the 401(a)(4) amounts safe harbor. In this case you might want to leave the father in the DC plan (he'll receive most of his bft from the DB and the portion which was offset from the DB, he'll get in the DC so you can avoid general testing.

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[pookah]

I know this thread is old, but it may need reopening. Recently we've gotten responses from the IRS questioning whether a particular plan provides "meaningful benefits". Although we can reply and argue the 'facts and circumstances', I wonder whether there is any merit to the argument that the Regs represent a case where Treasury has overstepped its bounds.

I don't see any refererence in the statute to requiring a "meaningful benefit". If there is a DB/DC combination, should the service, under 401(a)(26), require a higher level of benefit in the DB plan albeit at the cost of a lower benefit in the DC plan?

I suppose a corollary would be that you could not set up a DB plan covering all employees if the benefit level to each was sufficiently small.

Does anyone have any insight?

[Blinky the 3-eyed Fish]

Meaningful benefits are referenced in 1.401(a)(26)-3©(2). As for your question, the requirements of 401(a)(26) for the DB plan would not hinge on the DC plan in any way, even if it meant lower DC balances. The IRS would be concerned solely with whether the appropriate number of employees are receiving meaningful benefits in the DB plan.

[mbozek]

Why does father have to be an employee? Make him an independent contractor not eligible to particpate in plan.

[AndyH]

pookah, can you tell us what level of benefits the IRS was questioning as potentially not meaningful?

[Belgarath]

I like mbozek's idea. Get him out of it altogether! Only caveat is that I'm not all that familiar with the laws determining whether you are an employee or not. In other words, it is a facts and circumstances situation - merely paying someone on a 1099 doesn't automatically make them an independent contractor. But if you can get past these requirements, then I'd certainly opt for this approach.

[Blinky the 3-eyed Fish]

I thought I had read something, proposed regs maybe, that said the IRS was putting a definition to meaningful benefits to be at least 0.5% of compensation, but now I can't find where I read that? Can anybody help me reaffirm I didn't just dream this?

[Guest merlin]

Blinky-Paul Shultz referenced the 0.5% of comp as meaningful at the Northeast Region Employee Benefit Conference in June in connection with some upcoming guidance on cash balance plans. It doesn't apply to "normal" DB plans.

mbozek-How would you go about convincing an IRS auditor that one of the owners of the company is an independent contractor? I know that there are 20-some-odd questions that the Service uses to determine independent status, and a business owner could probably answer most if not all of them positively, but how do you get past the reality that all of his income is derived from one source,without even a smidgen of outside income?Also,aren't there employment tax issues wrt independents vs. employees? Wasn't that the prime issue with Microsoft and their freelance programmers a few years ago? The plan issues arose only after the freelancers had been reclassified as employees,as I recall.

[mbozek]

First what is the probability of an audit by the IRS- Last time I looked it was less than 1% for qual plans/ employers. Obviously the client would have to be aware that there is a certain level of risk.

Second counsel should review the 20 factors test and Section 530 rules to qualify the father as an independent contractor. Independent contractors are subject to SECA tax which is the same as FICA tax. In the microsoft case the independent contractors sued Micro. for benefits provided to employees. Why would the father sue his company to determine his status as an employee for benefits if he does not want to participate in the plan?

Third : Getting answers to your questions is the job of the tax advisor for the company.

Fourth: the client could choose other options, e.g., floor offset plan but with a higher cost. It all depends on client's risk tolerance.

[Guest merlin]

Your first post made the choice of ic status sound like a slamdunk,which it obviously isn't . This was a much better response. Thank you.

[mbozek]

It is not a problem for experienced tax counsel since the IRS cannot require that there be an employer- employee relationship. The IRS can only review the agreement to see if an independent contractor relationship exists under the applicable law. Given the low level of audits it is not likely that there would be a review. Also I think that a determination letter in which the plan excludes the father as an independent contractor would qualify for a statutory exemption from classification as an employee under an audit at a future time.

[AndyH]

Merlin, you had to know that was coming!

I opine on this July 4th eve that the cost of including 76 year old Dad @ 1% of pay (or even .5%) is worth avoiding the cost/risk/hassle of dealing with the independent contractor issues (or paying the fees associated with minimizing the risk).

p.s. this thread was started 2.5 years ago, so now Dad's 78 or 79-his cost is even less!

[Guest merlin]

Andy-right on!Something about forests and trees. BTW,anything more on your "fresh start" issue? Happy 4th everyone.

[pookah]

1% of pay in a cash balance plan. However it looks like all CB plans are being questioned now.

Originally posted by AndyH

pookah, can you tell us what level of benefits the IRS was questioning as potentially not meaningful?

[pookah]

To clarify my original post, I am aware of what the regs say. Does anyone think that the regs overreach the statute?