Has anyone else ever had the following situation: freeze participation

[John A]

A plan sponsor currently has a DB plan. The sponsor would like to continue the DB plan but freeze participation, so all current participants would continue to accrue benefits, but anyone not currently a participant would never become a participant in the DB plan. On the date of closing participation, the sponsor would like to start a new 401(k) plan that would be open only to employees who were not participants in the DB plan. Does anyone see this possibly working? It seems like it would be difficult to satisfy 401(a)(26), 410(B), and 401(a)(4). Are there any other issues/problems that should be considered? Anyone out there think this is viable?

[AndyH]

I've been asked this question many times by clients. I have seen it in one case, but the plan sponsor did not have a FDL since the change, and we doubt it's legitimacy. My take is that is a violation of the statutory maximum service requirement, to the extent that the future employees are not excluded by a reasonable classification. One way to get around this is to include them but give them a lesser benefit, which I'm not especially comfortable with but I think it can be done, provided it can pass the general test.

You will eventually will have a 410(B) and possibly 401(a) (26) problem since only a portion of non-excludable participants are benefitting.

If anyone has done this sucessfully, I'd like to hear about it.

[Guest Connie]

We have. The DB is a collectively bargained plan with unit credit provisions, which makes things easier. Initially, any employee in the eligible group could defer into the 401(k), but only those not covered by the DB received a match. After awhile, we discovered we could give a match to all (k) participants.

When we instituted a 401(k) for non union employees, we had to terminate the DB plan.

[IRC401]

Assuming that the employer can manage to keeps the plans in compliance with 410(B) and 401(a)(26), it still needs to ask whether this idea makes sense from a human resources perspective. In general, the 401(k) plan will (should) be a more valuable benefit. Therefore, they will be treating the new employees better than the old employees. Not a good way to encourage employee loyalty.

[Lorraine Dorsa]

We've done a variety of this on occasion, but in most cases the employer was trying to move to a 401k plan and terminate the DB plan so we ceased not only new participation but benefit accruals in the DB plan and then allowed everyone to join the 401k plan.

We have had a few cases where we've ceased new participation in the DB plan and left benefit accruals (usually reduced) in place, with the goal of trying to keep the older employees who were relying on the DB plan benefits relatively whole (bfts under new DB + value of 401k deferrals at retirement = bfts under old DB).

As AndyH says, you must be sure you continue to satisfy 401(a)(26) [although there is an exemption for DB plans covered by the PBGC which are not sufficient to terminate) and 410(B). In a low turnover small company or a large company with both new HCEs and NHCEs being hired after the cease of accruals, this should not be too much of problem. If you have a small closely held business with lots of turnover or growth, you'll be faced with 410(B) problems fairly quickly.

I do take exception to IRC401's statement that the 401(k) plan will and should be the most valuable benefit and therefore the new employees are being treated better than the old employees. For younger employees, his statement may be correct in the sense that a younger employee might end up with more $ at retirement, but you also need to consider that the employer was paying the full cost of the DB plan and in the 401k plan the employee is likely paying a majority of the cost. For an older employee, he might end up with not only less $ at retirement from the reduced DB + 401k combination, but also will have paid a portion of the cost.

, but for older employees, the DB may be more valuable (although everyone is so brainwashed about 401k plans even most of the employees will think

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[Guest JAREL]

I don't have a problem with using as a reasonable classification that employees hired after a certain date will not be eligible for the plan, particularly if the class does not include any current employee. I have seen this done before.

[AndyH]

To Lorraine and Jarrel:

Thanks for the comments. I want to make sure I understand. I have two clients right now (if not more) that would like to continue accruals (permanently if possible) for current participants, but not allow new participants (some of whom may become HCEs). Assume for a moment that each plan has a one year service requirement. Are you saying the plan(s) can be amended to exclude, for example, anyone hired after 12/31/99? Have you done this for an ongoing plan and received an FDL subsequent to such an amendment? (I stress ongoing because I wonder if the review standard is the same for a terminating or frozen plan, where this is often done.)

One plan has about 50 participants and the other about 250. Both could satisfy the ratio percentage test (and 401(a)(26)) for at least a few years with the hire date exclusion. I've had some very bright and very experienced people research this, and we can't find anything definitive either way. We lean (strongly) toward this being a violation of the statutory service requirement, and don't see any basis for considering hire date a "reasonable classification". Are you saying you've done this on more than one occasion and received IRS approval?

Any elaboration on the justification for this exclusion? Thanks.

[This message has been edited by AndyH (edited 03-27-2000).]

[Guest JAREL]

AndyH: I have seen this type of classification many times and I know that determination letters have been issued for this type of provision. My rationale stems from the fact that the plan is not requiring that this group of employees, "as a condition of participation in the plan, complete a period of service ... extending beyond the later of" ...(age 21, 1 year)etc. Instead, the plan is providing that as of this date, no further employees will become eligible. The classification might be catagorized as anyone hired after date xx or anyone not currently eligible for the plan. The regulations are intended to preclude plan provisions that bypass the minimum age or service rules. However, the plan is not imposing any condition on the group that is disguised as an age or service condition. They will never participate. For your own confort, I'd get a determination letter.

[Lorraine Dorsa]

There is no requirement that any plan cover all employees of a business (other than those who meet the statutory exclusions) and in fact, in larger businesses these types of plans are quite common.

As long as your plan can satisfy the minimum coverage (IRC 410(B)) and minimum participation rules (IRC 401(a)(26), applicable only to DB plans) then your plan is perfectly acceptable. [That's why there are minimum coverage and participation rules--because there is no requirement that everyone be included.)

Re the determination letter, I always recommend getting a letter and I would do so in this case, but not because I see this case as anything unusual or questionable.

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[richard]

Agreed. This approach is common with larger clients. Discrimination testing is usually not a problem because of the client's size (and since this isn't really an attempt to favor the highly paid).

401(a)(26) can become a problem over the years, so watch out. Once it looks like you will fail 401(a)(26), you can terminate the DB plan, and provide the affected employees with age-based profit sharing contributions (not contingent on their making deferrals) in the 401(k) plan (or in a separate profit sharing plan). It's tricky, but it works and can keep these employees whole.

[AndyH]

John A:

Seems you (and I) received a pretty specific and thorough answer, thanks to the respondents. Good question.

[John A]

AndyH: Agreed. My thanks to you and to all the respondents.