Benefit Accrual - Different Methods

[MGOAdmin]

I have a potential client who's plan document is written as such that the cash benefit is accrued as of the last day of the year (12/31). I was under the impression it could not be accrued on the last day, but had to be before then. (I normally see accrued after 1000 hours, or accrued monthly).

Are you permited to accrue a benefit on the last day of the year for a defined benefit plan?

[AndyH]

No, but I have seen similar language. I think that may be intended to address when interest starts getting credited, i.e. day after end of the year. Reread it with that thought in mind.

[Andy the Actuary]

You could have an active on last day of Plan Year rule for accruing benefits so long as it does not discriminate in favor of HCEs.

[AndyH]

Oh good, a disagreement! Arbitrators?

[Andy the Actuary]

My arbitrator is a d-letter that approved this design for a career-average DB formula.

Why would you argue that you can have a last-day-of-year rule with a DC plan but not a DB plan? Can you point to any code, regulations, wall grafitti that supports than you can't with a DB plan? I'm always searching for opportunities to eat crow!!!!!

[Lou S.]

Andy, I've never heard of a DB plan allowed to impose a last day requirement.

My understanding an this could be wrong is that you have to accrue at least a partial benefit for anyone with 1000 hours worked in the computation period but your could require 2000 hours for a full accrual.

Interestingly one of the top results in google for "db accrual last day requirement" is this only thread form 2008 on a similar topic. http://benefitslink.com/boards/index.php?/topic/40165-allocation-conditions-in-cash-balance-plans/

[Kevin C]

This seems to prohibit using a last day requirement for accrual service in a DB plan.

§2530.204-2,Accrual computation period.

©Partial year of participation.—

(1)

Under section 204(b)(3)© of the Act and section 411(b)(3)© of the Code, in calculating an employee's period of service for purposes of benefit accrual, a plan is not required to take into account a 12-consecutive-month period during which the employee's service is less than 1000 hours of service. In measuring an employee's service for purposes of section 204(b)(3)© of the Act and section 411(b)(3)© of the Code, a plan shall use the accrual computation period designated under paragraph (a) of this section. Under section 204(b)(3)(B) of the Act and section 411(b)(3)(B) of the Code, in the case of an employee whose service is not less than 1,000 hours of service during an accrual computation period, the calculation of such employee's period of service will not be treated as made on a reasonable and consistent basis unless service during such computation period is taken into account. To the extent that the employee's service during the accrual computation period is less than the service required under the plan for a full year of participation, the employee must be credited with a partial year of participation equivalent to no less than a ratable portion of a full year of participation.

(2)

For purposes of calculating the portion of a full year of participation to be credited to an employee whose service during a computation period is not less than 1,000 hours of service but is less than service required for a full year of participation in the plan, the plan may credit the employee with a greater portion of a full year of participation than a ratable portion, or may credit an employee with a full year of participation even though the employee's service is less than the service required for a full year of participation, provided that such crediting is reasonable and is consistent for all employees within the same job classifications, reasonably established.

It appears the 411(b) cite should be 411(b)(4)(B), not (3)(B)

[AndyH]

Thanks for the link Lou and the cite Kevin. I (and others) spent a lot of time on this issue before. My conclusion is and was that a last day provision was not permitted.

For what it's worth, I believe that in 2008 the Cash Balance Answer Book stated that a last day provision was ok in a CB plan. It now says that such a provision would seem to be precluded by Code Section 411(b)(4) and ERISA Section 204(b)(4)

[Andy the Actuary]

It's been about 15 years but my recollection is that a period less than 12 months did not constitute a consecutive 12-month period. I.e., the person did not complete the computation period. Though the plan is closed, I still have a copy of the document. It was very clear that no benefit service would be credited if not employed on the last day of the plan year. The plan did have an appropriate add-back provisions if 401(a)(26), 410(b), and 401(a)(4) were not satisfied. Though the fact that the plan received a favorable d-letter as recently as 2008 does not, in itself, support the last-day-of-year rule, nonetheless the IRS reviewer had no problem with it.

Let me be the first to admit that I have not seen this elsewhere in a DB plan.

[Kevin C]

I would say they got lucky with their determination letter application(s). A little more searching brought up the following

§2530.200b-1,Computation periods.

(b)Rules generally applicable to computation periods.—

In general, employment at the beginning or the end of an applicable computation period or on any particular date during the computation period is not determinative of whether the employee is credited with a year of service or a partial year of participation, or incurs a break in service, for the computation period. Rather, these determinations generally must be made solely with reference to the number of hours (or other units of service) which are credited to the employee during the applicable computation period. For example, an employee who is credited with 1000 hours of service during any portion of a vesting computation period must be credited with a year of servicefor that computation period regardless of whether the employee is employed by the employer on the first or the last day of the computation period. It should be noted, however, that in certain circumstances, a plan may provide that certain consequences follow from an employee's failure to be employed on a particular date. For example, under section 202(a)(4) of the Act and section 410(a)(4) of the Code, a plan may provide that an individual otherwise entitled to commence participation in the plan on a specified date does not commence participation on that date if he or she was separated from the service before that date. Similarly, under section 204(b)(1) of the Act and section 411(b)(1) of the Code, a plan which is not a defined benefit plan is not subject to section 204 (b)(1) and (b)(3) of the Act and section 411 (b)(1) and (b)(3) of the Code. Such a plan, therefore, may provide that an individual who has been a participant in the plan, but who has separated from service before the date on which the employer's contributions to the plan or forfeitures are allocated among participant's accounts or before the last day of the vesting computation period, does not share in the allocation of such contributions or forfeitures even though the individual is credited with 1000 or more hours of service for the applicable vesting computation period. Under certain circumstances, however, such a plan provision may result in discrimination prohibited under section 401(a)(4) of the Code. See Revenue Ruling 76-250, I.R.B 1976-27.

[Andy the Actuary]

Maybe. Please see highlighted text below. We're talking about benefit accrual and not vesting.

I would say they got lucky with their determination letter application(s). A little more searching brought up the following

§2530.200b-1,Computation periods.

(b)Rules generally applicable to computation periods.—

In general, employment at the beginning or the end of an applicable computation period or on any particular date during the computation period is not determinative of whether the employee is credited with a year of service or a partial year of participation, or incurs a break in service, for the computation period. Rather, these determinations generally must be made solely with reference to the number of hours (or other units of service) which are credited to the employee during the applicable computation period. For example, an employee who is credited with 1000 hours of service during any portion of a vesting computation period must be credited with a year of servicefor that computation period regardless of whether the employee is employed by the employer on the first or the last day of the computation period. It should be noted, however, that in certain circumstances, a plan may provide that certain consequences follow from an employee's failure to be employed on a particular date. For example, under section 202(a)(4) of the Act and section 410(a)(4) of the Code, a plan may provide that an individual otherwise entitled to commence participation in the plan on a specified date does not commence participation on that date if he or she was separated from the service before that date. Similarly, under section 204(b)(1) of the Act and section 411(b)(1) of the Code, a plan which is not a defined benefit plan is not subject to section 204 (b)(1) and (b)(3) of the Act and section 411 (b)(1) and (b)(3) of the Code. Such a plan, therefore, may provide that an individual who has been a participant in the plan, but who has separated from service before the date on which the employer's contributions to the plan or forfeitures are allocated among participant's accounts or before the last day of the vesting computation period, does not share in the allocation of such contributions or forfeitures even though the individual is credited with 1000 or more hours of service for the applicable vesting computation period. Under certain circumstances, however, such a plan provision may result in discrimination prohibited under section 401(a)(4) of the Code. See Revenue Ruling 76-250, I.R.B 1976-27.

[rcline46]

_{Check to see if the plan in question is using elapsed time. That will require last day to get a year of service.}

[Kevin C]

AtA, Year of service is highlighted because that was the search term I used. The paragraph refers to service/participation crediting for purposes of eligibility, vesting and accrual. I was mainly looking at sentences 1 & 2. The exceptions start with sentence 4, but I don't see one that applies to accrual for a DB plan. There is an exception that allows a DC plan to have a last day worked requirement to receive a contribution for the year.

I've only worked on a few plans that used elapsed time. They all credited fractional years for accrual. That seems consistent with

§2530.200b-9. Is there some place it says they don't have to get any accrual credit for a period of service if they are not employed on the last day of the computation period?

[Andy the Actuary]

Doubt that you'll find that a plan can specifically not credit service if not employed on the last day. Likely only the absence of saying you can't is what the provision was based on.

[masteff]

Kevin's cite above references Rev Rul 1976-250 which discusses the difference between DB and DC plans. https://www.charitableplanning.com/document/671769

Selected quotes:

"There is no similar requirement for defined contribution plans; in contrast, section 411(a)(7) provides that a participant's accrued benefit under a defined contribution plan is the balance of the employee's account. ... Thus, for example, a defined contribution plan could, without violating the minimum participation or vesting standards of sections 410 and 411 of the Code, require that a participant be employed as of the last day of a computation period in order to receive an allocation."

While it's a 38-year old ruling, I think the road map it lays out is mostly valid still. Especially given the reg cited cross-references to it.

[Kevin C]

AtA, I think we will have to agree to disagree. I read the following as saying you can't impose a last day requirement on accrual for DB plans.

(b)Rules generally applicable to computation periods.—

In general, employment at the beginning or the end of an applicable computation period or on any particular date during the computation period is not determinative of whether the employee is credited with a year of service or a partial year of participation, or incurs a break in service, for the computation period. Rather, these determinations generally must be made solely with reference to the number of hours (or other units of service) which are credited to the employee during the applicable computation period.

There are exceptions listed, but they do not apply to accrual in a DB plan.

[Calavera]

Don’t have anything legal to refer but from my personal cash balance plan experience:

According to the IRS the “last day rule” is not allowed for defined benefit plans. When I discussed it with Carolyn Zimmerman (the IRS actuary) during the Enrolled Actuaries conference, she said that this provision is often missed by the IRS reviewers during the determination letter process. She suggested amending the plan to remove this provision. She also suggested using the relief under IRC 7805(b) so it would be allowed to amend this provision prospectively without going back and recalculating account balances for employees who terminated their employment before this amendment.

[Calavera]

Here is another discussion: http://benefitslink.com/boards/index.php?/topic/41342-cash-balance-plan/

[Andy the Actuary]

Just for grins, I pulled up the document for which a couple favorable d-letters was obtained. Here's what it says.

"A Year of Benefit Service shall be a Plan Year with respect to which a Participant is credited with at least 1,000 Hours of Service and is employed on the last day of the Plan Year."

This is not exactly hidden!!!

Likely, the IRS overlooked this provision because it is not discussed in their review manual and checklist? Can anyone point to where. It's not unusual for the IRS to formulate a position and then decline to codify it.

By the way, I'm not arguing that this is acceptable. Only that it was done. Before using such a provision, legal counsel should be consulted.

[david rigby]

Don't forget the (admittedly unlikely) circumstance where the plan credits partial (or whole) accrual with less than 1000 hours. I think that could permit a last day rule.

[Kevin C]

A document reviewer used to DC plans probably wouldn't notice a problem with that.

I've seen a number of plans with determination letters that contained clearly prohibited provisions. However, as many times as I've had my eyes glaze over reviewing a draft document, I have sympathy for the IRS reviewers that do it on a regular basis. I certainly would not want that job.

[MGOAdmin]

Not sure if this changes anyone's answer, but the reason I posted this question is that the client is over age 62. He wants to contribute to the plan, then roll it out into his IRA. The way the document is written, it seems like he would need to wait until the end of the year instead of after 1000 hours.

Given the document says he does not accrue the benefit until 12/31, does he need to wait until 12/31 before he can take a distribution (assuming we do not want to amend the plan)?