new plan and 133-1/3 accrual rule

[jane murray]

sole proprietor (age 55) considering to adopt a new defined benefit plan effective 1/1/2017.  the sole proprietor does not have any employees.  the plan uses a unit benefit formula equal to 10% of average compensation times years of service.  the sole proprietor has 10 plus years of past service and his average compensation is at the annual compensation limit. the plan's normal retirement age is 65.

therefore, the accrued benefit as of 1/1/2017 is $1,791.67 (1/10 of the 2017 dollar limit) and the accrued benefit as of 12/31/2017 is the same $1,791.67. there is no target normal cost for 2017 and a funding target as of 1/1/2017.

the accrued benefit as of 12/31/2018 will be 3,666.67 (2/10 of the 2018 dollar limit).

does the plan violate the 133-1/3 accrual rule for 2018 since the increase in the accrued benefit for 2018 (3,666.67 less 1,791.67) is 133-1/3 more than the increase in the accrued benefit for 2017 (1,791.67 less 1,791.67)?

if the plan violates the 133-1/3 accrual rule, how can the plan be designed and still grant past service?

[Mike Preston]

Have you checked against the other two rules in 411?

[jane murray]

i think fractional rule can be used even though the benefit is not accrued over a period of at least 25 years. but im not sure if you can use years of service when using the fractional rule. any guidance would be appreciated.

[Effen]

No, that does not violate the 133% rule.  That is completely fine.

The accrual in year 1 was 10% and the accrual in year 2 was 10% - therefore, your accrual rate did not change.

The 133% rule is looking for backloading - that is accrual rates that increase as you get closer to retirement age.  It is testing the change of the rate of accrual, not the actual $.

[Calavera]

As I recall from one of the EA meetings, the IRS' opinion was that this design violate 133% rule. The suggestion was to grant only portion of the prior year. I do not have any more details.

Also note that this design essentially switches 1st year and 2nd year contribution requirements, (i.e. you gain extra 50% of target liability deduction in 1st year and lose it in the 2nd year), so you will get the same deduction over 2 years period. 

[Mike Preston]

I'm confused.  How is the accrual in the second year greater than 133.33% of the accrual in the first year?

[My 2 cents]

1 hour ago, Mike Preston said:

I'm confused.  How is the accrual in the second year greater than 133.33% of the accrual in the first year?

Please remember - in evaluating whether the 133 1/3% rule is satisfied, one does not compare prior years, only the accruals for the current and future years.  To fail, there has to be a future year whose accrual exceeds that of the current or an earlier future year by more than 1/3.

NO 133 1/3% ISSUES:  Plan provides 1% of pay per year of service.  Plan is amended effective immediately (whether prospectively or retroactively) to 2% of pay per year of service.  May need to worry about 401(a)(4) (especially if retroactive), but (if no discrimination issues) can always increase past accruals without failing the 133 1/3% rule.

FAILS 133 1/3% RULE:  Plan provides 1% of pay per year of service.  Plan is amended to continue providing 1% of pay per year of service until 5th anniversary of amendment, after which the accruals (prospectively or retroactively) jump up to 1.5% of pay per year of service after that date.

[jane murray]

2 hours ago, Mike Preston said:

I'm confused.  How is the accrual in the second year greater than 133.33% of the accrual in the first year?

my question or concern is that the first year accrual is zero since the beginning of year and end of year accrued benefit are the same. if the first year accrual is zero, then obviously the second year accrual is greater than 133.33%.   the question remains, what is the first year accrual in the case where the plan uses past service and the participant's beginning of year and end of year accrued benefit is the same?

[Luke Bailey]

I think those saying there is no violation are correct. You're comparing the annual rate of accrual in year 2 to the annual rate of accrual in year 1. See IRC sec. 411(b)(1)(B) and Treas. reg. 1.411(b)-1(b)(2). Here these are equal. You are not comparing the accrued benefit at the end of year 1 with the accrued benefit at the end of year 2, which here is 100% greater.

[Mike Preston]

Well, if you go back and listen to my presentations during the early years of the cash balance era, you will find that, as stated by Calavera, a potential solution (which of course assumes that there is a problem) is to limit the past service benefit in the first year to aproximately 75% of what the maximum is so that future years would satisfy the 133% rule.  I recently discussed this with somebody who was adamant that for 411 purposes, the past service benefit [and current year's benefit] could be aggregated, thereby solving whatever problem might have existed.