Reasonable Classification - ABT

[EBECatty]

Say you have a PS plan with each participant in his/her own group for allocation purposes and you want to run average benefits testing.

I'm aware of the apparent IRS position that every participant in their own group is not a reasonable classification because it may have the effect of excluding an employee by name. I understand that position if the employer is allocating completely individual rates, including some zeros, with no consistent objective basis (e.g., we like Ann so she gets 5%, but we don't like Ben, who does the same job, so he gets 0%). 

However, if the actual allocation itself is still made on a reasonable, objective, business-criteria basis (and the group is nondiscriminatory) can you use ABT? 

For example, an employer has two locations and every participant works at one or the other, say Florida and California. The plan says every participant is in a separate group for allocation purposes. The employer makes the "official" allocations individually, but everyone who works in Florida gets the same percentage allocation, and everyone who works in California gets the same percentage allocation. 

Is this still a reasonable classification for ABT purposes despite the plan document saying everyone is in their own group for allocation purposes? 

In other words, do the "reasonable classifications" for ABT testing need to be explicitly stated in the plan document, or are the "reasonable classifications" based on actual practice?

[Tom Poje]

at the moment the reasonable classification only applies to coverage testing. the IRS had talked about applying it to nondiscrim testing as well but they didn't follow up on that (yet).

[EBECatty]

Thanks--I realize now my original post wasn't clear. The question is can they use ABT for coverage testing even if allocations are based on separate classifications. Not concerned about (a)(4). 

[Tom Poje]

my understanding, even if you gave everyone the same %, simply because they are individual groups you are out of luck. sort of like cross testing - before you can cross test you have to pass the gateway minimum. in this case before looking at what was allocated you have to answer the question

is anyone in their own group?

if yes, you have an unreasonable classification, because you have the effect of someone by 'name'. so it doesn't matter if everyone gets the same % because you haven't passed square 1.

 

one such write up on the 'withdrawn' proposed regs had

Many employers that use rate group testing place each employee into a separate allocation group. This allows an employer the most flexibility when allocating contributions and satisfying either the ratio percentage test or average benefits test for each rate group. Employers that use individual allocation groups would, if the proposed regulations become final, no longer be able to satisfy rate group testing using the average benefits test as the groups will not satisfy the reasonable classification requirement. Their plans would need to either be amended so that the allocation groups satisfy the reasonable classification requirement or have each rate group satisfy the ratio percentage test, which could require significantly higher employer contributions than are needed under the current regulations. In addition, the average benefits test, currently an entirely numerical test, would include a "facts and circumstances" component. Without being reviewed by the IRS, employers will not know if their classifications of employees are considered reasonable.

 

[PensionPro]

3 minutes ago, Tom Poje said:

my understanding, even if you gave everyone the same %, simply because they are individual groups you are out of luck. sort of like cross testing - before you can cross test you have to pass the gateway minimum. in this case before looking at what was allocated you have to answer the question

is anyone in their own group?

if yes, you have an unreasonable classification, because you have the effect of someone by 'name'. so it doesn't matter if everyone gets the same % because you haven't passed square 1.

 

one such write up on the 'withdrawn' proposed regs had

Many employers that use rate group testing place each employee into a separate allocation group. This allows an employer the most flexibility when allocating contributions and satisfying either the ratio percentage test or average benefits test for each rate group. Employers that use individual allocation groups would, if the proposed regulations become final, no longer be able to satisfy rate group testing using the average benefits test as the groups will not satisfy the reasonable classification requirement. Their plans would need to either be amended so that the allocation groups satisfy the reasonable classification requirement or have each rate group satisfy the ratio percentage test, which could require significantly higher employer contributions than are needed under the current regulations. In addition, the average benefits test, currently an entirely numerical test, would include a "facts and circumstances" component. Without being reviewed by the IRS, employers will not know if their classifications of employees are considered reasonable.

 

Just curious.  Has the IRS stated this formally or informally - that a plan that has each participant as a separate allocation group automatically fails reasonable classification even if the employees benefitting qualify as a reasonable classification?  The Code says that

Quote

 

A plan shall be treated as meeting the requirements of this paragraph if—

the plan benefits such employees as qualify under a classification set up by the employer and found by the Secretary not to be discriminatory in favor of highly compensated employees. 

 

 

[EBECatty]

PensionPro, that was my thought process as well.

The regulations  speak of a classification established by the employer identifying the employees benefiting under the plan that is objective under the circumstances. Here, if the employer identifies "everyone in FL" as a classification and "everyone in CA" as another, that seems to meet the objective business criteria test pretty easily. But technically you are still allocating individually. 

I guess that's why I'm asking if you have to identify the classifications somewhere in the plan document; in that case, you could only use ABT if you had separate groups in the plan document with at least two employees in each group. 

Another take would be that you have allocated individually to each person for purposes of (a)(4) and the definitely determinable requirements, but are using different (e.g., CA vs. FL) objective groups of employees who benefit under the plan to pass ABT. 

Here's the regulation:

(b) Reasonable classification established by the employer. A classification is established by the employer in accordance with this paragraph (b) if and only if, based on all the facts and circumstances, the classification is reasonable and is established under objective business criteria that identify the category of employees who benefit under the plan. Reasonable classifications generally include specified job categories, nature of compensation (i.e., salaried or hourly), geographic location, and similar bona fide business criteria. An enumeration of employees by name or other specific criteria having substantially the same effect as an enumeration by name is not considered a reasonable classification.

[Mike Preston]

Good grief there's a lot of fiction in the above. If you have everybody in their own group and none of them get 0% you are not in any way precluded from use of the average benefits test.

[EBECatty]

Just now, Mike Preston said:

Good grief there's a lot of fiction in the above. If you have everybody in their own group and none of them get 0% you are not in any way precluded from use of the average benefits test.

Would your answer change if all members of a reasonable and objective class get zero? That way you are not singling anyone out by name, nor excluding anyone by name. 

Say in my example CA gets 5% and FL gets 0%. Assume it passes all numerical compliance tests.

[Mike Preston]

My answer wouldn't change it still has the same requirements. Does your example meet my definitions? No it doesn't.

[EBECatty]

Giving an objective class 0% still doesn't enumerate anyone by name. What is different about giving all classes something vs. giving some classes something?

[Mike Preston]

A reasonable classification must be enumerated in the document.

[EBECatty]

7 minutes ago, Mike Preston said:

A reasonable classification must be enumerated in the document.

Maybe I'm dense.

Either way the document would say "every participant is in a separate group."

I guess I'm just not seeing the distinction between saying "FL gets 5%; CA gets 8%" (which you seem to agree is okay because no one gets 0%) compared to "FL gets 0%; CA gets 8%" (which you say is not okay). The plan document terms have not changed. 

[RatherBeGolfing]

28 minutes ago, EBECatty said:

Maybe I'm dense.

Either way the document would say "every participant is in a separate group."

I guess I'm just not seeing the distinction between saying "FL gets 5%; CA gets 8%" (which you seem to agree is okay because no one gets 0%) compared to "FL gets 0%; CA gets 8%" (which you say is not okay). The plan document terms have not changed. 

FL gets 5% and CA gets 8% is fine

Fl gets 0% and CA gets 8% would not be fine if everyone is in their own group because it has the same effect as an exclusion by name, which is not a reasonable classification.

@Mike Preston Would a nominal allocation to FL solve the issue? FL gets $100 and CA gets 8%.  

 

 

[BG5150]

Side note:

At one of the Regional ASPPA's a couple years ago, I asked the panel if the only people who are getting zero are termed employees at EOY, could the ABT still be used for coverage?  They agreed that, yes you could.  Because termed ee's (like those with <1,000 hours) are reasonable business classifications and they could otherwise be excluded from other allocation methods (pro-rata, integrated) without threat to nondiscrimination (other than coverage).

[Mike Preston]

52 minutes ago, RatherBeGolfing said:

FL gets 5% and CA gets 8% is fine

Fl gets 0% and CA gets 8% would not be fine if everyone is in their own group because it has the same effect as an exclusion by name, which is not a reasonable classification.

@Mike Preston Would a nominal allocation to FL solve the issue? FL gets $100 and CA gets 8%.  

 

 

Yes. 

[Larry Starr]

3 hours ago, Mike Preston said:

Good grief there's a lot of fiction in the above. If you have everybody in their own group and none of them get 0% you are not in any way precluded from use of the average benefits test.

Thanks for some sanity! AMEN!!!!

[EBECatty]

Thanks.

Follow-up Q: What if the same employer has two plans.

Plan 1: Both CA and FL are eligible and get allocations. Assume it uses every participant in a separate group. Everyone will get an allocation, so should be fine to use ABT (no zero allocations so no exclusion by name). FL participants get 10% of comp; CA participants get 5%.

Plan 2: Only CA is eligible; FL is excluded altogether from the plan. Also uses every participant in a group. All CA participants get a 5% allocation in plan 2. All participants get an allocation, so should be fine to use ABT.

Combining both plans for ABT purposes gives everyone 10% and allows the plans to pass the numerical benefit percentage test. 

Okay to pass coverage using ABT?

[Mr Bagwell]

Is the OP a real scenario or hypothetical?

[EBECatty]

3 minutes ago, Mr Bagwell said:

Is the OP a real scenario or hypothetical?

Issue is actual, but classifications are hypothetical.

[Mr Bagwell]

So the employer is trying to give a different PS to each location for 2017?

[EBECatty]

It's a proposed design change for a number of issues that are larger than this one, including two plans as noted in the follow-up, but potentially losing the ability to use ABT for coverage could pose a problem.

[Mr Bagwell]

Thanks for the clarification.  I have thoughts, but I'll let someone else jump in first.

[EBECatty]

If you have helpful thoughts, please feel free. 

Other feedback if the design is as noted above--two plans with each participant in each plan getting an allocation, each using ABT?

 

[Mike Preston]

As long as the plan documents specify eligibility that runs in favor of FL and CA in plan 1 and just CA in plan 2 I can't imagine the circumstances that would preclude use of ABT.  And in the absence of another plan won't you have a coverage percentage of 100% if the plans are aggregated for coverage?  I must be missing something.

[EBECatty]

17 minutes ago, Mike Preston said:

As long as the plan documents specify eligibility that runs in favor of FL and CA in plan 1 and just CA in plan 2 I can't imagine the circumstances that would preclude use of ABT.  And in the absence of another plan won't you have a coverage percentage of 100% if the plans are aggregated for coverage?  I must be missing something.

Thanks. The situation involves an ESOP and 401(k), which I understand you generally cannot aggregate for coverage testing, but must aggregate when determining average benefits percentages.

So say Plan 1 is the 401(k) and Plan 2 is the ESOP. In that case, FL gets 10% in 401(k) and CA gets 5% in 401(k). In the ESOP, all FL employees are excluded by explicit plan terms, and all CA employees are covered and get 5% in the ESOP. 

Everyone has received an allocation in their respective plans, and everyone's average benefit percentage is 10%.