Can a profit sharing allocation formula be changed during a plan year?

[John A]

Can a plan document be amended to change a profit sharing allocation formula during the plan year, or does the amendment need to be adopted prior to the beginning of the plan year for which the change will be effective?

[Guest]

it depends on whether anyone has accrued under the eligiblity requirements...e.g. hours requirement.

e.g. suppose plan was 5.7% integrated and no hours requirement. since all employees have been given an SPD (ha, ha) they know and understand fully they are do a contribution under this formula. If you were to amend, this would take away from someone and that is a no-no.

[Guest Benefits Lady]

If the plan has last day of the plan year requirement (i.e., must be employed on last day of plan year to receive a contribution), you should be fine to amend. However, watch out for exceptions (like retirement during year, you still get contribution). If that happens and someone has "accrued" a benefit, I don't think you can change it.

[richard]

My understanding is that you can amend a profit sharing plan's allocation formula at any time prior to the end of the plan year, even if the eligibility for allocation in that year has been met by any participant.

The rationale here is that there is no obligation to make a contribution; therefore, no right to allocation is "accrued" until the contribution is determined.

For those who don't like this answer, one could accomplish the same thing by adopting another profit sharing plan before the end of the year, retroactive to the beginning of the year, with the desired allocation formula. Then make the desired contribution to the second plan and no contribution to the first plan.

(Note that with a money purchase plan, this doesn't work since the contribution is "accrued" once the eligibility requirements are met. Therefore, once cannot amend a money purchase plan to take away these contributions once accrued.)

[John A]

richard,

I agree that starting a new plan would probably work, but I don't think I agree with being able to change in the same plan because of the "definitely determinable" requirement. It seems to me that for a plan to have a "definitely determinable" allocation method, the allocation method cannot change after someone has accrued the right to that method. This does not mean the participant has accrued the right to any specific amount, only that the participant has accrued the right to the way that their share of an employer contribution, if it is made, will be determined.

How do you get around the "definitely determinable" requirement for an allocation method if you try to make the change in the same plan?

[richard]

Both the old allocation method and the new allocation method would be OK as far as being definitely determinable. In other words, once the company makes its contribution, it has no discretion on how it is allocated; it merely follows the terms of the document.

More important is the question of what is accrued? (And its corollary, what cannot be taken away?) Does an employee accrue a right to an allocation method for a specific period of time during the year?

Actually no. The employee only accrued a right to contributions once they have been allocated to him. And they are allocated to the employee only when the employer "declares" his contribution, which technically is done as of the end of the year. (By "technically," I mean that an employer should declare their profit sharing contribution with a Board Resolution. I realize that this is not always formally done.)

So, since the contribution (and its allocation) aren't "official" until the end of the year, there is no accrual until that time.

A sidebar on this.

IRS rules are generally set up to be consistent internally. In other words, the IRS generally does not allow you to do "X" directly, but allow you to accomplish "X" indirectly. This discussion of whether a change in allocation formula during the year is an example.

Note that you could not change the allocation formula after the end of the year retroactive to the beginning of the year. In other words, by December 31 (in a calendar year plan), the allocation formula is cast in stone. The alternative of setting up another plan (like I described in by previous comment) doesn't work, since the other plan would have to be established by December 31 to accomplish this change in allocation formula.

Consider, as an alternative, a money purchase plan. Here, once the employee has met the requirements for a contribution (say 500 hours without a last day requirement), the employer cannot reduce the formula for the entire year. The approach of freezing the first money purchase plan and establishing a second money purchase plan with a reduced formula doesn't work, because even if you freeze the first plan, the employee still gets the contribution.

As a final example, there was a debate about 3-5 years ago about whether the allocation formula in new comparabiliy profit sharing plans (i.e., different contribution percentages for different groups of employees) was definitedly determinable. The IRS originally objected, but later relented (and agreed that it is definitedly determinable as long as the plan document is carefully written) in part because one could accomplish the exact same thing by establishing several separate profit sharing plans, each covering the specified group of employees and excluding the other groups.

I'm not aware of any examples whether the IRS didn't allow "X" directly but allowed "X" indirectly.

Sorry for the lengthy response. Hope this helps.

[Guest]

I would still disagree you can change the formula for profit sharing.

see also ERISA Outline Book 3.214 1b3

"...if an amendment is adopted to change the allocation formula, any particiapnt who has been credited with [enough] service has a proteced allocable share of the formula under the pre-amendment formula." 2001 Edition.

[AndyH]

I think Tom is right. Actually, I'm certain that Tom is right. Then again, that's not exactly going out on a limb, since I haven't found Tom to be wrong yet.

But, be careful of his answers on April 1.

[Guest]

thanks for the compliments, but I have been wrong before and I will be wrong again (Heck, I got involved in pensions didn't I?)

But I have gotten smarter in regards to looking up stuff. The trick is to find the right resources.

of course, this is not to say Richard is 'wrong' either.

technically, there is nothing to stop one from saying the original contribution in the ps was '0' and then an amendment was put in changing the formula, and then putting in a new formula. I would not want to explain it to the IRS, especially if the contribution heavily favored the HCEs.

maybe if the reverse was true, but I wouldn't want to push it.

[Bill Berke]

I agree wtih Tom. Once you have accrued enough hours to share in any contribution, then the allocation formula cannot be changed for that year. I believe we are looking at the "all events test" in the reg's. Once all the events have happened, the the person is entitled to whatever. Which is why I think all DC plans should have a last day clause. The IRS is quire clear that this clause means that you do not pass the all events test until the last day - ergo - you can amend plan. But with no last day clause, once someone has accrued 500/1000 hours, the allocation formula cannot be amended for that person.