Cushion calculation due to increase in benefits to HCE's

I have a question regarding the calculation of the cushion amount under 404 for a cash balance plan since the plan was amended to freeze and then to increase benefits (for HCE’s).

The facts are as follows:

- only 2 participants in plan are HCE’s

- cash balance credits; 85% of salary for both participants; salaries for both participants have been in the 240K range.

- plan was amended in early May 2020 to freeze benefit accruals (contribution credits); There is a 1,000 hour requirement and neither participant received an accrual in 2020.

- plan was amended effective 1/1/2021 to unfreeze benefit accruals (adopted at the end of 2021); new contribution credits are a flat 250K for both participants.

Since the plan was amended to increase benefits in 2021 for HCE’s, the cushion amount in the maximum contribution calculation cannot reflect the increase in benefit formula for 2 plan years.  This would affect the maximum contribution calculation for the 2022 and 2023 plan years (the funding target for the 2021 valuation used the frozen accrued benefit).  Please correct me if I’m wrong.

With respect to the cushion amount for the 12/31/2022 valuation, my inclination is to use the 85% of salary formula through 12/31/2021 for the funding target (for the cushion calculation) with $0 cash balance contribution credit for 2020.    My confusion comes from the fact that the plan was frozen before the increase in benefits to the HCE's. 

I think it's the increase you need to exclude from the cushion for 2 years. Since the plan was frozen than all of the new accrual in 2021 and 2022 would need to be excluded when calculating the cushion amount.

The problem is that the law here is not entirely clear, and the IRS has yet to issue any regulations under 404(o) that would provide guidance.

The rule is that the liability resulting from any increase on behalf of HCEs which is adopted or effective, whichever is later, within the last 2 years is not included in the cushion amount. The problem is that it is not defined how "last 2 years" is measured. Is it 2 years ending on the valuation date? At BOY? On any date within the plan year?

You had an amendment adopted (let's say) 12/15/2021 and effective 1/1/2021 which increased benefits for HCEs. You also mentioned you're using an EOY val date, so that amendment has to be taken into account for the 12/31/2021 valuation (since it was adopted before the valuation date). However the amendment only increased the pay credits, so it would have no effect on the 12/31/2021 funding target, therefore it would have no effect on the cushion amount.

For the 12/31/2022 valuation, the 12/15/2021 amendment was clearly within the last 2 years so the increases added by the amendment for HCEs can not be taken into account for the cushion amount. In other words, determine the HCEs' hypothetical account balances as of 1/1/2022 as if the plan was still frozen, and use those to calculate the funding target for your cushion.

For the 12/31/2023 valuation it gets tricky. The 12/15/2021 adoption date is not in the last 2 years if you measure from the valuation date, but it would be if you measured from almost any other date in the plan year. What if the amendment had been adopted on 12/31/2021 instead? Then there would be a stronger argument in favor of treating it as being within the 2-year period. A 12/15 vs a 12/31 date would make no difference for almost any other purpose under the Code, so it seems strange that it would make a big difference here. If you want another argument, since the funding target is based on the accrued at the beginning of the year, maybe the 2-year period should be measured from the beginning of the year? The law is unclear.

Thanks Lou S. and C.B. Zeller

The information was helpful.