Applicability of “top-25” restricted payment rule in HCE-only Cash Balance plan

I'm looking for perspective on the issue of the Top-25 restricted payment rule in DB plans, or specifically in this Cash Balance Plan. We have a participant who is among the Top-25 highest paid employees and would be restricted from taking a lump sum under these rules under normal circumstances. The relevant facts are as follows:

• Individually designed DB Plan effective July 1, 2009, restated July 1, 2021.
• Plan has only ever covered HCEs (NHCEs have never been covered; professional medical group).
• There are approximately 60 participants, but about 70 employees total.
• Currently less than 100% funded, but still above 80% threshold.
• Benefits include interest credits tied to actual market returns, subject to anti-cutback rules (participants effectively "fund" their own benefit).
• Plan Document includes legacy restricted payment language referencing:
  • Top-25 highest paid HCEs
  • Current liabilities
  • Escrow arrangements
  • An explicit exception stating the restriction does not apply if the plan never benefited any NHCEs.

Here are my two specific questions:

1. From a technical standpoint, is it correct that the legacy top-25 restricted payment rule does not apply in an HCE-only plan, consistent with the "never benefited NHCEs" carve-out found in older individually designed documents? 

2. Setting aside funding level thresholds which are not currently triggered, how would you view the risk of allowing distributions in a less than fully funded HCE only DB plan, where early distributions could materially shift funding risk to remaining participants due to anti-cutback provisions? Particularly when the participant seeking the distribution is among the Top-25 highest paid?

More generally, is this just a known but acceptable feature? Is it still legally required to not allow a top 25 paid employee to take his full lump sum? Is this a fiduciary concern requiring discretionary limits? Or if this is not a legal issue, is this something that should be voluntarily adopted to prevent funding issues?

I appreciate any insight you can provide.

1. Is it correct that the legacy top-25 restricted payment rule does not apply in an HCE-only plan? 

 NO, Top 25 rule applies to all DB plans.  There are no exemptions.  Also, just for clarification, the rule is 110% funded AFTER the distribution.  

2. How would you view the risk of allowing distributions in a less than (110%) funded HCE only DB plan. 

The plan sponsor is risking plan disqualification.  If you are an actuary, you cannot recommend or condone that they do something illegal.  Their attorney can explain the risks and the sponsor can make an informed decision.  

3) More generally, is this just a known but acceptable feature? 

Not sure what you mean?  The top 25 rule is a statutory rule required to be in all plan documents.  It is not a left over "legacy" issue that was accidently left in the document.  

4) Is it still legally required to not allow a top 25 paid employee to take his full lump sum? YES 

This is a really good example of where good actuarial consulting is required and sponsors need to understand what they are getting involved with.  Cash balance plans, including market based cash balance plans, can still be underfunded and it can cause these types of problems.  They can also be overfunded in which case you will be having the participants wanting their benefits increased to capture the excess, which is also problematic.  There are other designs (variable plans) where these issues can be minimized, but the Top 25 rule can still be a problem even for those. 

One consideration is that there is no clear guidance related to what the 110% funded requirement is measured against.  It isn't necessarily the sum of the benefits.  There are other liability measurements that possibly could be used to satisfy the 110% rule.    Another answer is to pay the lump sum over time or to pay it to an escrow account that the plan could attach if it terminated without sufficient assets.  Not saying any of these are easy, but there are options in the regs.  

Thank you for your thorough response, I appreciate the perspective. My question on “legacy” was more historical than operational, as older individually designed DB documents did include explicit NHCE carve outs tied to restricted payment provisions. I haven’t found post-PPA regs explicitly preserving or revoking those carve outs, and that is why I am questioning. If you’re aware of a specific Code section or regulation addressing that point directly, I’d really appreciate having that information.

I also appreciate your comment that there may be different liability measurements that could be used in evaluating the 110% requirement. If you’re willing to elaborate on how those alternative measurements are applied in practice, that would be very helpful.

Agree with Effen, this isn't new and it hasn't gone away and there never is or was an exception for plans without NHCEs. What is interesting is that you say this is an IDP and that provision has been in the plan all along unless I misunderstood and that was added with CB conversion. So presumably they have received an IRS determination letter, probably two, with that anomaly of a disqualifying provision.

I used to subcontract to an actuary who mentioned that Datair's BPD for (I think) EGTRRA had a disclaimer that the 110% rule would not apply in a "never had NHCEs" plan.  After all, it is a nondiscrimination issue (and with no NHCEs, blah blah blah).

Anyway, I believe she mentioned that the IRS had them take that language out for the PPA version, and I can only guess it's out of Cycle 3 as well.