Amending cash balance contribution credits annually

We took over a cash balance plan that is a c-corp but they have a large group of doctor/owners.  Historically the doctors review their plan annually and request an amendment to adjust of the doctor's contribution credits.  Our actuary is concerned that this  series or pattern of amendments changing the benefit structure violates the definitely determinable benefit rule. He feels the plan should only be amended every 3-4 years.   The other concern is that these desired allocations could be construed as a CODA and will exceed the 402g limit.  Since the previous actuary allowed it and we have some other plans that amend to adjust their contribution credits (albeit not as frequently) I'd like to get more opinions on it.  Thanks!

The regs require pension plans to provide definitely determinable benefits, and that the amount of such benefits is not directly based on profits.  Beyond this there is not much to go on AFAIK and I've never heard of IRS raising this as an issue.   That said, I tell my clients while there is nothing prohibiting annual amendments to the plan, a yo-yo pattern of amendments to the pay credits could give the IRS an opening to challenge the plan on this basis.   I discourage annual amendments, but at the end of the day it's up to the client, it is not my place to "allow" or not allow.  

We typically have the sponsor review their formula every three years or so and adjust/amend on that cycle accordingly unless other relevant business (not individual personal owner) conditions or events warrant an earlier change, such as ownership changes, major shifts in business (like pandemic response) or M&A activity.

Personally, I think an annual amendment is a blatant pattern of discretion in practice and I don't think it matters whether that discretion is attributed to the individual owners (deemed impermissible CODA) or attributed to the employer (deemed impermissible discretionary profit sharing) and violates the definitely determinable requirement. Maybe if no individual owner was modified more frequently than every third year and/or the frequency of amendments was necessary to add and/or delete individual owners it would be more defensible.

Furthermore, we even try to discourage clients from a yo-yo pattern with respect to individual credits even if staggered three years apart. If an owner is allowed to do $50,000 for three years, jump to $150,000 for three and then back down to $75,000 w/o a corresponding business reason for the employer, I think that's a potential issue. Probably less likely to garner attention, especially if among a larger group of owners, but plan sponsors and individual owners still need to be aware of the risk. Without some defensible business reason, I typical recommend an individual's credit amounts be amended on a trend, whether up or down. Note that ANY amendment where it could be argued by IRS that an individual had discretion with respect to their credit amount could be viewed by them as an impermissible CODA.

No, it is not your place to allow or not allow amendments, but it is your place to provide prudent advice concerning the risk regardless of past practices.

My understanding is the IRS has backed off the argument that annual changes are a "cash or deferred arrangement".  They have been allowing sponsors to use very creative allocation methods that produce the same result and have backed off.  For example, you can have a plan that has a variable contribution formula set by an annual BOD resolution.  As long is is a BOD decision, and not a participant decision, it is ok.  Yes, the BOD can be the participant, but they need to have their BOD hat on when they decide to make the contribution.  If the BOD can pay different bonuses to different individuals, and that bonus impacts the cash balance allocation, then the BOD is directly impacting the allocation.  

Obviously you need to do what you are comfortable recommending, and not all attorneys agree, but there are lots of plans out there with recent IRS approval letters that allow complete annual discretionary benefits, as long as it is a Board decision and not a participant decision.

1 hour ago, Effen said:

Obviously you need to do what you are comfortable recommending, and not all attorneys agree, but there are lots of plans out there with recent IRS approval letters that allow complete annual discretionary benefits, as long as it is a Board decision and not a participant decision.

Assume a medical group that is a partnership of professional corporations, an affiliated service group.  The CB plan is adopted by individual doctor PCs who choose to participate in the plan.  Each PC has a single board member - the shareholder doctor.  So effectively the board decision is also a participant decision.  The plan allows "annual discretionary benefits" as decided by "the board", which presumably would be each individual PC's board since the individual PCs are the employers of the doctors.  Seems like it would be real easy for IRS to argue that it doesn't meet the definitely determinable requirement, and they might also find the annual benefit grant correlates with profit.  IRS might be "backing off" the deemed CODA (which is a separate issue from DD and not related to profit), but that's not equivalent to written regs.   I suppose if a plan document had written provisions to the effect and got a DL the sponsoring employers could rely on this.  Are there volume submitter documents with such language?

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 Are there volume submitter documents with such language?

Yes. 

 I did go back and look at one of the documents to refresh my memory and they way it is done is that the cash balance credit is a multiple of a bonus.  The board pays the bonus, which then drives the cash balance allocation.  You need to make sure the BOD is specifying the amount of the bonus through an annual resolution. 

I was very leery of this design for many years,  but an attorney walked me through the arguments and showed me the correspondence with the IRS.  We then implemented the plan for one of our clients and the IRS issued the determination letter.  

13 hours ago, Effen said:

I did go back and look at one of the documents to refresh my memory and they way it is done is that the cash balance credit is a multiple of a bonus.  The board pays the bonus, which then drives the cash balance allocation.  You need to make sure the BOD is specifying the amount of the bonus through an annual resolution. 

 

Interesting.   Does the 401(a)(17) limit come into play here?  IOW if someone’s regular wages are already over the limit and then a bonus is declared, can a CB plan even consider that bonus?  I’ve seen plans where the pay credit is a function of comp over a certain level, e.g. 200% of comp over $200K.   So if a plan contribution is not desired simply keep wages under $200K.

Thank you for your comments!

I hadn't really thought of that, but I think I would argue the only comp I am considering for benefit purposes is the bonus.  Therefore the actual total comp is only relevant for Non-discrim testing.

I am not sure what the constraints are that you are using to determine how to amend the pay credits up or down each year. But typically if they can be articulated you can just have the plan auto adjust the pay credits up or down each year rather than having to amend the plan. 

This is what is done in variable / adjustable accrual rate plans and the logic can be used to adjust the pay credits in a cash balance plan as well.

The IRS routinely takes a number of positions. The impermissible CODA position described above seems like a stretch. Show me the "cash" or other item of value that is being given up by the participant as an explicit exchange for a CB credit?   

21 hours ago, Effen said:

 

Yes. 

 I did go back and look at one of the documents to refresh my memory and they way it is done is that the cash balance credit is a multiple of a bonus.  The board pays the bonus, which then drives the cash balance allocation.  You need to make sure the BOD is specifying the amount of the bonus through an annual resolution. 

I was very leery of this design for many years,  but an attorney walked me through the arguments and showed me the correspondence with the IRS.  We then implemented the plan for one of our clients and the IRS issued the determination letter.  

Doesn't this type of formula go directly against this 2017 IRS memo? Or am I missing some information? Thank you

tege-04-0417-0014.pdf

I don't think so.  It really relates to how the bonus is determined.  In the Examples in the IRS memo, the final phrase is, "However, if the plan terms do not afford the employer any discretion to allocate a participant’s compensation between salary and bonus, the plan benefit formula would be definitely determinable."  Therefore, the key is clearly defining who has discretion and keeping that discretion outside of the plan document.  

8 minutes ago, Effen said:

I don't think so.  It really relates to how the bonus is determined.  In the Examples in the IRS memo, the final phrase is, "However, if the plan terms do not afford the employer any discretion to allocate a participant’s compensation between salary and bonus, the plan benefit formula would be definitely determinable."  Therefore, the key is clearly defining who has discretion and keeping that discretion outside of the plan document.  

 

Agreed, if anything the memo seems to support this sort of plan design.  They specifically say the fact that the employer can vary the compensation doesn't impact DD, as that is outside the plan. 

31 minutes ago, Effen said:

I don't think so.  It really relates to how the bonus is determined.  In the Examples in the IRS memo, the final phrase is, "However, if the plan terms do not afford the employer any discretion to allocate a participant’s compensation between salary and bonus, the plan benefit formula would be definitely determinable."  Therefore, the key is clearly defining who has discretion and keeping that discretion outside of the plan document.  

 

22 minutes ago, shERPA said:

Agreed, if anything the memo seems to support this sort of plan design.  They specifically say the fact that the employer can vary the compensation doesn't impact DD, as that is outside the plan. 

Okay I think I see your point. Correct me if I'm wrong here - you're saying that you can have such a formula, but need to make sure you have proper backup showing proper plan operation in case of examination? I guess that is a valid design - however it seems to me to "push the envelope" a bit based on this wording from the memo:

“However, employer discretion that is not expressly stated in the plan document, and that leads to the manipulation of compensation, may result in operational disqualifying defects. If a Specialist reviewing a plan in the determination letter process has a concern about the employer’s ability to manipulate compensation for the benefit formula, the Specialist might consider a referral to Examination (subject to management approval).”

And also based on these comments from the ERISA Outline Book regarding the memo:

"Any employer that is considering amending its plan to utilize one of the types of formulas discussed in 6.b.2), 6.b.3) and 6.b.4) below, but without the explicit employer discretion language, should be aware of the potential examination pitfalls and be prepared to maintain records that will show proper plan operation. Practitioners designing these plans also should explore other ways to reach the contribution and benefit goals sought by the plan sponsor that are less likely to raise definitely determinable benefits concerns."

Anyway, thanks for the thoughts on this topic.