Tips for Handling Combined DB/DC Plan Testing (Corrected)
Editor’s Note: Richard Block and Kevin Donovan have been kind enough to revise and correct our previous report on their April 9 Enrolled Actuaries session in which they shared their insights into testing DB and DC plans on a combined basis. The corrected post appears below; many thanks to Richard and Kevin for their help!
Nondiscrimination testing has been likened to rocket science. And that's in reference to just one flavor of plan. So imagine how exponentially those complexities must increase when the testing involves both defined benefit and defined contribution plans. An April 9 session at the Enrolled Actuaries meeting held by the Conference of Consulting Actuaries and the American Academy of Actuaries in Washington, DC addressed such a situation.
Longtime ASPPA members Richard Block of Block Consulting Actuaries, Inc., and Kevin Donovan, managing member of Pinnacle Plan Design, LLC, were the panelists in the discussion.
Block and Donovan highlighted several relevant concerns related to plan requirements. Among them:
- All plans must have the same plan year. Plans being aggregated must have the same start and end dates.
- Benefits rights and features must be available on a non-discriminatory basis. “The premise is that the owners are getting most of their money in the defined benefit plan, and most of the employees are getting theirs in the defined contribution plan,” said Donovan. “There cannot be features in the defined benefit plan that are not in the defined contribution plan,” he added.
- The only qualified plans that may be aggregated to comply with Internal Revenue Code Section 401(a)(4) are plans qualified under Internal Revenue Code Section 401(a).
- Contributions to 403(b), SIMPLE plans, and SEPs, cannot be aggregated for non-discrimination purposes with tax qualified retirement plans. However, contributions to these plans must be recognized for the maximum benefit limitations of Internal Revenue Code Section 415.
Top Heavy Compliance
- 401(k) safe harbor plans allow principals to contribute elective contributions without regard to ADP testing non-safe harbor 401(k) plans are subject to.
To demonstrate compliance with Top Heavy minimum benefits, the regulations allow three safe harbors, the defined benefit plan may provide Top Heavy minimum benefits, the defined contribution plan may provide a Top Heavy minimum allocation of 5% of pay or the plans may show contributions provide comparable benefits using the methodology from Revenue Ruling (Rev. Rul.) 81-202; however, in the same breath, they reminded the audience the IRS obsoleted 81-202 in 1993.
Eligibility, Block and Donovan recommended eligibility should be identical for DB and DC plan participants. Normal retirement age (NRA) should be the same for both kinds of plans, as well. If the normal retirement ages are not the same, "You've got to be really careful here," cautioned Donovan, noting that problems will arise if the normal retirement ages are different. "You should be looking at your documents," said Block, "very carefully."
Like other plan features, Block and Donovan said, vesting should not be discriminatory. If the plans use the statutory minimum vesting schedules, those schedules are deemed to be non-discriminatory. If the vesting schedules for the plans do not use the statutory minimum schedules then proof the schedules are non-discriminatory will be based on all relevant facts and circumstances.
Because of the lack of specificity in the regulations, Block cautioned attendees regarding differing vesting schedules. "The problem when you have ambiguous rules," he said, is that "you don't know if amounts will be sufficient."
Block and Donovan focused on gateway contributions in their discussion of allocations regarding DB/DC plan testing. The IRS amended the Internal Revenue Code §401(a)(4) regulations (TD 8954) which were published on June 29, 2001 and applicable to plan years that began on or after Jan. 1, 2002 that instituted the concept of gateway contributions.
These regulations prescribe rules for testing DC plans that are aggregated with DB plans for purposes of Code Sections 401(a)(4). These rules apply in situations in which the employer aggregates plans because one of the plans may not satisfy the non-discrimination standards on its own.
The regulations set forth that the combination of a DC plan and a DB plan may demonstrate non-discrimination on the basis of benefits if the combined plan (the DB/DC plan) is primarily DB in character, consists of broadly available separate plans or satisfies a minimum aggregate allocation gateway requirement that is generally similar to the minimum allocation gateway for DC plans that are not combined with a DB plan.
Each type of plan must comply with Code Section 404 (tax deductibility) separately if the DB plan is covered under Title IV of ERISA, Block and Donovan reminded. Where the DB plan is not covered under Title IV of ERISA, the deduction limits are greatly reduced. Where the DC plan contribution is no more than 6% of pay for DC plan participants, the deduction for the DB plan is subject to the same limits as if there were no DC plan. Where the DC plan contribution exceeds 6% of pay, the overall deduction limit may not exceed 25% of pay for participants in either plan, plus 6% of pay for DC plan participants.